“All that glitters is not gold” — Growing valuation bubble of Indian start-ups

by Sandeep Kumar | June 16, 2021

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 The valuation game

The Venture Capital valuation is a simple game, but never an easy one. While there is little to learn, to play it perfectly takes years, if not decades of experience under the belt.

So how do the VCs arrive at that valuation figure? Market Opportunity? Product Market Fit? Strong Founder Team? Disruptive Product Offering? Extensive Network Economics?

Nah.

Capital invested divided by the stake diluted. That’s it!

The VC chooses the amount of capital he is ready to deploy and the stake he wants to have in the company. Of course, the wish is to part with the least capital for the most stake. Now coming up with these two numbers, the capital chunk to invest and the amount of stake to buy, this is where experience comes in.

The winning bet in your portfolio

Most VCs have personal favorite ranges which they are comfortable with. Some VCs may like to hold only a few concentrated bets while others may want to deploy small amounts into numerous startups. The premise is the same. Each VC wishes to hold at least one winner in its portfolio, the winning bet that ‘returns the fund’.

This gets us to staging. The valuations do nothing to the VC portfolio, except increase the unrealized returns section, which, as the name suggests, are ‘unrealized’ and don’t mean anything unless the company makes an exit from that valuation.

But what if the company is not yet ready for an IPO or a buyout?

The VCs of course know this. Hence when they get together to finance a startup at some stage, let’s say series A, they are offering just enough money to take the startup to the next funding stage. This continues until the IPO or buyout.

Nowhere do the VCs use the DCF or any other model to find a fair value of the shares of the startup. Startup valuation is not a valuation game, it’s a pricing game. It is not about finding a startup trading at a lower than its fair value price and hoping the market corrects itself, the game is about finding another buyer who will be ready to pay higher. All this has nothing to do with cash flows generated from the assets held by the startup, adjusted for the underlying risks of all sorts (DCF basically). All these valuations are nothing more than exhaust fumes as suggested by Fred Wilson, an NYC based VC:

“Early-stage valuations aren’t valuations. They are the exhaust fumes of negotiation about two things — the amount raised and the amount of dilution.”

The information asymmetry

Now let’s take a look at what we have: You are a VC that is trying to get a stake in some startup. What do you do to get an idea of how much you should pay? You don’t have DCF or any other model to help. So, you look at what similar companies have been valued at. With new business models operating in diverse geographies, you realize that it is hard to say how you can define a similar company. Let’s say you came up with food delivery as one category. Despite the difference in the business models, one can hardly cobble together a list of 4–5 startups in the Indian space.

So, the VC game is plagued with opaque, inconsistent deal information. While the figures the VC arrives at are most probably wrong and have nothing to do with reality, they have nothing to worry about as long as they are able to find someone who’s ready to buy at a higher price from them.

The Indian startups in numbers

The past few years have been a gala time for the Indian startups who have managed to secure funding unabated despite the pandemic and its blues.

Startups in India managed to raise $7.8 Bn until April itself. This is a significant number almost 70% of the total $12.1 Bn raised in 2020 and more than 50% of $14.2 billion raised in 2019.

The average funding size has increased to $25.21 Mn, up from $14.94 Mn in 2020. There have been 402 funding rounds until April itself, against 1,114 deals in 2020 and 1,036 in 2019.

Overvaluation and the global landscape

The push towards absurd overvaluations has been a result of the negative interest rate environment. Post the GFC, there was heavy lending and even more borrowing. So much so that people had to pay up money just so that they could lend money. Of course, this led people to look for alternative avenues to park their money and generate juicy returns. The baseless optimism and hollow belief in spotting the next Bezos, Zuck, or Musk have led to an audacious amount of money flowing in, creating completely senseless valuations, having no roots in reality.

Tesla, more than $13 Bn in debt at the end of last year, recently had a market capitalization of $160 Bn, greater than General Motors and Ford combined. At the IPO price, Square was valued at close to $3 Bn, which is 50% below the $6 Bn valuations for which it had raised money from private investors a year before. Uber which in accounting terms stands at around 5x times its revenues, is also grossly overvalued as it is nowhere close to being the leader in the driverless car’s space. WeWork tried to go for a $47 Bn listing but ended up getting corrected to $8 Bn.

