tZERO is developing an alternative trading system (ATS) or dark pool powered by blockchain and distributed ledger technology. tZERO is positioning itself as an alternative to the traditional capital market system by solving the following problems:
- Allowing companies to easily raise capital by issuing security tokens that derive value from underlying businesses
- Increasing trade security and speeding up trade settlement
- Reducing trading costs by removing financial intermediaries and middle-men from the trading and fundraising process
Security tokens are digital assets that are backed by other assets or represent a claim on underlying businesses. For instance, gold, real estate and company shares are prime candidates for security tokenization.
tZERO’s security token trading platform will provide opportunities for public and private companies to raise capital through STOs. It also aims to provide investors a regulatory-compliant platform upon which to trade security tokens. They target to launch a trading platform by 6 Aug 2019 that will allow tZERO token holders to sell to unaccredited investors.
tZERO completed its own Security Token Offering (STO) of preferred TZero security tokens on 6th August 2018 in compliance with US securities laws. The STO reportedly raised USD 134 million from over 1,000 global investors. tZERO will use the funds raised to develop its trading platform. It has already minted security tokens and has issued custodial wallets to investors on 12th October 2018.
The tZERO token was used purely as a fundraising tool. Until now, the token has no specific use on the platform and is not required for trading. The token is ERC20 compliant and will pay 10% of adjusted gross revenue to token holders on a quarterly basis, which is effectively a dividend.
Issued tZERO tokens will be locked in custodial wallets for 90 days (until 10 January 2019) to comply with US securities laws. After the lockup period expires, token holders should be able to trade tokens with other accredited investors on tZero’s upcoming trading platform. New accredited investors will also be able to open accounts after this 90-day period.
tZERO is a subsidiary of Overstock, one of the first major online retailers to accept Bitcoin as a means of payment.
A viable alternative to traditional and crowd-based funding?
TZero’s platform plans to integrate distributed ledger technology with existing financial market processes to reduce trade settlement time and cost while increasing liquidity. It also seeks to improve transaction efficiency, transparency and auditability. The platform will eventually support the trading of licensed security tokens, which provide a novel method for companies to raise capital outside of traditional financial frameworks.
Traditionally, companies looking to raise capital opt to sell shares through Initial Public Offerings (IPO) or, in the case of startups, venture capital funding.
IPOs are the culmination of a long process that requires compliance with securities regulations and partnerships with financial service intermediaries. This makes the IPO process almost inaccessible to medium-sized companies and startups who want to access equity capital markets.
Access to venture capital markets is very competitive for startups. Also, obtaining venture funding often requires startups to sacrifice significant degrees of operational control.
Initial Coin Offerings (ICOs) took off in 2017 as a means of crowdfunding that was easier than ICOs and venture funding. Using ICOs, startups could raise tens of millions of dollars by issuing utility tokens and without sacrificing any shareholding or operational control. Essentially, ICOs allowed startups to raise funds by working around securities laws. However, utility tokens don’t protect investors since they aren’t registered as securities and usually don’t represent claims on company assets or profits. Utility token value does not have to be tied to the underlying business, which reduces its investment appeal. These tokens may risk being classified as unlicensed securities by the authorities, which would essentially render them worthless.
Raising capital by issuing regulatory-compliant security tokens is, in theory, an attractive alternative to traditional fundraising sources and ICOs. Unlike utility tokens, security tokens derive value from underlying businesses and assets and may allow token holders to participate in dividends or vote on certain matters.
tZERO’s platform aims to enable secure trading in security tokens, using blockchain to speed up post-trade settlement and enabling companies easier access to fundraising. The platform will allow buyers and sellers to trade through dark pools, allowing investors to place orders and trade without revealing information such as order volume. tZERO will act as a direct link between buyers and sellers, with transactions securely recorded on a distributed ledger.
A Chinese private equity firm, GSR Capital, has invested as much as USD 270 million in tZERO. The total investment could reach as high as $404 million and potentially give tZERO a valuation of $1.5 billion.
tZERO and BOX Digital Markets LLC (BOX Digital) also announced a planned joint venture to launch the industry’s first regulated security token exchange. BOX Digital plans to contribute expertise and personnel toward obtaining regulatory approval and operation of the security token market.
Issues and open questions
tZERO’s token sale was reviewed by the SEC in February 2018. Parent company Overstock revealed that the SEC had requested “certain documents related to the Offering and the Tokens” as part of the overall 2017 ICO market investigation.
While there were no apparent penalties handed down by the SEC, investors should be aware that the SEC is keeping close tabs on token trading in general. SEC regulation on security tokens and STOs is evolving and strict regulations could impact security token trading in general
It remains to be seen whether enough companies and security tokens will on tZERO other than confirmed listings such as KodakCoin. People will also want to know whether TZero will add utility tokens, and which companies in the pipeline to launch their tokenized securities on tZERO. These questions apply to both tZERO and its competitors.
There are currently not a lot of prominent exchanges that allow trading in security tokens and asset-backed tokens. This will soon change with many exchanges entering the market. Upcoming competitors for tZERO include:
- Binance: the world’s largest crypto exchange by volume will launch a security token exchange in Malta in partnership with the Malta Stock Exchange.
- OKEx: also plans to launch a security token exchange dubbed OKMSX in partnership with the Malta Stock Exchange and Neufeld, the German blockchain platform.
- CEZEX: potentially Asia’s first tokenized security exchange
- Templum Trading: is also planning a regulated alternative trading system (ATS) much like tZERO.
It will be interesting to see which combination of these players captures a sizeable share of the security token trading market.
To learn more about tZERO, visit https://www.tzero.com/.