The Evolution of the Security Token Industry

The Evolution of the Security Token Industry


Adam Chapnick: Hi, I’m Adam Chapnick, with
the Security Token Academy. Today we’re pleased to bring you a corporate
member interview with Harbor. The company is a gold corporate member of
the Security Token Academy. Harbor’s an institutional-grade digital securities
platform for compliant fundraising, investor management and liquidity, powered by blockchain
technology. For investors, the Harbor platform enables
online access to quality private investments with unique potential for enhanced liquidity. Adam Chapnick: Today, we’re going to learn
more about the company, their products, and much more and to do that we go to San Francisco,
where I’m joined by none other than Joshua Stein, the co-founder and CEO of Harbor. Hey Josh, it’s great to be speaking with you
again. Joshua Stein: It’s great to speak to you again. Thanks for having me. Adam Chapnick: For those who might not know,
can you tell everybody about Harbor and why it was created? Joshua Stein: Sure. Harbor got going late 2017, and David Sacks
was one of the original PayPal founders, was raising a VC fund. He was really into blockchain technology. He wanted to tokenize the fund to enable some
liquidity amongst his investors, and as he dived into it, he realized there was no compliant
way to do that. And he said, “Aha, there’s a business here.” He pulled in me and the other co-founders
and we were off to the races. Adam Chapnick: Amazing. So over the past six months, the security
token industry has definitely evolved. Where do you think the industry’s headed? Joshua Stein: I think the industry is headed
towards something very different than what everyone had in mind, to begin with. If we go back to the very beginning in 2017,
ICOs took off. People in the security token industry, us,
a number of other platforms got started in late 2017 to early 2018. We had several ideas, some of which were right
and some of which were incorrect. The ideas that were right were ICOs would
not last forever, that the compliance issues were going to cause them to get shut down,
and those were both true. And then what we saw was a big investor demand
for tokens. The security token industry idea was, well,
if people are so interested in investing in tokens that aren’t backed by anything, not
by a contractual promise or a security writer, perhaps even a functioning software protocol,
then investors would really be interested in tokens backed by real-world assets. Joshua Stein: Harbor got started by focusing
on quality, real-world assets and institutional partners, that i.e. the highest quality segment
of that security token market that we all thought was going to come to exist. And what happened was, is the mistake that
everyone in the industry made is we thought that tokenization, the excitement around the
liquidity, would draw in investors. And so the focus was on finding people with
quality assets and compliance and getting them out into the hands of investors. What happened was that investor demand did
not materialize. Investors who are interested in quality US
real estate with 5% cash-on-cash returns, there’s almost zero overlap with investors
who were really interested in the tokens and the ICOs of 2017. And so I think what Harbor’s pivoted and what
the industry has pivoted to, but Harbor, in particular, is focusing on the needs of those
investors, the people who were investing in quality US real estate, private debt, and
those other alternative asset classes. Harbor has focused on, and we’ve revamped
our platform, to enable those folks. Joshua Stein: We went from a model of essentially
crowdfunding, plus tokens, where everything was done under the Harbor brand name, to a
white-labeled software product where the brand name and the color scheme is all focused on
that sponsor, where the same tools are available to them and they’re enabling their investors. Adam Chapnick: Let’s talk about your recent
announcement with iCap Equity. I know they’ve raised over 100 million dollars
across four different funds, with 1,100 investors. Can you tell us more about the business challenges
iCap was looking to solve with you guys at Harbor? Joshua Stein: Sure. So iCap is really interesting and I think
I would call them a reference implementation. They really show what Harbor can do and how
we’ve changed. So iCap came to us, they did not recently
raise $100 million. They’d raised that $100 million in the past,
over time. And so they had 1,100 investors, in four different
funds, that had come into them through 17 different broker-dealers and other placement
agents. They were already seeing a demand for liquidity. Their real estate manager in the Pacific Northwest,
they had extended the maturity of their funds, and so most of their investors were very satisfied
with the return that they were getting and wanted to stay in the funds. But some of their investors wanted to get
out. And so this was a world in which all the investors
had signed, everything was on paper. The investors had no right to transfer. There was no easy way to find other people