The WeWork fiasco was dubbed as a wake-up call in a Morgan Stanley report stating that the days of ‘’ were over.

Unicorns were considered rare. Today, however, the United States has a herd of more than 100 of them, with 100 more outside the US. Each worth a billion dollars or more.

Will history repeat itself?

Let’s talk about the Indian scenario and the startups which we believe are overvalued and most likely to come back to their intrinsic value as and when the markets correct themselves.

1. Byju’s: World’s most valuable Ed-Tech Company

Byju’s operates an online learning platform. It also creates a mobile app for pupils that offers a variety of learning activities. Exam preparation classes are also available. Original material, watch-and-learn movies, rich animations, and interactive simulations are all available to users on the site. The firm is having an EV/Revenue multiple of 17x.

It is the only major player in the Ed-Tech space in India, which has led the company to raise multiple rounds of funding and leading to an enormous increase in valuation. Knowledge in today’s world is free, however, Byju’s creates unique content with animation and the product often seems to be overpriced. In recent times there were a number of instances on various social media platforms where people questioned the pressure on the sales team and how Byju’s is so concerned about their sales when they try to push their offering in the market.

In the long run, the expected return from Byju’s is questionable. Below is the chart of the revenue and valuation of Byju’s over the last five years.

2. Cred — The borrower’s messiah

Losses in billions of dollars are nothing new for hyper-funded companies, especially when they’re chasing size and consumers at any cost. CRED’s metrics tell a tale in and of itself. CRED has made a profit of $71,000 in its second year of operation. CRED hasn’t been able to monetize its user base in FY20, despite acquiring a large customer base with a high propensity to spend and consume.

While the two-year-old company’s sales remained low, its total expenditure increased by more than 5.9 times to $52 Mn in FY20, compared to $9 Mn in FY19. The greatest cost center for the financial firm was advertisement and marketing, which accounted for 47.6% of total expenditure. From $3 Mn in FY19, such costs increased by 9.3 times to$25 Mn. During the fiscal year that ended in March 2020, CRED spent Rs 726.7 to earn a single rupee of operating revenue. CRED’s yearly loss in FY20 was INR 360.3 Crore, up 5.9 times from the $8 Mn it lost in FY19. The current cash burn is difficult to sustain, with an appalling EBITDA margin of -1979.5% in FY20, and the company will have to focus on its collections.

Despite registering astronomical losses it has attained a unicorn status by raising its valuation to $2.2 Bn in 2021. It is worth noting that the company is founded and led by Kunal Shah who is a known name in the start-up world for founding and leading numerous companies which may be an explanation behind the astronomical valuation of Cred. The graph below shows the valuation and losses of Cred over the years.

3. CarDekho — India’s leading car search venture

CarDekho helps users buy cars along with expert reviews, detailed specs, and prices, comparisons as well as videos and pictures of all car brands and models available in India. It has recently acquired an auto marketplace, Carmudi (Philippines) in late 2019 to expand business in Southeast Asia. GirnarSoft, the parent company of Jaipur-based automobile-related services behemoth CarDekho, has seen its losses increase by 155% to $45 Mn in FY2020. This comes after the company’s losses had already increased by 39% in the previous year.

Despite that CarDekho has managed to raise its valuation. Last year, Cars24, a CarDekho competitor, increased its consolidated revenue to $418 Mn and achieved unicorn valuation, and has a much lower EV/Revenue multiple. Let us now see the EV/Revenue Multiple of the peers in this game through the table below.

As per the last reported revenue and valuation figures.

We can infer from the table that CarDekho has a huge EV/Revenue multiple which signifies that the valuation of the firm is increasing at a much faster rate with respect to the revenue that the company generates, leading to overvaluation of the company. The graph below shows the valuation and revenue of CarDekho.

