Our game plan in coming months
While this article can be read stand alone, the reader will find it useful to have a read the following articles before in order to get a better context of our reasoning process.
Before we go into a deep dive into the article let's go through some conceptual items. While they may seem disjointed initially they will all converge, and a good understanding of these concepts before hand is necessary to understand the convergence.
Custodial vs Non Custodial
Assets that are custodied with others are custodial assets. Shares, money deposited with banks etc are custodial. Travellers cheques and cash are non custodial as they are deemed bearer assets. However they are still typically issued by a centralized party who can cancel them at whim.
The only truly non custodial assets are things like Bitcoin in a cold wallet you have and bars of gold and other precious items.
Assets that are inherently custodial in nature make no sense on the blockchain. For eg: Most regulators do not allow bearer securities, broker/dealers/custodians are required to hold the registry in a physical centralized manner as part of the regulations and any transfer has to be verified, recorded and signed off by the centralized party. The SEC has been quite clear on this as part of its guidance on blockchain related matters.
Physical assets such as real estate is hard to tokenize. It is a tangible real world asset, and its ownership is recorded with centralized authorities. Any tokenization is essentially holding it via a fund style structure which takes you in the securities domain.
Proponents of real estate and securities tokenization have 2 main arguments which go something like this:
You can now own small bits of property anywhere in the world at the click of a button by buying property tokens.
There are couple of problems here. This argument assumes that this was not possible before. Many people pooling their funds together to finance a large asset is something the Dutch East India company pioneered centuries ago.
Property fractionalization is around in the form of real estate investment trusts for quite some time.
And if you tokenize you are going into the securities domain which has all kinds of restrictions on international ownership and the registries have to be centralized (see explanation above).
One more issue is real estate ownership is recorded with centralized parties (the government). In developed nations such as Australia, there are good records around ownership maintained in a centralized manner, so there is no real pain point to address. And in developing countries, while records can be patchy, the government has no incentive to cede its authority of record keeping to a decentralized network, neither is it possible to get the population to switch records from the state to you.
If your system has an off ramp to a custodial centralized record system then that is a major flaw in your decentralized architecture. While this issue can be solved, it is a major roadblock.
The second argument in favor of so called “Securities tokenization” goes around elimination of middlemen.
Right now in the financial world, capital formation happens via brokers, sub brokers, fund managers, each of who take a cut. On the securities exchange, ownership records are done in a layered manner where the actual ownership is replaced via a series of daisy chained beneficial interests. This reduces the speed at which transactions can be settled and creates unnecessary paperwork and administrative hassles.
Security tokenization and its predecessor “Crowdfunding” are held out as the evolution of finance in general and all finance will become direct to customer and the current middlemen based approach will eventually fade out similar to the way Neanderthals did.
Before we jump to conclusions let us first examine why the current system evolved to being the way it is.
Those who look to raise capital are looking for answers to 3 main questions
- Is it confirmed that I will get it?
- What will it cost me?
Certainty of access to capital often trumps cost considerations. The way traditional finance has gone about this is somewhat like this. Sub brokers reach out to direct investors. Brokers aggregate sub brokers. Fund managers aggregate money from brokers. Capital is formed in a decentralized and tiered manner.
When someone is looking to raise capital and is doing a pre-listing roadshow, they will hit the institutions represented by the fund managers, family offices, etc. This is because the capital is already formed and these entities are in the position to give outcomes to the fundraiser fastest in terms of certainty.
Going direct to investors means by passing the middle layers but it also means investing in building this distribution which can be quite time and effort intensive. It is ideally suitable only for businesses with existing distribution, ideally something in the B2C space. Especially if they are going about building something that a large amount of people deeply care about. For eg: Consider someone building solar panels locally that are more efficient.
But there are several business models that do not fit this niche and are quite viable and profitable. For them equity crowdfunding is not necessarily a good option.
In addition security tokenization is not really an ideal fit for equity raise. Smart contracts for the funding and operations and distributions of revenues and profits to investors are a great idea but there are some practical roadblocks to it.
