The information in this section has been extracted from publicly-available documents, including trade, industry or general publications and other third-party sources as cited in this section. Industry websites and publications generally state that the information contained therein has been obtained from sources believed to be reliable; however, their accuracy and completeness are not guaranteed and their reliability cannot be assured. While we have exercised reasonable care in compiling and reproducing such official, industry, market and other data in this document, it has not been independently verified by us or any of our advisors, and should not be relied on as if it had been so verified.
On 3 January 2009, the BTC network came into existence with Satoshi Nakamoto mining the genesis block of BTC. Although created in 2009, it did not reach the mainstream until 2017, when BTC gained traction and credibility with the media, regulators, the public and the mainstream financial system. On 8 August 2015, Ethereum (“ETH”) entered the cryptocurrency market, recording 2,881 transactions and has been growing in popularity ever since. On 12 June 2017, ETH overtook BTC in terms of total transactions made in one day, with a recorded 292,941, compared to BTC’s 268,951 transactions. However, according to CoinMarketCap, as of 31 December 2017, despite more than 1,335 cryptocurrencies in existence, BTC still held the largest market share, with over 38% of the market (US$220 billion of US$572 billion). On the same day, ETH held the third largest market share of over 12% (over US$69 billion of US$572 billion).
As of 11 December 2018, there were 2,068 cryptocurrencies available, breaking down to 1,189 tokens and 796 coins, representing an over 5,000% increase from the 40 cryptocurrencies available in December 2013. On 11 December 2018, the top ten most traded cryptocurrencies were BTC, XRP, ETH, Stellar, Tether, Bitcoin Cash, EOS, Bitcoin SV, Litecoin and TRON.
Problems with cryptocurrencies
According to analysts, some of the biggest problems associated with cryptocurrencies are the following:
- transaction delays;
- not a store of value;
- prone to price manipulation;
- unlikely to be regulated and therefore mainstream;
- prone to fraud; and
- potential for taxation
Cryptocurrency, and BTC in particular, as a payment system, is deeply flawed. One of the major problems associated with cryptocurrency is transaction delay.
For example, analysts at Bank of America Merrill Lynch conducted a study in respect of BTC transaction speeds and determined that for each of the daily 300,000 BTC transactions, users experience a wait period of approximately ten minutes. According to industry experts, the slow transaction speeds can be blamed on scalability; as blockchains become longer, transactions are held up in the queue awaiting approval. Scalability has proven to be a key issue for BTC – as more people use BTC, the speed of transactions slow down, therefore discouraging widespread adoption and use of BTC as it is much slower than conventional payment processing systems.
Not a store of value
According to cryptocurrency analysts, cryptocurrency is not a store of value, having failed many aspects of the definition. A store of value, as defined by Wikipedia, is “the function of an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. The point of a store of value is risk management due to a stable demand for the underlying asset.” Due to the extreme price volatility of cryptocurrency, and BTC in particular, it cannot be said that the value of BTC is “predictable”, nor can it be said that there is stable demand for the asset.
A second aspect of store of value is liquidity. According to Wikipedia, “Money is one of the best stores of value because of its liquidity, that is, it can easily be exchanged for other goods and services.” Until transactional issues limited the ability of BTC to be exchanged for goods and services, the liquidity and acceptance of the currency had been consistently rising. However, now that BTC has reached its peak block-size, transactional delays have discouraged retailers from accepting and consumers from using BTC in every day transactions, such that it is now difficult to find a vendor that will accept BTC as a form of payment.
The above views were well summarized by the Federal Reserve’s chairman in July 2018. In his view, cryptocurrencies have no intrinsic value, are not used often as a means of payment and are not a store of value. When asked whether cryptocurrency is considered a currency, Mr. Powell stated: “If you think about what currencies do, they’re supposed to be a means of payment and a store of value, basically. And cryptocurrencies…they’re not really used very much in payment. Typically, people sell their cryptocurrencies and then pay in dollars. In terms of a store of value, you know, look at the volatility and…it’s just not there.”