4. Unacademy

Unacademy is a Bangalore-based educational technology startup in India. Unacademy lessons are available in the form of Live Classes, which are both free and available on a subscription basis. Unacademy earned $12 Mn in revenue but spent $53 Mn, resulting in a loss of INR 300 crore. Employee benefits accounted for 23.7% of the edtech start-up’s costs, while other expenses accounted for 75%.

While 2020 brought plenty of development, the corporation would need to significantly increase its expenditures to reverse the losses it had in the fiscal year 2020, which ends on March 31, 2020. Unacademy’s revenue in FY21 is estimated to be over $55 Mn. It’s worth $3 Bn or approximately 35 times the expected income. The graph shows the valuation and loss of BharatPe.

5. BharatPe

When we talk about e-commerce giants, PayTm, Amazon, and Flipkart all wanted payments to take place within their own closed networks. BharatPe’s goal was to achieve what all the large brands were afraid to do: simplify things for retailers by adopting a standardized interoperable QR code. It allowed shops, street food vendors, and tea vendors to accept payments using any UPI app (PhonePe, Google Pay, PayTM, and so on) without having to download the apps. It was a simple and cost-effective approach with an added layer of security. The payment system’s complexity was reduced by a factor of ten by combining multiple UPI apps into a single sticker.

BharatPe was able to achieve early success by keeping things simple. BharatPe’s product strategy is based on making things simple for merchants, and the company uses P2M transactions as a springboard for future services. Because BharatPe does not charge merchants a setup or transaction fee, its fundamental feature money collection using QR codes is essentially a loss-maker for the company. It must spend a large amount of money to manage the servers that process millions of transactions every day. However, this provides BharatPe access to merchants who are passionate about their products and eagerly accept their offers. Despite having no visible revenue stream and without even earning a penny, the valuation of the company is increasing, and currently, it stands at $900 Mn, very close to the unicorn status. The graph shows the valuation and revenue of BharatPe.

The apprehensive loop of growing valuations

The indications are all too familiar. With large markets, illustrious founders, rapid growth, and top early-stage VCs on your side, you have a good chance of raising the next big round, even if you don’t yet have unicorn status (the desired billion-dollar value). And when major acquisitions are made for unproven companies, and valuations double or triple in a matter of months, it begs the question: are we in a bubble? This is always a challenge because most people only realize they were in an economic bubble after it has burst in the past.

Rich valuation multiples have also spread from the typical suspects — consumer internet companies — to enterprise software providers. This is a first. SoftBank, for example, invested in Mindtickle last year, valuing it at $500 Mn based on estimated revenue of $20 Mn — $25 Mn. Even SaaS companies in the United States, including Slack, Zoom, Snowflake, and Cloudflare, have gone public in recent years with great success. Sentiment in India often comes straight from the United States, particularly in related industries and from funds that invest in both nations, including several of India’s leading venture capital firms. Startup valuations are also affected by how publicly traded firms trade if retail investors are ready to pay high prices for loss-making companies, whether banks financing a share issue can find enough at a given price, and so on. There isn’t a single bubble across the board. Because of the vast quantity of money available in the market, investors are willing to pay a premium for good business. But that should be done judiciously.

Investors beware

For the first time in years, it’s possible to claim that private markets are more logical than public markets. If stock markets are the yardstick, select pricey companies may not be overvalued. A closer examination of what constitutes a bubble, as well as what Indian entrepreneurs are doing, reveals a more complete picture. Growth investing has been positive in industries that have recovered quickly from the epidemic, and there has been a lot of interest in a few market leaders. At such levels, one would expect some amount of rationalization. Investors must evaluate the prospects and the future road map of a company before investing. As more investments flow into a company without a proper business model or less revenue, it results in overvaluation creating a bubble. Investors can lose a colossal sum by not choosing the right company.

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This article has been co-authored by Sayan Mitra and  , who is in the Research and Insights team of Torre Capital.