who might be interested in buying. And so they came to us and they were looking
for a compliant way to enable better liquidity. Joshua Stein: We’ve implemented the platform
with them and their investors. There’s three components to it and I’ll end
with the component that really enables the liquidity. One component of the Harbor platform is a
fundraising platform, a way to manage the fundraising process more compliantly, more
quickly, and more easily, a way to get investors through the necessary vetting checks, seeing
and signing the documents and funding. Joshua Stein: The second component is the
investor relations management piece. These individual investors and their broker-dealers
and placing agents have logins where they can see the PPM, where they originally invested. They can see their latest financial statements,
and the sponsor iCap can communicate with those investors. And then the liquidity piece, power by ERC-20
stair tokens by the Ethereum blockchain is a private bulletin board or private marketplace
system. These investors and their broker-dealers and
advisors can indicate if they want to buy more of these existing funds or if they need
to get out. Joshua Stein: Before, what would happen is
these investors didn’t have the legal right to get out. If they wanted to get out anyway, they would
contact their broker-dealer, they’d contact iCap and someone would literally write down
on a sticky and put it up on their computer monitor. And if someone later said they wanted to buy,
they’d match them up by email. Instead, there’s an internal bulletin board. Individual investors can indicate whether
they want to buy more of one of these funds or they want to sell what they have. It gets routed through their broker-dealer
or RIA, who posts to this bulletin board. People match, just like in any bulletin board
system, manually. They find somebody who they’re interested
on the other side of the trade. They arrive at terms with the trade and then
the trade goes through. Joshua Stein: It’s all electronic, it’s all
powered by the blockchain to ensure that every trade is compliant, every time. But you’re aggregating interest and you’re
doing it in a controlled fashion that’s not only compliant but meets the needs of that
fund manager. Adam Chapnick: That’s a ton right there that
you guys just figured out how to solve. I know that for a long time that’s been sort
of an obvious expectation that funds were going to need to handle all of those friction
points that you mentioned. I mean, other than the fact that you’re putting
the sticky note industry out of business, which I think is maybe the only downside here,
do you see all of these sort of private funds like this in the world eventually going to
this? Doesn’t it seem like there’s no reason not
to? Joshua Stein: I think that’s correct. I don’t think there’s a downside. Some of the nuances of why we’re offering
this and why this is attractive, I think are interesting to the audience that’s going to
be watching this video. This is on our private bulletin board system. This is not on an exchange where you have
an order book, where you have a bid and an ask, and what’s called adapter, you can see
all the orders. These things are going to trade relatively
thinly. They’re not like a public security or a Reg
A. This is not a fund manager that wants to publish their financials out to the world. Joshua Stein: What they want to do is enable
more liquidity than they have today, and I would call these things semi-liquid. We are aggregating the interest to help enable
liquidity, and we are automating. We’re taking something that used to take weeks,
now down two days, and we think eventually same-day. We’re taking a lot of the friction out that
happens administratively, but these are not public securities, and a fund manager is not
going to want their LP interests or their debentures trading in an open market with
a bid-ask and a potential bid-ask spread. In other words, they want to enable liquidity,
but not public price discovery. They want to enable liquidity amongst investors
that they know and trust. Joshua Stein: In this case, iCap is letting
their 1,100 plus existing investors trade amongst themselves. They’re allowing those BDs and RIAs to bring
in new buyers, but they’re not throwing it open to the public. They don’t want to deal with people that they
don’t know. And if new people try to come in, they have
to come in through one of the broker-dealers or RIAs that are already in there, or new
broker-dealers or RIAs that want to become part of their private marketplace. Joshua Stein: In other words, we’re providing
a technology platform, but it’s their marketplace. It’s not Harbor’s marketplace. And I think that’s what’s really important. I think eventually we’ll get to what the original
vision of the industry was, which is this vast sea of alternative private investments
being semi-liquid and findable, easily, and there’s sort of being one large pool of liquidity. But I think it’s going to take a very long