Prone to price manipulation
One of the biggest issues associated with cryptocurrency is volatility. The prices of cryptocurrencies can rise and fall dramatically over a short period of time. Volatility is a result of a number of reasons, however, the biggest driver is considered to be the activities of cryptocurrency “whales”, which are individuals or institutions that have large cryptocurrency holdings. Whales impact the market by opening large buy positions on a crypto trading platform. Upon noticing this order, smaller investors will assume it to result in a price increase, which will drive the price of cryptocurrency upwards.
When the price of cryptocurrency is at a level that favors the whales, they adjust their order and capitalize on the price spike. Once this occurs, the price of the cryptocurrency falls dramatically. This type of market manipulation enables ‘pump and dump’ schemes and other forms of related abuse.
Unlikely to be regulated and therefore mainstream
Cryptocurrency currently functions in uncharted territory; regulations guiding their use are either non-existent or unclear due to difficulties applying existing laws and regulations to this evolving environment. Lack of regulation that could protect against fraud, ensure fund security, verifiability, and fairness and associated legal uncertainty has, amongst other reasons, turned institutional investors away from the market. The lack of institutional investors, in turn, makes it difficult for other investors to take the currency seriously enough for it to become a mainstream currency, giving rise to liquidity issues.
Prone to fraud
According to a report released by the Satis Group, the majority of ICOs in 2017 were found to be scams, while only a small fraction successfully traded on an exchange. Specifically, the report found that more than three quarters of ICOs listed in 2017 were “identified scams”. The report described such ICOs as having or had “no intention of fulfilling project development duties with the funds, and/or was deemed by the community (message boards, website or other online information) to be a scam”. According to the US Federal Trade Commission, in the first two months of 2018, consumers were defrauded out of $542 million in cryptocurrency scams and will lose a total $3 billion by the end of the year.
Due to the high likelihood that an ICO will be fraudulent and the lack of recourse available to investors due to the unregulated nature of the cryptocurrency space, there has been a plunge in demand for cryptocurrency and ICOs in 2018.
Potential for taxation
Cryptocurrency is now being taxed by most nations under one of three taxation categories: (i) income tax, (ii) company tax, and (iii) capital gains tax. Although there is considerable confusion around the taxation of cryptocurrency, the predominant trend is to regulate cryptocurrencies like Bitcoin as if they were “property” and “assets”, rather than traditional currencies in the technical legal sense.
Security tokens and asset tokenization
According to analysts, although there may be future successful ICOs and cryptocurrencies in the future, this is not the future of the blockchain. Security tokens are now seen as the next opportunity to legitimize the blockchain in the eyes of those who doubt it, including institutional investors, who may still be hesitant to enter the cryptocurrency market.
A security token is a digital representation of value that is subject to regulation under security laws. Unlike utility tokens, a security token is caught by the US Howey test created by the US Supreme Court to determine whether certain transactions qualify as “investment contracts” such that they are subject to certain disclosure and registration requirements.
Under the Howey Test, a transaction is considered an investment contract if:
- it is an investment of money;
- there is an expectation of profits from the investment;
- the investment of money is in a common enterprise; or
- any profit comes from the efforts of a promoter or third party.
Although the Howey Test uses the term “money,” later cases have expanded this to include investments of assets other than money. The term “common enterprise” isn’t precisely defined, and courts have applied varying interpretations.
By meeting the conditions of the Howey test – namely that a security token is an investment in some kind of common enterprise with the expectation of profit from the work of others – security tokens bring regulation into the cryptocurrency space. Although this is seemingly at odds with the original decentralization goals of cryptocurrencies like BTC, the regulated nature of these new types of tradable securities offer significant opportunity to the marketplace. The regulations bring credibility back to the cryptocurrency space, which was lost due to unscrupulous ICOs, wildly fluctuating coin prices, and highly publicized hacks.
A security token can represent equity, debt, or any other asset, including alternative assets, which are assets that do not conform to the traditional asset classes of securities bonds or certificates, such as real estate, commodities, private equity, distressed securities, hedge funds, carbon credits, venture capital, financial derivatives and investments in real estate, forestry and shipping. To tokenize an asset is to change the right to the asset into a digital representation that resides on the blockchain. When an asset is tokenized, nothing has been done to the asset itself, only the way that ownership of the asset is managed has been changed. As a result of tokenization, fractional ownership of the asset and trading on a global basis is now possible.