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Understanding how the pandemic has fueled the growth of the Secondaries Market

by Sandeep Kumar

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Secondaries Market and its Performance during Pandemic

The buy-and-sell of pre-existing investor commitments to private equity and other alternative investment funds is referred to as the private-equity secondary market. Transferring interests in private equity and hedge funds can be more complicated and time-consuming due to the lack of established trading venues for these interests. Private equity has traditionally been an illiquid sector, with institutional investors acquiring buyout funds and waiting more than ten years to enjoy the rewards. Private Equity was designed for investors who preferred to buy and hold assets rather than sell them for a quick profit.

Market downturns have historically had a short-term impact on secondary markets. The Covid-19 pandemic has brought about an evolution in the financial world and a similar change has been witnessed in the private equity secondary market. Through this article we will understand how the secondaries performance has fuelled post the onset of pandemic.

Historical Returns in the Midst of Pandemic

Market downturns have historically had a short-term impact on secondary markets, reducing transaction volumes, delaying realisations and distributions, and placing downward pressure on price. Secondary markets have usually returned from market downturns with significant activity, and have presented excellent possibilities for investors with available investment money once volatility has subsided and stability has been restored.

During the pandemic, due to great degree of uncertainties and subsequent volatility, investors in the secondary market grabbed the opportunity by buying the dip and securing their positions by purchasing at greater discounts. According to Greenhill’s Report, greater interest has been seen particularly in COVID-proof” sectors, newer vintage funds and more concentrated exposures, which are easier to diligence and underwrite. The secondary market experienced large volume growth in the second half of 2020 and into 2021. In 2021, we can expect secondary transaction volume to hit new highs. Secondaries may find more enticing pricing as a result of the market’s uncertainty, resulting in increased prospects and profitability.

Why the secondaries market are attractive?

· Recent Vintages (post-2015): Recent vintages with unfunded capital have become more attractive to investors in the present circumstances. Investors get insight into the portfolio and platform investments, as well as assurance that the increased cash available may be used offensively as well as defensively. High-quality GPs with ample money who are seen as capable of handling market disruption are especially appealing.

· GP-led Transactions: The number of tail-end funds and older assets appears to have risen with the possibility that the COVID-19 epidemic would further delay exits. High-quality general partners have continued to use the secondary market to maintain high-performing firms while also providing current limited partners with a liquidity alternative. With a number of secondary deals started this summer, the GP-driven market has led the resurgence in secondary transactions.

· Single Asset Transfers: As the frequency of single asset transactions in high-quality firms increases, general partners keep seeking for methods to keep their best companies. Diversifying among funds is one method secondary investors may reduce concentration risk. Single asset transactions are especially desirable in the COVID-19 environment since it is easier to assess the impact of COVID-19 on a single firm than a large mix of portfolio.

· Dry Powder Advantage: These days, investors are demand more liquidity and the ability to rebalance their portfolios across asset classes. Due to this demand, a secondary market has emerged where investors may sell or buy private equity commitments rather than just waiting for a return. The seller of a PE share can access liquidity in the secondary market, just as in the normal stock market, while the buyer receives access to private equity funds and diversification.

It has been estimated that in the year 2020, players in the secondary market have enjoyed high levels of dry powder that is ready for deployment. They are in a position to enjoy profitability by buying in at above average discounts to lock in greater appreciation. With the current trends, it is estimated that the transaction value for secondaries will exceed $100 Bn by the end of 2021. The growth trend is not expected to end anytime soon as markets are now more liquid than ever due to technological innovations in the field and the growing acceptance of digital assets and tokenization.

Source: Acuity Knowledge Partners

Secondary Buyouts

Since 2006 to 2019, SBOs have witnessed a growth of 5.2% per year. This option has been experiencing rising popularity due to better liquidity options and lower risk staregies. Study conducted by Deloitte estimated that more than half of the investors surveyed expect SBO funds will offer one of the best opportunities for returns over 2020–2021.