time to get there. I think the intermediate steps are for people
to be able to have liquidity in a controlled fashion, amongst a group of people that they
can trust. And they can open up who has access to it
over time. But I think what you’ll see is early adopters,
for the most part, are going to want to have that control. Adam Chapnick: That is so interesting, and
it’s something that only someone who’s dug-in and sort of gotten into the nitty- gritty
of execution would really understand, like you guys. I mean we talk about that a lot here in big
picture, but you guys have been on the ground and are seeing sort of what the rate of adoption
is going to be. To that point, do you think that these funds
are going to end up opening themselves in a white-label environment that you’ve created
to the public, or are they going to end up listing in some future situation? Are they going to end up listing on third-party
exchanges so that people have access to these investment opportunities? Joshua Stein: I think it’s going to vary by
fund manager, it’s going to vary by the structure of the investment in the asset class. LP interests in a private fund will always
trade very thinly, and that is because of the due diligence or the informational requirements
to really understand the investment to get in. Those are always going to be really high. Those are generally long-term hold investments,
so people want some liquidity, but they’re not going to be trading in or out. Joshua Stein: Also, there are tax consequences,
depending on the structure. iCap’s structure is they raised money from
investors as debt notes. So investor investing in an iCap fund has
a debenture paying a set interest rate. Those don’t have the same tax and structuring
implications that limit the liquidity, so those can trade as often as you want, there’s
no limit on the number of investors. If you think of an LP interest in a private
fund in the US, there’s what’s called the publicly traded partnership rules, that can
put some real limitations on how often this can turnover and what venues it’s in, so listing
it on exchange is problematic. Joshua Stein: I think of debt as a great asset
class just in general, on a macro level, that can trade far more often. That debt, I think will tend to list on exchanges
over time, as this builds up. I think that certain types of REITs, like
private REITs and others, and these funds, they will just tend to trade in these private
marketplaces amongst limited groups of parties, because there are sound business reasons why
these fund managers do not want to open it up to the public at large. Whereas with debt, you don’t have those same
concerns. Adam Chapnick: Yeah, I love that you’re mentioning
debt. I agree with you. I think that has a lot of potential that’s
unencumbered by a lot of the things you’re talking about. That’s a great point. Adam Chapnick: So shifting gears, what are
your thoughts on SEC and the regulations and rules here in the US as they’ve evolved to
this point? As being someone who’s really deep in it,
do you think we’re too harsh here or not enough regulation? Where do you think they sit? Joshua Stein: If I was king for a day, I mean
sure, there are changes I’d make. There are some detailed policy changes I think
could still protect investors, but really enable better private markets. But I would say on a high level, overall,
the SEC’s doing a pretty good job. From an industry point of view, they’re not
moving fast enough. They’re not being specific enough. From an SEC point of view, I don’t speak for
them, but I feel confident that they feel like they’re moving very quickly, and they’re
doing their best to help industry along. Some of this is just a necessary and inherent
tension because each side has a different job to do and different imperatives that drive
what they do. And some of is just, there’s a speed of change
whenever there’s technology-driven changes, there’s a speed there, that’s just different
for regulators, and it’s different for what the financial industry is used to. I’d say overall, the SEC’s doing a pretty
good job. Adam Chapnick: That’s great. Okay. Can you explain some of the different types
of investors that you’re coming across? What’s the profile? Joshua Stein: So I think what’s interesting
is if you look at iCap’s investors, it’s mostly individuals, some small institutions, but
it’s mostly individuals making average investments of 50, 100, couple $100,000 dollars. Those are precisely the kinds of investors
in these private placements that have to be accredited, but think doctors, dentists, lawyers,
professionals. It is a relatively large group of folks in
the US and abroad who can invest in it. I think those are precisely the kinds of people
that do need liquidity, where they’re investing to pay for their kids or their grandkids’
education. And if that fund extends their maturity from
three years to five years, or four years to seven years, that’s a big deal to them, they
might need that liquidity. I think that’s the sort of thing that iCap
was seeing. Joshua Stein: But I think long-term, they’ll