As noted above, according to TechCrunch, there are US$256 trillion worth of real-world assets in the world, providing a significant opportunity to tokenize securities and other forms of assets on private or public blockchain networks. If this opportunity is fully realized, according to a study conducted by nex.io, the security token market is projected to be worth US$4 trillion by 2025. According to other analysts, the market may grow at an even faster pace, with estimates that the security token market will be worth US$10 trillion as early as 2020.
Benefits of security tokens and asset tokenization
The benefits associated with security tokens are numerable, many of which are a result of the blockchain technology which holds the potential to solve inefficiencies associated with illiquid assets, with the ultimate benefit of providing greater liquidity to the marketplace while remaining cost effective and efficient.
This White Paper will focus on the following benefits of security tokens: (i) liquidity; (ii) accessibility; (iii) divisibility; (iv) lower investment risk; (v) automated compliance; and (vi) lower costs.
Liquidity – tokenization provides increased market depth
The promise of global liquidity is perhaps the security tokens’ most valuable trait.
Liquidity is related to trading volume and can be measured using price impact from trading, or by observing the bid-ask spread. Tied to the concept of liquidity is the illiquidity discount, which is a discount demanded by investors when a security cannot be easily converted into cash for its fair market value. When the liquidity discount is high, the asset is said to be illiquid.
Through tokenization and the creation of a market and a greater pool of investors to trade security tokens, assets that would otherwise be illiquid (e.g. as real-estate) have reduced trading frictions and therefore increased liquidity. Asset tokenization and security tokens therefore allows sellers of illiquid assets to minimize the liquidity discount inherent in illiquid assets.
Accessibility – security tokens provide asset owners with access to a larger investment base
As security tokens are digital they can be easily accessed globally at any time of the day via smartphone applications. Therefore, through security tokens, an investor located in any part of the world can invest in a tokenized asset efficiently without leaving their country with the security, speed and ease of transfer offered by blockchain network.
Divisibility – security tokens introduce fractional ownership thereby opening the market to investors
Generally, high-value assets require a primary owner of the underlying asset, and for those assets that do allow joint ownership, it can be difficult to obtain. However, as security tokens are divisible, security tokens increase the potential for fractional and shared ownership. As a result, high value single unit investments (e.g. real estate, gold and art) can be fractionalized, providing further liquidity from investors that were previously priced out of such investments.
Lower investment risk – security tokens have the security of real-world assets behind them
When a security token is purchased, an investor is purchasing the rights to the underlying asset; the security token is simply digital proof of ownership in that security. Security tokens therefore combine the innovation of blockchain with the backing and safety associated with traditional financial assets, providing institutional and retail investors with the opportunity to invest in privately owned assets not previously available as an institutional-grade security.
Additionally, an investor can diversify their investment portfolio due to the possibility of owning parts of several assets and asset types.
Automated compliance – automatic regulatory compliance for security tokens
Security tokens are comprised of a number of smart contracts, which is a program designed to automatically execute once a specified criterion is satisfied. Smart contracts dictate how the token can be bought, sold and traded in a compliant way. If the security token is coded correctly, it is technically impossible for anyone to buy, sell, or trade the security in a non-compliant way.
Lower costs – lower fees due to lower administrative burden
Many of the world’s assets, such as real estate, art, and private equity funds are characterized by low liquidity, due in part to the high transaction costs when such assets change hands. Tokenization of assets and the use of security tokens to represent ownership of the assets simplifies transfer of ownership, reduces the administrative burden, removes third-parties, manual processes and other related trading frictions from the transaction, thereby dramatically reducing the associated costs.