Source: Deloitte Insights

The Way Forward

As a result of the current market dislocation, protracted volatility, and ongoing pandemic, the secondary market has seen lower pricing and more opportunities in younger assets. Financial decisions made by investors in the secondary market may be influenced by structural changes caused by economic crises, and failing to account for these fundamental breakdowns in the market may result in investors making incorrect interpretations and portfolio selections. However, secondaries are still, absolutely a great place to put your money. In the second half of 2020 and into 2021, the secondary market saw significant volume growth. Secondary transaction activity is expected to reach new highs in 2021.

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This article has been co-authored by Tamanna Kapur and Sargam Pallod , who is in the Research and Insights team of Torre Capital.

The state of European Fintech and with the explosive growth and maturity, who are here to stay?

by Sandeep Kumar

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Overview of European Fintech Market

From payment processing to insurance and wealth management, the digitisation of the financial services has led to a massive growth of the fintech market all across the world. In this article we will be focusing on the European region in particular, where the fintech market is growing so rapidly that the fintech adoption in the region has surpassed that of the USA. At the start of the year 2021, Klarna was the only fintech decacorn in the region and now Revolut and Checkout have also joined the club. The year saw a record growth in the number of fintech unicorn additions as 19 startups were promoted to unicorn status.

Source: Crunchbase

Surge of Fintech Funding in Europe

Overall funding to European fintech scale-ups reached €4.55 Bn in 2017, but fell to €3.52 Bn in 2018. However, in 2019, European fintech businesses, particularly those in the growth and late-stage stages, witnessed a massive increase in fundraising rounds, culminating in a total of €8.81 Bn in fintech funding, a 150% increase over the previous year and nearly double the number in 2017. Around €4 Bn was raised by European fintech businesses in the first half of 2020, already more than in the full year of 2018, but lagging behind the trend of 2019, when more than €8.8 Bn was raised.

Fintech Investments size in European Funding Round till H1 2020

Regulatory Environment

The rise of non-financial companies into the tightly regulated financial sector has resulted in a rising need for regulators, the fintech community, and the financial services industry to properly engage with developments in this space. The vast bulk of financial services legislation and regulatory norms predate rapid technological advancements and consumer demand for change. While governments in a lot of nations want to be viewed as promoting innovation, the law has been slower to catch up.

Regulatory authorities across Europe, including the European Central Bank, the FCA in the United Kingdom, the AMF and ACPR in France, the AFM and DNB in the Netherlands, the European Commission and Parliament, the BaFin in Germany, the CSSF in Luxembourg, and the European Securities and Markets Authority (ESMA), have publicly stated their support and launched new regulatory initiatives to encourage innovation, along with the European Commission and Parliament, the European Central Bank, and the European Securities and Markets Authority (ESMA). The EU Commission has started a study on technology and its influence on the European financial services industry as part of its customer finance action plan, which is expected to have a substantial impact.

Growth in Europe’s FinTech Deals

With about a third of the region’s unicorns belonging to the fintech sector, companies have attracted the interest of the investors. With a collective valuation of $178 Bn, the market has raised more than $11 Bn in the present year. In the first half itself, the market had raised funding that was 1.5x of the previous year. While the number of deals in Q2- 2021 fell sequentially by 8%, the investments have grown by 30%. This has resulted in hitting a quarterly record of $7 Bn which was facilitated by megarounds of Klarna, Trade Republic, SaltPay, etc. The recent focus of investors as observed has been on wealth management and insurance tech.

Source: Crunchbase

Record Year for Fintech Exits

The growth of European fintech has also facilitated the rise of fintech exits in the region. The first half of 2021 witnessed about $26.5 Bn (or €22.6 Bn) worth of exits. This has been a record high in the exit scenario, and gives high hopes to investors, particularly after less than $2 Bn worth of exit activity in 2020.

The most successful one this year has been the public listing of Wise — a London-based money transfer company. The company went for direct listing in the London Stock Exchange which increased the company’s valuation to over $13 Bn as of August 2021. Apart from this, Tink and Currencycloud were strategically acquired by Visa for $2.1 Bn (€1.8 Bn) and $960 Mn (£700 Mn) respectively.

In total, fintech exits banked VCs $70 Bn during the period from January till July. Of the total figure, about 20% of the exit figures have come from Europe.