be really interesting because as you enable more liquidity, as you use technologies so
that you can break minimum check sizes, you can break the face amount of these debentures
down into smaller amounts, you allow a broader group of credit investors to come in, and
on the secondary markets you can allow non-accrediteds to get in, which I think is really exciting. In the US, after the securities are held for
a year, under Rule 144, they’re no longer restricted securities and non-accrediteds
can buy. Now, you can open this up to a broader group
of investors. I think that’s really exciting for the industry,
it’s really exciting for the sponsors, and I think it’s exciting for those investors. Adam Chapnick: Yeah, that’s definitely the
sort of Holy Grail of this whole enterprise, is trying to figure out how to unlock all
that liquidity out on Main Street, I guess is what they would say. So we’re eager to see how that plays out. On the topic of tokenization though, how does
Harbor tokenize existing cap tables? Why is that a good use case for blockchain? Joshua Stein: Well, it’s the same use case
for blockchain. I think it’s the evolution of the industry. Originally, everyone thought yelling the word
token, would cause investors to rush in. What we’ve seen is that’s not the case. So using the word token or blockchain, it’s
not a good marketing gimmick for raising money. It is a good use of the technology to unlock
or enable greater liquidity down the road. If you think about it, the liquidity in tokens
was exciting to a certain type of investor who is speculating in those ICOS or those
utility tokens. It’s not exciting to the traditional investors
coming into traditional private placements, because they’re coming in generally with an
extended timeline. They’re generally not forward adopters of
technology. Joshua Stein: Tokenizing existing cap tables,
i.e., applying digital technology to make transfers more efficient, and easy, and compliant
to exist in cap tables, is providing liquidity exactly when investors might need it. So rather than saying, “Hey, you’re going
to have liquidity down the road whether you need it or not, when you may or may not, at
some point in the far future,” and using it as a marketing gimmick to raise funds. What you’re saying to investors is, “You’re
already in this fund. I’m now enabling greater liquidity for you,
at no cost to you. I’m giving you something of value, at no cost
to you, precisely when it is that you need it.” And I think that’s what’s exciting, from the
point of view of Harbor as a technology company, is by focusing on existing cap tables, you
get out of this issue of a marketing angle and you get into applying technology at the
point of need, to people who need it and value it. Adam Chapnick: Yeah, it makes so much sense. I think as a marketing angle, the buyer has
to understand the benefit. I think that’s been a hurdle that we’ve observed
through a lot of guests recounting their stories that the buyers just had trouble grasping
the whole benefit of tokenization, but once you just hand them the benefit, they can’t
live without it, it sounds like. Joshua Stein: Well, the other thing I’d say
too though, is the liquidity benefits from tokenization, I believe in it, the industry
obviously believes in it, the people who are throwing capital to invest in the companies
believe in it, but it’s not real yet. And so it’s problematic to try and sell investors
on the story to use it, to have them invest capital in the first place, being reliant
on a belief in liquidity that isn’t real yet. Adam Chapnick: That’s a great point. Joshua Stein: Right? And that’s problematic, and that’s why investors
aren’t valuing it. There are regulatory implications, disclosure
obligations, there’s a whole bunch of things. It’s a lot easier to just go to folks and
say, “Hey, you’re going to have the ability to transfer this. The GPs going to… If you use this platform like Harbor, you’re
going to be allowed to transfer. It’s going to be a lot easier. You’re going to have to follow the securities
rules, a lot of those are going to be baked into the platform. That’s a lot better sell and in fact, if you
look at Harbor’s website today, we have scrubbed the word token. It doesn’t appear anywhere near us. The word blockchain is still there, but it’s
much more downplayed. It’s precisely because the investors, they’re
not interested in the blockchain, they’re not interested in tokens. What they are interested in is if they need
to get out, they want to be able to get out, and they don’t want to take four weeks and
a ton of paperwork and that’s what we enable. Joshua Stein: We’re not selling investors
on blockchain, we’re selling fund sponsors on a platform that gives their investor a
better experience while they’re in the fund, i.e., they’ve got this portal, they can go
in, and they can see their statements, and they can interact, and we’re providing them
a way to make transfers quicker, and more efficient and more compliant. Adam Chapnick: I love it. Given that you understand this space so well