Cryptocurrencies may be traded against fiat currency, alternative crypto assets and market pegged cryptos which track the value of external “real-world markers”, such as gold, USD, the SGX. Some cryptocurrency exchanges are structured similar to stock markets, allowing traders to set limit orders, market orders, stop loss orders, and act as either a market maker or market taker.[i]
In order to facilitate the increasing volume of cryptocurrency traded and number of transactions per day, it is necessary to have a well-functioning network of cryptocurrency exchange. Unlike stocks, cryptocurrencies are traded 24/7 globally on different exchanges with few barriers to entry and minimal censorship. The price of the traded cryptocurrency is determined by a free-floating market exchange rate established by buyers and sellers on global exchanges in different currencies and trading pairs.[ii]
The value of trading volume on major blockchain exchanges has grown exponentially over the past two years. According to blockchain.info, on March 22, 2016, the value of cryptocurrency traded on major blockchain exchanges was US$21.4 million. Nine months later, on December 22, 2017, this value hit an all-time high with trading volume peaking at US$5.4 billion, representing an increase of 24,949.62% over the nine-month period. On December 23, 2017, trading volume fell to US$1.97 billion, initiating a correction in the market. The amount traded has since levelled to range between US$188.5 million and US$3.1 billion. While the value of exchange trade volume remains volatile, growth over the past two years suggests that the market shows no signs of slowing down.[iii]
Fiat to crypto exchanges
Fiat to crypto exchanges allow investors to purchase cryptocurrencies with fiat currencies (e.g. USD), usually originating from a bank account. The majority of these markets only provide access to a limited number of cryptocurrencies, such as BTC, BCH, ETH and Litecoin.
As an alternative to the fiat / crypto model, OTC cryptocurrency trading allows users to purchase BTC and engage with the BTC protocol. At a fundamental level, OTC trading is a peer-to-peer (“P-2-P”) exchange; platforms connect the user with trading counterparties and leave the execution of trades up to users.
Instant exchanges provide users with the applicable exchange rate before the transfer allowing users to determine if the applied rate is consistent with fair market value. The fee structure applied is a “fixed miner fee”, meaning that the exchange’s profits come from the spread between the actual miner fee, which is the fee paid to the digital currency miners (the systems that process the transactions and secure the respective network), and the standard fee charged to customers.
A decentralized exchange is an exchange that does not rely on a third-party service to hold users’ funds. Instead, trading is P-2-P through an automated process. Amongst other solutions, this system is achieved through proxy tokens (crypto assets that represent a certain fiat or crypto currency), assets (e.g. equity) or through a decentralized multi-signature escrow system.
A cryptocurrency derivative exchange is an exchange that allows customers to trade multiple products that are linked to the price of cryptocurrencies. These exchanges allow players with risk-management experience to enter the sphere and potentially reap big profits, while simultaneously lowering the risk factor for the market as a whole.
Security token exchanges
Security tokens may be traded against fiat currency, alternative crypto assets and market pegged cryptos which track the value of external “real-world markers”, such as gold, USD, and the SGX.
Security token exchanges are licensed exchange platforms for security tokens. Such exchanges aim to help traditional investors trade tokenized securities and alternative assets through the use of security tokens. The exchanges can act as a platform for the initial sale of tokenized securities through a STO and tokenized assets while providing both issuers and investors a centralized platform for secondary trading.
Currently, the security token market is characterized by a lack of liquidity, due to the few regulated security token exchanges currently in operation.
In order to facilitate the increasing volume of security tokens traded and the number of transactions per day, it is necessary to have a well-functioning network of exchanges. Unlike stocks, security tokens are traded 24/7 globally on different exchanges. On par with its competitors, Vaultex will trade on a 24/7 global basis.
Cryptocurrency exchange market players
As the growth in demand to buy and sell cryptocurrency grows, the number of trading platforms developed to facilitate such trades has also increased. According to Coin.Market, as of 10 December 2018, they were indexing 212 cryptocoin exchanges with a total 24h Volume of US$2.80 billion on 7,353 trading pairs.
Security token exchange market players
Although a relatively nascent market, there are already a number of security token exchanges that have recently launched, are in the process of launching or have announced that they intend to launch. According to analysts, including analysts from medium.com, the market consists of the following types of players: (i) existing players, which have either revamped or are in the process of revamping their current platform to facilitate STOs and the trading of security tokens; (ii) new players; and (iii) institutional players.
SharesPost: Founded in 2009, SharesPost focuses on online private equity secondaries. SharesPost announced in May 2018 that it was revamping its existing alternative trading system (“ATS”) to facilitate secondary trading of security tokens, with the goal of building out its ATS and expanding in Asia.