How are Different Segments Faring?

The use of technology in financial services is vast and gives rise to various segments including payment processing, neobanks, insuretech, crypto-exchange, wealth management tech, etc. Let us have a look at how some of these sectors have been performing:

 Payment Platform — With the digital payments sector expanding across the globe, this segment has benefited from a high proportion of funding received over the years. This is evident from the success stories of Klarna and Checkout. The pandemic has further accelerated the potential of the sector. Looking at the top 10 VC backed fintech exits in the region, more than half of the companies belong to the payments and money transfer segment, these include WorldPay, Wise, Adyen, etc.

 Insurtech — This segment has been witnessing greater attention from investors since 2020. In the first quarter of 2020, insurtech comprised about 20% of the total fintech rounds in Europe. The sector’s combined valuation for the year amounts to over $23 Bn. Insurtech funding in Q2 of 2021, has increased by about 403% on just Quarter on Quarter basis.

 WealthTech — Wealth management technology companies, or simply the WealthTech sector has also led growth along with the insurtech sector, witnessing an increase in the investor preference. While the number of deals for the segment increased by only 9%, the funding in Q2 of 2021 grew by 272% on Quarter on Quarter basis.

 Cryptocurrency and DeFi — Cryptocurrency and Decentralised Finance (DeFi) are gaining momentum in the finance world. With great buzz around crypto, the funding in such companies has jumped 300% from what it was in 2019, amounting to $1.4 Bn this year. Some examples of companies in this segment include — Elliptic, Blockchain.com, Copper, etc.

 Other Segments — Looking at the Quarter on Quarter funding rounds, funds in fintechs involved in the banking segment as well as capital markets rose by 70% individually and digital lending by 64%. On the other hand, QoQ investments in real-estate fintechs fell by 87%.

How has the Pandemic Impacted the Market and What is the Way Forward

With the onset of the Covid-19 pandemic, there has been greater reliance on digitization of various operations across different industries. This has facilitated the growth of the fintech sector post-pandemic as businesses are working to adapt to the new normal. The regulatory environment has also supported the growth process in the European region, so much that it is now performing better than North America. Particularly, the payments segment has always been investors’ favourite, however, the post-pandemic focus of investors has shifted towards insurtech and wealth management tech firms.

We believe the current boom of the fintech market in the continent is to be continued in the coming years. This is evident from the significant growth in the VC funding in recent years, with the overall funding round size average increasing by over 100% compared to three years ago. Investors are expected to gain huge returns from the growing valuations of some unicorns and their great successful exits.

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This article has been co-authored by Tamanna Kapur and  , who is in the Research and Insights team of Torre Capital.

Security Tokens: The next big trend which will revolutionize the Private Markets

by Sandeep Kumar

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Understanding Security Tokens

Blockchain is one of the most rapidly growing digital technologies in recent history, and its revolutionary decentralized model is being adopted by a wide range of industries. With the total Security Token market crossing $1 Bn in total volumes in July 2021, the discussion around how security tokens can transform and enable access to otherwise inaccessible private markets has been growing. Security tokens are essentially digital contracts that are blockchain-based protocols embedded in the network for fractions of any existing asset, such as real estate, a car, or corporate stock.

When investors use security tokens, their ownership stake is recorded on the blockchain ledger. With their ability to demonstrate value, security tokens have the potential to disrupt traditional financial markets in favor of newer, more hybrid blockchain models. They combine the merits of blockchain technology and regulated securities market, offering a wide range of financial assets including fractional ownership opportunities which allow investors to trade even the most illiquid assets like private shares, real estate, art, and even esoteric assets like vintage cars.

Owing to these benefits, there has been increasing adoption of STO in both public and private markets, so much so that some expect it to even outperform the traditional markets in the next 5–10 years.

Evolution of STOs and their Growth

The idea of STOs evolved from Initial Coin Offerings (ICOs) which serve as utility tokens distributed to raise capital from investors. ICOs may even involve the use of virtual assets that are yet to be built on the ecosystem. Since the launch of Ethereum in 2014, ICOs were successfully issued for several securities till 2016. However, with its success, the number of scams in the ICO market also increased with about 80% of the ICO projects deemed to be a fraud. These issues led to the development of STOs as they provide a shield of compliance, regulation, and tokenization to digital assets transactions.

