Exempt Market Update 2019

The exempt market in Canada is going through some major developments that will fundamentally change how the private market will be seen by investors.

Digital Securities provide companies, who are raising capital, the opportunity to offer their investors another potential exit that until now was only seen as a pipe dream.

It’s no longer a dream, it’s in fact reality. Digital Securities are a direct representation of the securities a company offers to investors, but instead of a piece of paper, it’s put on a technology that is immutable. 

Companies around the world are raising capital offering investors Digital Securities, which would allow them to have secondary market trading.

ATS (Alternative Trading Systems) have been around for decades around the globe, in most cases unused due to inefficiencies and high costs.

With over 16 ATS now launching in the USA and more coming in Europe and ASIA we will see more ATS secondary markets for private shares than public stock exchanges in the next 24. The reason is very simple. There is more private companies than public listed.

450 Million private companies vs 85,000 public listed companies worldwide.

$2.4 trillion raised by U.S private companies vs. $2.1 trillion by public companies, a gap that has been widening for 6 years. With the decline in the number of public companies and the rise of private financing will drive a need for efficient secondary market trading of private shares. A blockchain enabled and global compliant digital security is critical to the success of secondary markets for private shares.

On 29 May 2019, OMEGA has filed an application with the regulators to launch a Digital Securities ATS. This announcement shows you how the market is evolving to provide further liquidity in the private capital markets. This will not be the first ATS in Canada. 

KoreConX is leading the market by providing the tools for Exempt Market Dealers to put their business online, in a secure and compliant manner, to be connected in the private capital markets ecosystem.

The KoreConX all-in-one platform, powered by IBM’s Hyperledger Fabric, is the key infrastructure that, until now, was missing from the private capital markets. Our globally compliant digital securities protocol is the key to creating efficient securities management throughout their lifecycle. 

KoreConX Revolutionizing Private Capital Markets

www.koreconx.com

www.KoreConX.io

Minimizing Failure Vector Surfaces for Digital Securities

Modern capitalists and ancient Chinese may disagree on many things, but the one thing they do seem to agree on relates to security of the realm. George Washington, back in 1799, said, “…offensive operations, often times, is the surest, if not the only (in some cases) means of defence.” A similar sentiment can be seen in Sun Tzu’s writings. It is now a common saying in football: The best defense is a good offense.

If digital securities are to play an innovative and differentiating role in modern capital markets, the one thing they have to support is the trend towards democratization of capital. Ironically, Main Street retail investors have been sidelined in the ‘public’ markets that ostensibly were designed with the general public in mind. 90% of households are generally unaffected by the gyrations of the stock market.

Decentralization of capital brings with it several risks. Inefficiencies aside, some of the financial risks are poor governance, insecure transactions, hacking, and architectural instabilities in the financial platforms. The general public will never be able to store their own private keys safely. Public blockchains are still too new and fragile to support widespread adoption by the vast majority.

The most important lens through which we need to look at this is that of the lay investor, whose primary need is safety. They may not say it, but they definitely think it. For financial systems and in particular digital securities, we need to minimize the number of ways in which the security of digital securities is compromised. Security experts have a fancy term for this, ‘attack surface’, which is the entire set of vulnerabilities possible through all the ‘attack vectors’, each of which is one method of attacking applications or networks.

Unlike the usual attack vectors such as phishing, email, pop-ups, attachments, chats, etc., digital securities can be compromised by non-traditional vectors such as forking, hacking, and adverse selection by miners’ activities, and commingling of cryptocurrencies and digital securities. Adverse selection, in particular, is not criminal activity, but the net effect is that retail investors suffer the consequences since concentration of mining power centralizes points of failure or throttles securities transactions.

All of the ways in which digital securities can fail are the ‘failure vectors’. The collective magnitude of these failure vectors defines a failure vector surface. The surface area, in some intuitive sense, captures the magnitude of potential failures. The larger the surface area, the higher the risk. (Move your mouse onto the various surfaces for color highlights.)

The spider chart above shows various failure vectors, some of which are outright attack vectors, while others represent potential failures not from attacks but due to the inherent nature of the underlying blockchain. Such a visualization is useful only when comparing two or more subjects of evaluation and that too in a relative way and by ignoring the actual values.

One caution: Do not conclude from this chart that public blockchains are necessarily bad. This chart is not an evaluation of the technology or the competence of the developers. It just speaks to the potential problems that developers and users must keep in mind when using it for this particular use case, that of digital securities.

Can public blockchains systematically reduce the magnitude of all these failure vectors? There is certainly awareness of these failure vectors. However, all current reengineering in public blockchains, such as the ERC20-based protocols, is a defensive strategy.

Keeping to the wisdom of the ages about offense being the best defense, another approach is to start with a blockchain that has been engineered from the ground up to specifically minimize the failure vector surface as much as possible.

For this reason, we chose Hyperledger Fabric as the base blockchain on which we built the digital securities platform. The risk of failure is mitigated because some of these failure vectors either don’t apply or they are considerably minimized due to the nature of the Fabric blockchain. We prefer to let Fabric deal with a number of these failure vectors, while we focus only on those failure vectors that are specific to KoreChain, the digital securities blockchain application.

Difference between Crypto and Security Token

Is there a difference between cryptocurrency and a security token?