now, for those watching, can you explain why real estate particularly is a good asset for
tokenization, and if there’re types of real estate in particular, that are ideal? Joshua Stein: I think real estate is a great
asset class because it’s so large, so fragmented, and so illiquid, and it’s also one that a
lot of the smaller end of a credit investors is very interested in. You can see that throughout a number of the
real estate crowdfunding platforms. You can see that in these syndicated club
deals, that the same group of folks will do again and again, and we think club deals is
a good market. We’re able to get 20 folks who will pool their
funds into one real estate investment, than overlapping group of 30 folks in the next
one, and overlapping group of 40 in another opportunity. Joshua Stein: Enabling liquidity in an asset
class that historically has had pretty good returns, a good risk-return profile, and that’s
very understandable to investors. You invest in real estate, you have a much
better understanding of that as the average investor and you’ve just been so illiquid. That’s in part, what has kept people out of
investing in real estate is the minimum check sizes have been too large, and you’re locked
in for such a long period of time. We provide a platform that makes getting into
the investment a lot easier from a paperwork perspective, staying in it, you’ve got this
investor relations portal, it’s a lot easier to manage those investors, whether you’re
a club deal or otherwise a fund sponsor. And then finally, that liquidity piece is
powered by the blockchain, because most folks going in, tend to hold the entire time. But everybody, but especially individuals,
need liquidity from time to time. So real estate’s a great one. Joshua Stein: Then, I think debt just generally. Debt will be more liquid for regulatory tax
and informational reasons. Debt will be more liquid because from a regulatory
standpoint in the US, there’s not a limit on the number of holders. From a tax perspective, turnover and holders
of the debts does not present difficulties or problems in the same way it does with equity
and partnerships, for example. And then finally, debt informational, it’s
a lot easier to understand the investment. With debt, you need to understand maturity,
interest rate and credit risk, and that does require a fair amount of due diligence, but
a lot less due diligence than taking an equity stake, for example, in a fund. Adam Chapnick: Yeah, that’s a great point. So Harbor was in the news earlier this year
because of a new partnership with Gemini. Can you tell us a little about that? Joshua Stein: Sure. Gemini has the Gemini USD, GUSD stable coin. We struck a partnership with them, where they’re
our preferred stable coin providers, so folks can invest in investments using GUSD, and
they can do that today if we’re the fundraising platform. If an issuer wants to extend out dividends
using our platform, they’re enabled to do it using GUSD. Joshua Stein: We chose them because we think
they are the premiere sort of institutionally-oriented platform out there in terms of stable coins. You can see it, they have had regulations
and compatibility with folks that are concerned about stability and sort of the things that
institutions need and that regulatory compliance, they’ve been leaders in the space, and so
we were very excited to partner with them. Adam Chapnick: Yeah, that’s great. Can you talk a little more about exactly what
is the role of a stable coin, like a Gemini dollar, how does that work out in a security
token use case? Joshua Stein: I think short-term, it’s a great
funding mechanism. Instead of wiring in funds, folks can use
Gemini USD and so the payment is instantaneous. You don’t have the same fees that you do with
wiring. It’s a lot easier for everyone to track and
deal with. It’s an incrementally better step than using
wires for getting into an investment. Unlike using Bitcoin or Ethereum, there isn’t
that currency risk. If someone’s investing into investment using
Bitcoin or Ethereum, someone’s taking currency risks because that fund manager is investing
using dollars or some other type of fiat. So, either the fund manager takes the currency
risk or the investor takes the currency risk, but somebody’s taking that currency risk. With Gemini USD, you don’t have that. Joshua Stein: But I think what’s interesting
is in the future as you get more and more adoption of blockchain technology, as the
UX and UI gets much better, I could see distributions happening using GUSD. So if you think of an iCap for example, as
they allow lower and lower face sizes for these debentures and they trade more and more
often, there’s practical logistical limits to that today because you have to generate
ACH payments or wire payments to make all those monthly interest payments. If say, for example, you lowered those face
amounts to $1,000 and you’re making interest payment of $10 bucks a month, that’s not economical
to do via wires. Even doing ACH, then it becomes logistically
difficult to track all these people, to do withholdings, and to send all the payments