Coinbase: Coinbase, one of the most popular cryptocurrency platforms, announced in early June 2018 that it was “on track” to operate as a regulated broker-dealer and thus enable secondary trading of security tokens. Through acquisitions it acquired three licenses: a broker-dealer license, an ATS license, and a registered investment advisor license. Coinbase is now listing security tokens on its platform.
OpenFinance Network (“OFN”): Launched at the end of June 2018, OFN is one of the first US based regulated security token trading platforms. OFN is a trading, clearing and settlement platform for alternative assets which combines a centralized matching system with a decentralized P-2-P settlement process.
tZERO: Launched in 2014, tZERO is a distributed ledger platform and cryptocurrency owned by Overstock and regulated by the Securities and Exchange Commission (“SEC”). tZERO will facilitate the trading of security tokens that are issued through STOs, particularly those that are compliant with FINRA and SEC regulations. Currently, tZERO’s services include; stock inventory management systems, brokerage services, and smart ordering routing services. On 16 October 2018, the company announced that it completed the issuance of preferred tZERO security tokens via a STO. tZERO plans to designate an approved trading platform by 6 August 2019, so holders may then resell their tokens to non-accredited investors. tZERO also plans to register the security tokens to enable secondary trading in additional trading environments and international securities exchanges.
Templum: Templum, through its subsidiary Templum Markets LLC, is a platform for STOs and secondary trading of security tokens. In February 2018, Templum acquired Liquid M Capital, giving them access to an ATS and thus enabling a secondary market. With the ATS, Templum can offer liquidity for securities they tokenize and remain compliant with US security regulations.
CEZEX.IO (“CEZEX”): CEZEX is Asia’s first licensed digital assets exchange platform for asset-backed securities tokens based in Cagayan Economic Special Zone, a special economic zone in the Philippines. CEZEX provides market participants access to tokenized assets through the operation of a regulated market. CEZEX has developed its exchange operating system, listing platform and trading APIs and intends to launch its security tokens in the last quarter of 2018. In October 2018, CEZEX announced its intention to extend their services into Hong Kong, which would make CEZEX the first security exchange to offer regulated security token trading in the country.
SMART VALOR AG (“SMART VALOR”): SMART VALOR was founded in Switzerland in April 2017 and is an online investment platform with a focus on alternative investments such as: (i) cryptocurrencies and non-security tokens; and (ii) asset-backed security tokens such as equity in young companies, real estate, crypto funds, venture capital, and private equity funds. SMART VALOR operates as Financial Intermediary, having been accepted as member of the VQF SRO, a recognized self-regulatory organization under the Swiss Anti-Money Laundering Act. The launch of the platform is scheduled to proceed in two stages. The first stage will be implemented with the public launch of the VALOR Platform in Q4 2018, which will focus on cryptocurrencies and non-security tokens. In the second stage, the platform will expand its offering to asset-backed tokens.
Gibraltar Blockchain Exchange: In October 2017, the GSX Group confirmed that it was also planning to revamp the Gibraltar Stock Exchange, which it owns, to become the world’s first regulated exchange for listing and trading security tokens.
Australian Securities Exchange (“ASX”): The ASX is one of the first exchanges to recognize the benefits of distributed ledger technology (“DLT”) and tokenized equity. In 2015, it began exploring different applications of DLT and in December 2017, it announced that it would replace its registry, settlement and clearing system with a DLT-based system developed in partnership with Digital Asset (“DA”), a blockchain infrastructure provider to major financial institutions. In doing so, the ASX became the most significant blockchain convert among mainstream financial institutions to date. In April 2018, The ASX released additional details about the project in a consultation paper, stating that the new system is estimated to commence operation between Q4 2020 and Q1 2021.
SIX Swiss Exchange (“SIX”): Based in Zurich, the SIX is Switzerland’s main stock exchange and one of Europe’s largest. In July 2018, SIX announced that it has started building a fully integrated trading, settlement and custody infrastructure for security tokens. The SIX claims that the new project, SIX Digital Exchange (“SDX”), will be the first to offer an end-to-end solution for security token markets. Services will include both issuance and trading and will tokenize existing securities and non-bankable assets to create liquidity for previously illiquid assets. The SDX will be regulated by Swiss financial regulator FINMA and backed by the Swiss National Bank. The project is expected to roll out in phases, with the first services to come online in mid-2019.