If you are selling shares for an early stage business, then you are dealing in uncertainty. While investors might be ok with it, there is no real value add by recording them as security tokens.
Security tokens excel when the outcomes are predictable/programmable. Debt with predefined outcomes is a good fit. If debt is too stifling for a business, then a royalty or a revenue share also works well in terms of programmable investor distributions.
However in order to distribute a portion of revenue made by the company to investors in an automated manner, you need to have control mechanisms at the intake to record what came in. For eg: An ice-cream shop raised funding from investors and it sell $5 per cone and has promised investors that they will get $1 per cone. In order to keep the business honest, the Point of sale or till needs to record the purchase directly in a blockchain native currency.
That kind of mass retail payment infrastructure does not exist on blockchain as of now. There are several smart groups playing in this space, one of the most notable is Mosendo led by Rossco and Clayton. But till such infrastructure layer does not fall in place in a big way, applications such as royalty based tokens cannot be built. Plus the amounts needed would necessitate splitting the amount into shares which in turn takes you into the securities space.
Another programmable solution for which security tokens are a good fit is peer to peer lending. It is perfect for recording payment obligations and portability of capital worldwide can lead to great outcomes for both the investors and lenders. Interest rates in the developed world are approaching zero. Imagine being able to make a double figure return by lending to someone in a developing country like India. In addition your dollars go far further and one investor would be able to fill up an entire loan eliminating the need for securitization.
While this is a great fit, it again runs into the same lack of off ramp solutions. You might send money to someone in India using crypto, but they will find it hard to convert it to rupees and use it for their day to day purposes. When groups like Mosendo or Libra take care of this problem, wonderful applications can be built on top of them.
A bit of a disclosure here, Rossco is an advisor to Konkrete team, however he or any one at Mosendo has not asked us to give a shout. I am doing that here simply because we are big fans of what they are doing and given that he is an adviser I am more closely aware of what they are up to. There could be other cool projects doing something similar which I am blissfully unaware of.
Offramping is not an insurmountable hurdle. It’s lack does creates some friction.
Ideally what you want is an asset that can be natively sourced and represented on the blockchain. Invoices are such an asset and can be sourced, validated and represented on the blockchain.
In addition invoice factoring does not carry regulatory restrictions associated with securities lending, which means a global network of investors with secondary trading and non custodial tokenization.
Some background reading as below:
We at Konkrete believe our first wedge offer is the B2C invoice factoring play.
This will allow us to build out the distribution and infrastructure in a controllable manner. We fully intend to turn Factorium into a DAO in its own right in due course.
Step 2 is factoring larger invoices. Offramping is not a major issue as money can be sent in form of fiat to the business directly and the platform can take the responsibility of converting any crypto received to fiat.
Larger invoices however will become an issue as it may not be possible to have one investor purchase the entire invoice which may be worth several tens or hundreds of thousands of dollars.
At some point you need to be able to allow many people to come together and buy only a part of the invoice. Fractionalizing an invoice so that many financiers take a part interest in it is a grey zone from a regulatory standpoint. While it seems part ownership will not be treated as a security it may go the other way.
Either way the challenge that needs to be first addressed is how do you accelerate capital formation. The answer counter-intuitively enough is to introduce middlemen. We will build systems that incentivize capital raisers in a transparent manner to help fill out the funding requirements of a large invoice. Think syndicates in Angellist.
We will provide the necessary tools so that syndicate formation is easy. The invoice will be always sold in its entirety to the invoice and the syndicate internally can decide how to ascribe ownership of its assets to its members. Syndicate originators will get rewarded for their efforts.
Real estate development can also be financed in a similar manner. The entire process is a series of tasks done by various 3rd party consultants who invoice the developer for the work done. All of these invoices can be factored and the development can be completed.
So here is how our time line looks like
- Factorium launch in closed beta (already done) → 15 August 2019
- Factorium public beta → 15 September 2019
- Factorium soft launch → 15 October 2019
- Factor token sale → 15 November 2019
- Build out investor distribution through June 2020
- Launch of syndication July 2020
- Factor larger invoices through July 2021
- Launch of real estate backed stable coin August 2021 … more on this in a coming article.