and take the charges. Joshua Stein: A world in which you can do
all of that on the blockchain, at almost zero transactional cost, is a world in which you
can lower the face sizes, more folks can come in and invest, you can get more liquidity,
and you can more efficiently make your distributions. And so that, I think of stable coins, a crypto
dollar, being very important for that longterm vision of a more granular, more liquid, more
accessible marketplace for these alternative investments. Adam Chapnick: Yeah, it’s starting to paint
a picture of all the benefits to both of the stakeholders’ sides, really knitting together. It’s fun to hear you describe it as someone
who’s doing it. I hope people are absorbing that as we’re
sharing it because it’s exciting. As the space does evolve and become more integrated
with the legacy finance world, like we’re discussing, where do you see Harbor fitting
in among the other systems and processes in private capital markets? Joshua Stein: I think where we’re fitting
in today, so we provide a software platform on which people can conduct private placements,
their brand name, their color scheme, but that makes it all. They can raise money from more investors,
from more countries, more quickly and more efficiently because administratively, they
can process them through, they can get the compliance done, they can get people in, and
dollars aren’t slipping away because folks are balking at a lengthy and difficult logistical
process. Joshua Stein: On the sponsor side, if you’ve
ever tried to raise for more than a dozen people using manual processes, emails, you’ve
wanted to blow your brains out. It’s just too difficult. I think we fit into the current structure
today. It’s this large fragmented industry measuring
in the trillions of dollars in private capital. I don’t think we fit in, frankly in the largest
players. Everything’s going great for them today. Joshua Stein: If you’re a Blackstone, they’re
going to be late adopters of something like this, and they may or may not end up just
developing their own platform. I think if you are a small to mid-sized sponsor,
you’re not interested in spending millions or tens of millions of dollars to develop
your own platform. You’re interested in plugging into standard
technology, standard platforms, that then can plug in the way Harbor can, to that whole
Ethereum or other blockchain ecosystems, where we’re plug and play with custodians. We’re plug and play with stable coins like
Gemini. We’re plug and play with ATSs like Openfinance,
or SharesPost or others. We’re plug and play with these really interesting
technologies like derivatives with DuyDX, and margin lending with a Maker Dao, or a
Compound, or others. Dharma or others. I think that’s what’s really exciting. Joshua Stein: I think, where do we fit in
the ecosystem? We fit in with the small to midsize players,
folks for whom adopting technology early gives them a competitive advantage and providing
a better for their investors and enabling types of investment opportunities down the
road that they couldn’t otherwise offer. Because now you can break down the sizes,
and you can combine and recombine these things in interesting ways. Adam Chapnick: No doubt. So all that having been said, what is next
for you and the folks at Harbor? What goals did the company have, as we look
ahead at a 2020? Joshua Stein: Right now, I think we’re facing
a very different set of challenges than we were, say, six to nine months ago, but they’re
exciting challenges. The challenges before during crypto winter
or in the early part of this year was, okay, where is adoption going to come from? Now what we’re seeing is, we think with the
private marketplace concept, with taking out the hype around blockchain, but focusing on
the actual value that’s delivered to the fund sponsor, the investor, we’re starting to see
real adoption. Joshua Stein: I think the challenges are all
around scalability and standardization and we’re excited. We think what you’re going to see initially
are these silos of liquidity, these fund sponsors with their own private marketplaces. You’ll see a few folks that are more interested
in publicly accessible, tokenized investments, but then we think over time, you’ll see these
start to knit together. And eventually, you’ll see that what we’re
talking about, which is that world in which the blockchain is the DNS system, it’s the
open addressable system of all these investments, and folks can more seamlessly get in and out
of them. Adam Chapnick: Josh Stein, the co-founder
and CEO of Harbor. Thanks so much for speaking with us today. We wish you and everybody at Harbor the best
of luck. Joshua Stein: Thanks, Adam. Really appreciate you having me. Adam Chapnick: Harbor is a gold corporate
member of the Security Token Academy. To learn more, go to our website, securitytokenacademy.com,
click on the directory tab, and then select, corporate member. For everyone here at the Security Token Academy,
I’m Adam Chapnick. Bye bye.

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