The subject of tokenized securities has filtered back through the market since the hype days of 2018. Companies operating in the space are finally receiving regulatory approval, but with security regulations varying across various jurisdictions, different operators are facing unique challenges.
Europe has been making some progress on this front, and the U.S. is starting to come along. Texture Capital, an institutional marketplace for private capital, recently received the regulatory green light to trade securities in the United States. Richard Johnson, CEO of Texture Capital, spent some time with Coinscrum host and Honeycomb Digital CIO Baxter Hines to discuss the development.
Johnson spent much of his career on Wall Street in the securities industry on the trading side of the market. He moved into the crypto and blockchain space in about 2014, saying that when he discovered bitcoin, he came into the market with a trader mindset. Once he dug deeper, he recognized the potential for the technology and pivoted his career toward the space.
He described how his lightbulb moment came in 2018 during the previous bitcoin bull market when the BTC price was hovering above $18K, followed by the ICO boom. At that time, SEC Chairman Jay Clayton said that every ICO he’d seen resembled a security and that these platforms needed to be registered under the Securities Act. Texture Capital’s Johnson agreed with him, saying that the technology is amazing and companies should have a path to raise capital using blockchain technology as well as to issue tokens. That’s when he started thinking about founding Texture Capital, since which time it’s been a “long journey.”
(14:27) “We filed our paperwork with FINRA and the SEC over a year ago. And we finally got our approval in September. It’s normally a six-month process but when you say you’re using blockchain, it ends up being double or triple those timelines,” explained Johnson, adding that they are excited to move into launch mode.
Texture Capital is one of the very few U.S. companies to have its digital securities license, an approval that allows it to conduct private placements in digital format on the blockchain, run a digital securities operating platform, and perform investment advisory and secondary market trading through an alternative trading system (ATS) in the United States.
Johnson explained how the firm is very focused on the private markets, comparing it to the public markets. For instance, in 2019, there were USD 2.7 trillion worth of issuances in the private markets vs. USD 1.2 trillion in the public markets. Where the private markets are lacking, however, is with transparency. It’s a market that’s very opaque and the market structure hasn’t evolved over the past four decades. The biggest evolution that they’ve seen in the private markets is DocuSign.
So Texture sees it as a real opportunity to come in and rebuild the market structure from scratch using blockchain technology. Johnson explained how the blockchain ledger can create a layer of transparency and transaction history, and they can apply smart contracts on top of that, which enables programmatic compliance.
“That’s what we’re tackling now. We’re tackling the private markets. We’re helping companies raise money by doing a digital securities offering. We can tokenize previously issued securities, so we’re basically just taking the securities and creating a blockchain record. And I think the main advantage of digital securities is in terms of the transfer of value and on the trending side. So the ATS is going to be key to a lot of our business strategy,” said Johnson.
Considering that Texture Capital only received its regulatory approval two months ago, they’ve just started accelerating their go-to market strategy. Johnson said that it’s going very well and they’re in discussions with nearly a dozen issuers about coming onto the platform. He explained that real estate is a big focus, as there is a lot of interest in real estate from companies or funds doing tokenization on the blockchain.
Real estate is a massive asset class that is global and it is also very illiquid. So the way that funds are structured is anywhere from five to seven to 10 years over which time investors are locking up their money. But the turns generally speaking have been very good.
(18:13) “There’s a lot of demand for getting into these types of investments but there’s low liquidity. So that’s kind of the sweet spot for using blockchain technology. So i think we’re going to see a lot of real estate entities coming onto the platform. We’re also seeing some interest in VC-type funds. There’s already been a few of those that are out there. But we’re targeting any type of company —it doesn’t have to be a blockchain company — to come and use this and have some transparency, be able to connect better with investors and also be able to offer secondary market liquidity to their investors and to their employees.”
Texture Capital’s Johnson described a regulatory landscape in which a crypto token can trade in Japan and Europe and in the US very easily. But it’s not the same for security tokens, which are confined by the jurisdiction they’re in. He explained how the way they behave in the US is likely different from how they behave in other types of jurisdictions.
One of the goals is to have 24/7 trading for security tokens. Many people talk about it, but Johnson believes the market is still a long way away from it. He says “we need to do the basic stuff in our own backyards first.” The regulatory environment, he adds, has been challenging and a slow process, as during the ICO craze there was a lot of focus on separating the good projects from the bad. But there’s been a lot of change lately indicating the SEC has changed its tone a little bit. He pointed to the upcoming change in leadership at the SEC and also a new Senator who was elected in the state of Wyoming, who is very pro-Bitcoin.
(21:07) “That’s going to be a very positive voice to have on Capitol Hill,” said Johnson.
He also pointed out that a lot of companies have moved offshore out of the United States, saying there was a bit of “regulatory arbitrage” going on for a while with jurisdictions such as Gibraltar and Malta popping up and being very blockchain friendly. He says that this dynamic is changing and that regulatory attitudes are improving in the United States.
(21:35) “They’re getting more comfortable with it. It’s never going to be a revolution, it’s going to be an evolution. And we’re happy that we’re part of that system where there are regulators, and we want to work with them to bring this whole space forward,” said Johnson.
He also discussed the ecosystem that Texture Capital works with to make all of the magic happen, pointing to custodians and transfer agents as being key. He explained how transfer agents record the official ledger of ownership, and you’ve got to have one of those involved in the US. Otherwise you can’t do it. While many people say the blockchain is the record of ownership and ‘let’s use that,’ Johnson says the industry isn’t there yet.
Custodians are another key feature, and this has been an area in which regulators have struggled. If you think about bitcoin, he said, you can custody it on your private key. But if you took that framework into security tokens, it introduces a host of questions: What if other people had the private key? How can you be sure that it’s safe? As a result, you need a completely new framework for custody that’s different from crypto and different from regulated securities when you’re dealing with security tokens.
(23:04) “That’s actually been one of the things slowing development down in this space. The good news on that front is that the DTCC seems to be making moves into this space…That’s another thing we need to have. It’s not just companies like Texture. We can’t do this on our own. We need the market infrastructure players around us to move forward. That’s how we will get take-off in this space,” said Johnson.
Texture Capital built out all of its own technology though they are not a tech company, they’re a broker dealer. They can issue tokens on the Ethereum blockchain, but they are blockchain agnostic. They are talking to some other blockchains about possibly supporting them. They are also agnostic when it comes to token providers. So if somebody wants to issue a token that’s securitized, they want to trade that and get it into their ATS and figure out a way to trade it.
Texture is focused on equity, given that one of the key features to have is liquidity. There are other players in the space, however, that are looking to fixed income, though he is doubtful about this asset class given the amount of liquidity that is available in the private markets. Johnson explained how at some point in the future, Texture hopes to integrate stablecoins.
(27:39) “We really want to innovate here and if we have a security transaction go off in the ATS, then to be able to settle that instantly, delivery vs. payment in an atomic transaction vs. the stablecoin, it will be a huge development. So that’s definitely on our roadmap for 2021.
Overall, Johnson said they don’t expect the private markets to be as liquid as the public markets but more liquid is a big improvement and can really transform how capital is allocated throughout the economy.