Report: STOs are Feasible in Germany, but Face Two Key Challenges

Recent research led by Prof. Dr. Philip Sandner highlights the current state of the security token industry in Germany. While there are certainly signs of support and growth, there remain two key obstacles that the industry must overcome in order to accelerate security token adoption.

The Security Token Industry in Germany Explained

Security tokens are anticipated to bring significant benefits to the world’s existing securities system. When securities become tokenized, they can be issued, traded, sold, transferred, cleared, and settled in a matter of seconds. The current systems of today can take days for such actions to complete.

Germany has made a name for itself in becoming an adopter of security tokens, at least from a regulatory point of view. Germany’s financial markets regulator, BaFin, has approved numerous STOs.

Neufund launched one of the first Security Token Offerings (STOs) in Germany, raising €3 million back in December 2018. BaFin also approved the sale of tokenized bonds by Bitbond and StartMark’s STO which aims to raise €50 million.

A new report from Philipp Sandner — head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance and Management — says security tokens are indeed the future. However, prior to that future being realized, a few challenges need to be overcome.

The recent security token activity in Germany suggests several important points, according to the research. First, it is obvious that there is plenty of support for security tokens. BaFin has given the green light for security token use, and several companies have already leveraged — or are currently leveraging — the STO to raise capital. In this sense, Sandner and his colleagues say Germany shows support for security tokens on the supply side.

On the investor side of the house however, things are different. The demand side simply isn’t there yet and according to Sandner and his team, it won’t develop without solving two key challenges.

Regulatory Challenges

The first challenge centers around regulatory compliance and existing securities regulations. Every STO must be compliant. Yet, as a result of the current legalities in Germany, direct tokenization is very difficult, if not impossible.

Companies have to find legal workarounds in order to conduct a tokenized offering. Bitbond did this by structuring its offering as a form of debt financing. But not every startup trying to raise capital has this option.

Cashlink created security tokens which were deemed virtual shares — another unique workaround that complied with German law. Still however, Sandner says straightforward tokenization of equity in a direct manner is not possible in Germany.

Revised laws are needed to account for the new capabilities enabled via blockchain technology. The Liechtenstein Blockchain Act could do just that. The act would allow for the tokenization of an asset without any complex legal requirements.

Investor Challenges

The second challenge revolves around investors. In virtually every investor-type, there are ongoing obstacles.

For institutional investors, Germany lacks a secondary market. Ultimately, this negatively affects the added liquidity of security tokens, a primary benefit of tokenizing an asset in the first place. Beyond this, storage and custody continue to remain a problem as well.

When it comes to retail investors, the technical requirements are too demanding. They ultimately create a barrier to entry. Investors need to manage wallets and private keys, which have a high degree of sophistication and generally lack in the area of UI.

Therefore, the research concludes that while “security tokens are the future”, the industry’s development will require some time. Many aspects of the ‘supply’ are there, and even continue to rise. Yet the demand continues to face challenges. The research concludes,

“[While] there is an increasing ‘supply’ of security tokens in the market, the ‘demand’ for security tokens by investors is still very low and only very slowly increasing. As always, if supply exceeds demand, prices drop. In the case of security tokens, this is reflected in unexpected low fundraising volumes or significantly high market expenses to reach the investors that are — up to now — still quite scarce.”

What do you think about the FSBC’s research findings? Do you agree with the challenges their research highlights? What are the keys to solving these challenges and accelerating security token adoption? Let us know what you think in the comments section below.

Image courtesy of PRNewswire.