The roots for STOs were set up in 2017, and it started to gain traction in 2018 with a total of 28 STOs raising a collective value of $442 Mn during the year. As per PWC’s 6th ICO/ STO report, over $4 Bn was raised through 380 token offerings in the year 2020. Tokenization of assets and the subsequent market for STOs is expected to witness exponential growth in the future, growing at a CAGR of 59% during the period 2019–2030.

How Do Security Tokens Work?

Making a security token entails reserving and naming your token symbol, developing a token that can enforce regulatory compliance through programming, and minting and distributing the token to investors. When an off-chain traditional financial asset is represented on-chain, it becomes a tokenized security. Tokenizing an existing share certificate is a good example. An issuer creates a security token that represents a claim to ownership in a company. The issuer then creates a whitelist of wallet addresses (typically Ethereum) of investors who are permitted to purchase stock in the company or invest in the concerned security. All individuals on the whitelist must demonstrate that they comply with the restrictions for that specific security.

If you try to trade a security token with a counterparty, the Issuer will check to see if they are whitelisted. If they are, the transaction is completed. If not, it will display an error message and you will be unable to complete the transaction. This is possible through smart contracts, or autonomous contracts on the Blockchain, which give the ability to be automated and transacted with little cost and in a short amount of time. Security tokens, in contrast to the majority of other crypto assets, are not bearer instruments. Because anyone who obtains your Bitcoin private key has the ability to spend your Bitcoin, it is a bearer instrument.

The security token is an electronic representation of the security rather than the security itself, hence cannot be stolen. No one can transfer a token to their wallet unless it is whitelisted; otherwise, they would have gone through KYC/AML and you would have known who they were. Hence, security tokens are well secured.

Types of Security Tokens and their Acceptability

· Equity Tokens  The ownership of an item, like corporate stock or debt, is represented by equity tokens.

· Asset-backed Tokens — This is a blockchain-based token that is linked to a tangible or intangible object of significant value.

· Utility Tokens — Utility tokens give users access to a product or service at a later time. Companies can utilize these to raise funds for blockchain project development.

· Debt Tokens — Debt tokens are the equivalent of a short-term loan with an interest rate based on the amount borrowed by the company. Example — Steem.

How are security tokens transforming the private markets?

Due to limited access, opaque pricing, intermediaries, high minimums of $100K+, limited liquidity choices, time-consuming and burdensome legalities, and other factors, non-institutional investors are unable to have easy and direct access to high-quality private market investment possibilities.

Security tokens allow investors to buy, sell, and swap rights to shares of private corporations using digital tokens, overcoming the problems in the secondary market for private equity. It’s critical that it records, issues, and validates sales all at once. This benefits both existing secondary market investors and makes secondary markets more accessible to a wider group of investors. It ensures transparent ownership and pricing.

A digital token would allow an investor to sell security far more readily than actual shares in a startup (which require notarial acts or intermediaries). We’re talking about a type of investment that combines the safety and security of reality — owing to a stable value represented by a real asset — with the investment simplicity of the blockchain world, which requires no notary deeds or lengthy processes to manage securities, but only a digital wallet! Investing in private markets is as easy as in public markets.

Benefits of Security Tokens

· Improves accessibility to real-world digitized assets

With a total of $256 Tn in real-world assets available globally, asset classes such as fine arts and real estate have numerous opportunities to open up trading spheres and be traded easily and quickly with STOs.

· Enabling Fractional ownership

Security tokens can be used to raise cash for large-scale investments. The value of a costly art collection can be split down into fractions and distributed to a large number of investors using security tokens. The security token investors would benefit from the increase in the value of art collectibles. People can build their portfolios without having to spend a big sum of money since security tokens allow investors to acquire fractions of fine art or collectibles. However, semantics, such as dividing the value into fractional ownership, must be addressed.