The answer is yes, there is a big difference. And it is time we get these right so the thick fog around this topic can begin to clear up. It is very important to understand how each of them is very different from each other.

You probably read or hear these two words every day and in most cases in the wrong context. Before we get into the difference lets make one thing clear.

Crypto or Cryptocurrency is an alternate (i.e., non-fiat) CURRENCY
Security Token is an EQUITY POSITION IN A COMPANY

All over the web, there are many discussions, blogs, articles, and tweets on using blockchain. Of course, many of them follow to the extraordinary words “Crypto”, or “Cryptocurrency” and “Security Token”.

I am amazed by the number of people who use these two words interchangeably, yet they are so different as stated above. Let’s have a look at each one in more detail.

What is Crytpo or Cryptocurrency?
Wikipedia has a clear definition: “A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.”

Crypto or Cryptocurrency is just a currency. Other examples of currency are Dollars, Euros, Pesos, etc. These currencies are traded worldwide by currency traders. Nowadays we have the introduction of digital currencies such as Bitcoin, Ethereum, Litecoin, etc. Wikipedia has put together a list of these digital currencies.

Currencies are regulated by a securities commission or foreign exchange agencies. The rules around who can purchase currency and trade them are very simple. In most cases, it is required to be 18 years or older. ID Verification, AML (Anti Money Laundering), and some basic KYC (Know Your Customer) will be done. Not more than this is required to purchase a currency.

For trading, the platforms will need to be registered with commissions and/or regulators in their country to legally operate the exchange. This financial regulator is regulating the currency, transfer, and trading business.

What is Security Token?
In 2017 we saw the emergence of companies issuing tokens to raise capital. In countries such as USA and Canada, regulators have been very clear on this form of capital raising.

When a company offers a token from their company for an investor to invest in, the goal is for the token to trade and gain in value. Security agencies, including the SEC in the USA and the CSA in Canada, have made it clear that when companies are conducting a token offering in which the token has the ability to trade and gain in value, it must be issued as a security token.

Security Token is a tokenized security that is issued by a company. The security represents an equity position in the company. In order to issue the security, the company must comply with regulations as to how it can market the offering, who it can attract to invest in their company, reporting requirements, trading restrictions, and custodianship (Transfer Agent) requirements.

For a company to issue a security token it must:

  • Determine what jurisdiction (countries) it wants to attract investors from
  • Determine what exemption to use to offer their security token to investors (accredited or non-accredited investors)
  • Determine trading restrictions per jurisdiction and exemption
  • Determine reporting requirements per jurisdiction and exemption
  • Determine Transfer Agent requirements per jurisdiction and exemption
  • Determine if Broker Dealer is required per jurisdiction
  • Determine what regulated ATS Secondary Market is available for trading

As you can see it’s clear how different these two are from each other and there should be no confusion going forward.

Here is how the two can come together and be used in the proper context. You can use cryptocurrency to invest in a security token offering by a company. But that can only happen as long as the company has agreed to accept this form of digital currency, the investor meets regulatory requirements, the company can offer their securities in the country (Jurisdiction) of residence of the investor, and if the company is using a broker-dealer, the dealer is also prepared to accept that form of payment.

Capital Raising “Capital markets point of view” dealer

For private issuers, raising capital is the next natural step once you have exhausted other traditional forms of financing. It becomes even more enticing when you read about other firms doing it, and thinking why shouldn’t that be us.

However, being prepared to take the issuer to the next level can be a source of frustration if you’re not ready for it. Nobody is willing to just hand out money; you have to make a convincing case based on fact and incomplete due diligence documentation can leave you out in the cold.

Issuers must prepare comprehensive information which covers who the guiding minds behind the issuer are, who the current shareholders are, business continuity planning, company financials, what is it that makes you unique and a comparison with competitors in the same industry.

Dealers are bombarded by people who claim to have the next best thing, but if you can’t boil it down to facts and figures, they won’t spend much time looking at you. Using up to date technology to gather all the corporate information is critical to your success. Using a platform to house your cap table management, minute book, financials, investor relations and corporate data in electronic format means you can walk into a meeting prepared for whatever they throw at you.

For dealers, having a platform whereby issuers can login and input all the relevant information that you need from them, allows you to control the process and weed out the unprepared ones before you devote a lot of time to analysing potential deals. A controlled mechanism whereby issuers know what information they need to provide and where to put it, saves everyone significant time and effort.

Taking it one step further, for registered dealers to have the ability to easily showcase their approved products online, along with pertinent information about the issuer – corporate biographies, financial information, information about the proposed raise –  helps dealers to bring their proposed offerings to potential investors. From a compliance perspective, it means having all of your due diligence in one place, for when the regulators come to visit.

Taking it two steps further, for investors to b able to view potential offerings, input their Know Your Client (KYC) information to determine their eligibility, answer questions to determine the suitability of the investment, have the platform conduct the necessary AML checks and then provide an efficient method for payment, once approved by the CCO, and you have an efficient and cost effective ecosystem which helps issuers, dealers and investors communicate.

KoreConX has an all-in-one platform to accomplish this and ensures that all parties are acting in compliance with securities regulations. Issuers can effectively connect with dealers who in turn can connect with investors all while ensuring that they have the necessary KYP/KYC processes and documentation in place, should they get audited.