London Stock Exchange: London Stock Exchange Group (“LSEG”) and the Financial Conduct Authority (“FCA”), the U.K.’s main financial regulator, have partnered with U.K.-based startups Nivaura and 20|30 to issue tokenized equity in a U.K. company in a fully compliant manner. Targeting both institutional and accredited investors, the partnership will leverage LSEG’s hybrid exchange platform for European equities. 20|30 will act as the ‘guinea pig’ as the first company to test out the process and has been accepted into the FCA sandbox and will conduct one of the UK’s first equity-token offerings. Following a lock-up period of one year they intend to launch the service to the public, allowing start-ups and small- to mid-size corporates to tokenize their own shares.
Malta Stock Exchange (“MSE”): Neufund, a community owned platform has collaborated with MSX, a vehicle of the MSE and has partnered with Binance to create a global, decentralized and EU-regulated stock exchange for listing and trading security tokens, and in particular, equity tokens. The parties aim to conduct a pilot project in December 2018 which will include the public offering of equity tokens on Neufund’s market with the goal of trading such equity tokens on Binance and other crypto exchanges pending regulatory and listing approvals. According to Neufund, the deal will represent one of the first complete, regulated ecosystem for tokenized securities, from issuance through trading.
How Vaultex compares
Vaultex will stand out from the competition through our key competitive strengths and commitment to regulation and innovation. As further described in the following Business Section, we intend to launch as a platform for the listing and trading of Gold Tokens and selected cryptocurrency pairs, for which licensing is not required. Upon receipt of the relevant licenses (as described above), Vaultex will operate as a fully regulated exchange for the listing and trading of security tokens. Vaultex will focus on providing liquidity to the market, listing and tokenizing assets applying best of breed technologies, conducting comprehensive KYC/AML checks, applying high security standards and providing an efficient and inexpensive user experience.
Problems with existing exchanges and markets
In addition to the issues with cryptocurrencies themselves, a number of issues have been identified with the current cryptocurrency and security token market, including:
- lack of liquidity;
- lack of institutional trading;
- transaction delays and restrictions;
- compliance with applicable laws and regulations; and
- lack of accountability.
As security tokens, tokenized assets and the security token market is relatively nascent, the below described problems are more commonly agreed as issues with cryptocurrency exchanges. However, in order to avoid replication of the mistakes made with cryptocurrency and cryptocurrency exchanges, it is necessary to highlight certain of these problems. The Vaultex Exchange has been developed with these issues in mind to ensure that its innovative platform aids the development of the security token market.
The section below outlines some of the issues that Vaultex intends to address, and the following Business Section will detail how the Vaultex Exchange overcomes such issues.
Lack of liquidity
A problem facing cryptocurrency exchanges is a lack of liquidity. Market liquidity refers to the ability of market participants to transact or of the overall market to absorb large purchases without affecting the overall prices.
In terms of cryptocurrency, when trading, traders often have to post their sale and wait for the order to be filled. Many exchanges do not have a reserve pool, meaning that traders must wait until there’s a willing buyer on the network before their order is filled. The lack of liquidity makes it difficult for traders to sell their cryptocurrency, forcing them to hold the cryptocurrency longer than desired and potentially losing out on a favorable trade. When numerous speculators make the decision to sell a cryptocurrency at the same time, the lack of liquidity and inability to fill orders can cause price swings.
Liquidity also remains one of the biggest roadblocks to widespread adoption of security tokens. Although liquidity is hailed as one of the greatest promises of the security token, the security token market is characterized by a lack of liquidity, as many of the cryptocurrency exchanges currently in existence cannot list security tokens due to regulatory restrictions. These exchanges need to obtain a license to operate a securities exchange in order to list security tokens, which many do not have. Further, the traditional stock exchanges like NASDAQ or NYSE would not be able to list security tokens due to a lack of infrastructure for clearing and settling blockchain-based digital assets.
Unless the right infrastructure is established to allow different participants to engage in trade of security tokens, the market could remain highly illiquid.