· Provides Increased Liquidity

Liquidity is determined by the number of traders (sellers and buyers) in a particular market. Accelerating transactions and fractional ownership through asset tokenization has the potential to increase liquidity by allowing more people to enter the investment space and buy/sell at higher volumes. Security tokens increase liquidity by making it easier to buy and sell in a market or underlying asset that is not available or difficult to buy or sell. Security token offerings are a win-win situation in terms of overall liquidity when it comes to asset classes that were illiquid in nature.

· Transparency

The status of a security token transaction can be tracked from start to finish, and all parties involved have access to an up-to-date golden source of truth on-chain. With an up-to-date record, it reduces record-keeping disputes and the need for parties to reconcile.

· Reduces Cost

Security tokens aim to eliminate intermediaries and simplify investing for investors. Chainiumu, a crowdfunding platform, was created with the sole purpose of connecting investors to investors without the use of go-betweens. In the long run, this will increase accountability and transparency. With an STO, businesses can enable investment through tokenization. Because smart contracts can embed trading restrictions into a token, the cost of an IPO or other securities trading can be significantly reduced.

Major projects in the STO space

· Tezos

BTG Pactual, Latin America’s third-largest investment bank, and Dalma Capital, a Dubai-based asset manager, announced plans to launch security token offerings on the Tezos blockchain in 2019. According to a press release, the banks hope to “address a deal pipeline of more than $1 Bn for existing and prospective token issuances.”

· TZero

tZERO is a technology company whose mission is to democratize access to private capital markets. It is a subsidiary of Medici Ventures, Overstock.com, Inc.’s blockchain-focused wholly-owned subsidiary. tZero was created to provide more legitimacy and oversight to initial coin offerings (ICOs), as well as to allow businesses to create and issue tokenized assets for investors. tZero, unlike other decentralized blockchain platforms, has been designated as an alternative trading system (ATS) and is regulated by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

· Polymath

The platform’s primary goal is to assist traditional financial securities in integrating with blockchain technology. Polymath is based on the fact that tangible assets are being drawn towards being a part of blockchain technology, which is primarily powered by its native token (Poly). Polymath is made up of four core layers that define token creation and adherence to the operating guidelines. These include the Protocol layer, Application layer, Legal layer, and Exchange layer.

In general, the protocol layer is in charge of all platform computation. The application layer, on the other hand, allows users to generate their security tokens. Those who want to create tokens on the forum can get help from the legal layer. Finally, the exchange layer functions more like a closed-end KYC/AML accreditation, providing users with instant liquidity for their assets.

Developments that needs to be catered in the long run

· Wider acceptability

STOs will take time to gain trust due to the poor reputation of ICOs in the market. To be accepted by the mass, major financial institutions must vouch for STOs. This would take some time, even with the security of regulatory requirements. The time has come to impose regulatory requirements that will act as an excellent first line of defense and protect investors.

· Integrating systems and requirements

Companies will be responsible for developing data transport protocols and interfaces, as well as writing and maintaining the existing system architecture. This may necessitate the use of specialized skill sets, which will increase costs in terms of both human resources and system enhancements to interface with SSTO-specific blockchain technologies.

A glimpse of the future

It is clear that significant changes are already taking place in the realm of finance and investing, and many of them have the potential to be beneficial. This is especially true for people who are enthusiastic about blockchain technology and the opportunities it provides. Security Tokens combine blockchain technology with the requirements of regulated securities markets to facilitate asset liquidity and financial accessibility. These tokens are regulated securities that are issued in the form of digital tokens in a blockchain ecosystem. Through automation and “smart contracts,” the blockchain environment promotes securities regulatory objectives of disclosure, fairness, and market integrity, as well as innovation and efficiency. The security token market cap increased by more than 500% in 2020, and the best is yet to come for security token offerings. Securities, which are traded financial assets such as equities, debt, and more, can become even more effective by employing blockchain as a foundation.

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This article has been co-authored by Sayan Mitra and  , who is in the Research and Insights team of Torre Capital.

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