Lack of institutional trading
Despite widespread demand for cryptocurrency exposure, they are currently “under-owned” by institutional investors. The regulatory and reputational risks associated with including cryptocurrency in an institution’s portfolio have acted as a significant barrier to widespread adoption among institutional investors. In addition to the foregoing concerns, institutional investors have been hesitant to trade outside of traditional regulated markets and engage in trades on the current infrastructure.
Transaction delays and restrictions
Traders can encounter numerous delays across their transactions in respect of cryptocurrencies. These delays begin when opening a trading account due to inefficient KYC and AML processes. Deposits and withdrawals on the blockchain can be slow as the transactions must be approved on various chains. According to analysts, scalability is causing transaction delays. As blockchains become longer, transactions are held up in the queue awaiting approval. Due to the volatility in the market, these delays can cost traders if they cause them to take advantage of favorable pricing and miss out on transactions.
In addition to delays, traders are also faced with trading limits as exchanges often place restrictions on the amount of cryptocurrency that can be bought and sold at one time. Some of these restrictions that impact the amount that can be bought, sold or withdrawn include transaction methods, verification levels, length of time the customer has been trading on the platform and exclusivity of the platform. Such restrictions can slow down and impede trading – those looking to buy or sell a high volume of cryptocurrencies are required to make a number of smaller transactions over a period of time.
Compliance with applicable laws and regulations
Currently, there are very few regulated security token exchanges in operation, although as described above, a number of regulated exchanges are working to launch their own security token exchanges, which are likely to attract the attention of institutional investors. Additionally, new players entering into the market are focusing on launching platforms that are fully compliant in order to grow confidence in the security token market.
Lack of accountability and susceptibility to crime
Exchanges are susceptible to corruption and difficult to hold accountable, particularly with the lack of legal framework they’ve enjoyed over the years. Many virtual cryptocurrency exchanges lack the necessary policies and procedures to ensure the fairness, integrity, and security of their exchanges. As a result, there have been a number of hacks that have resulted in millions of dollars being stolen, causing investors to lose their entire investment as some of the platforms have stopped operating and the lost cryptocurrency has not been recovered. Investors suffer additional losses due to the drop in the price of cryptocurrencies following these events.
To guard against the potential for hacking, traders and platforms have taken precautionary measures. Although helpful in reducing hacking, such measures can create delays and bottlenecks that hamper the trading process. As a result, exchanges and traders face a trade-off between security and efficiency. For example, some traders prefer to store their cryptocurrency holdings in offline wallets. Anytime they wish to trade, they are required to move their cryptocurrency out of offline storage to online storage before they can make the trade, adding delays and complexities to the trade.
Security token exchanges that have just launched or are in the process of launching will need to strike a balance against guarding for the potential of such hacks while ensuring that the exchange functions efficiently.
Vaultex intends to launch as a platform through which spot gold bullion, other precious metals and commodities may be tokenized and the resulting tokens may be listed and traded by CTA Approved Investors. Vaultex will initially focus on the tokenization of spot gold bullion and it is intended that the Gold Tokens will be the first tokens available for trading in the second quarter of 2019. Following the listing of the Gold Tokens, Vaultex will undertake the tokenization of spot silver, spot platinum and spot palladium. It is Vaultex’s intention to then tokenize futures contracts for precious metals tokenized on the Vaultex Exchange and to issue and index to a basket of precious metal tokens that can be traded and hedged against. If there is sufficient market demand at this stage, Vaultex will also facilitate the listing and trading of certain pairs of Exempt Cryptocurrencies.
Upon receipt of the relevant licenses from the MAS, Vaultex intends to operate as a fully regulated centralized exchange facilitating asset tokenization and the creation and trading of security tokens and cryptocurrencies by Vaultex Approved Investors. In doing so, Vaultex will act as a bridge between traditional financial markets and assets, issuers, investors and the cryptocurrency space. Through tokenization, the Vaultex Exchange will provide companies and asset owners with a deeper and more global pool of investors while investors will be provided with access to previously inaccessible assets in an efficient and cost-effective manner.
As described throughout this White Paper, Vaultex’s vision is to launch an exchange that embodies the following factors:
- Full regulation and compliance: Vaultex intends to establish a market for STOs and security token trading that is fully licensed and compliant with MAS’ requirements and operates within Singapore’s regulatory framework.
- Standards: Vaultex intends to create a high standard for listing and rules for admission and trading.
- Quality and compliance: Vaultex will institute stringent AML/KYC checks on all potential traders.
- Liquidity: The Vaultex Exchange will be developed as a marketplace for tokenized securities, bringing a new level of access, liquidity, and transparency to traditional and cryptocurrency markets.
Upon the launch of the Vaultex Exchange, Vaultex will facilitate the tokenization of spot gold bullion, other precious metals, commodities and the listing and trading of the resulting tokens under the CTA Exemption by CTA Approved Investors. Vaultex will initially focus on the tokenization of spot gold bullion and it is intended that the Gold Tokens will be the first tokens available for trading in the second quarter of 2019. Through its platform, Vaultex will combine the strength and benefits of gold and digital tokens, providing a greater pool of investors with the opportunity to participate in the market in an efficient manner, thereby further increasing market strength and liquidity.
Vaultex will initially tokenize spot gold bullion due to the many advantages associated with gold, and in particular, its excellent liquidity and stability during uncertain economic climates. Gold is a highly liquid market, and according to the World Gold Council, with notional volumes greater than any individual stock, most stock baskets, multiple bond markets – including medium- and long-dated US Treasuries – and most non-US dollar currency pairs.
Gold also has universal marketability and value; the intrinsic value of gold has remained intact in global marketplaces over a significant period of time. According to the World Gold Council, the investment market for gold has one of the longest histories of all monetary instruments dating back to approximately 500 BC.
Highlights and trends
According to the World Gold Council, in the third quarter of 2018, the gold market saw the following highlights and trends:
- average daily gold trading volumes of 29 million ounces, with a value of US$35.8 billion;
- gold bar and coin demand rose 28% year over year and 20% quarter over quarter (“q-o-q”), as investors took advantage of lower gold prices and sought protection against a backdrop of financial uncertainty;
- China – the world’s largest bar and coin market – saw demand rise 25% y-o-y;
- Iranian demand hit a five-and-a-half year high;
- jewelry demand saw price-led y-o-y growth of 6%;
- central bank gold reserves were up 22% y-o-y, representing the highest level of net purchases since 2015, both quarterly and year-to-date, and notable due to a greater number of buyers; and
- demand for gold in technological applications rose by 1% y-o-y, marking the eighth consecutive quarter of growth, primarily driven by gold’s use in electronics such as smartphones, servers and automotive vehicles.
Currently, the three most important gold trading centers are the London OTC market, the US futures market and the Shanghai Gold Exchange. These markets comprise more than 90% of global trading volumes and are complemented by smaller secondary market centers around the world (both OTC and exchange-traded).
Application of market trends to Vaultex Exchange
The World Gold Council has estimated that the average daily trading volumes in respect of gold for 2017 fall between US$100 billion and US$250 billion per day. If between 0.0025% and 0.01% of the global OTC daily trading volume is conducted on the Vaultex Exchange and 0.00004% trading fees are applied on all trades made, an annual revenue of a minimum and maximum of US$3.65 million and US$36.5 million, respectively, can be estimated.
In addition to the Gold Tokens, Vaultex intends on tokenizing a range of alternative assets including real estate, commodities, other forms of precious metals, futures, indexes and energy. Following the listing of the Gold Tokens, Vaultex will undertake the tokenization of spot silver, spot platinum and spot palladium. It is Vaultex’s intention to then tokenize futures contracts for precious metals tokenized on the Vaultex Exchange and to issue and index to a basket of precious metal tokens that can be traded and hedged against.
The Vaultex tokenization process is straightforward and similar to securitization of traditional assets. The key additional step is the addition of a tokenization stage which applies a smart contract and digital token to the traditional share rights of an asset holding special purpose vehicle. The digital security token smart contract includes details of the asset, including its location, appraisal details, exchange rules and redemption rights.
The following charts are examples of the tokenization and redemption process envisioned for gold and real estate, respectively.
 Information used from the World Gold Council is included for review and commentary purposes only.