03. STO and the Token Economy
Qu: I have observed that the successful STO cases so far have incorporated the idea of the token economy. You are an expert in the field of the token economy, I would also like to ask you if there are any recent developments in the research of the token economy?
Meng: Regarding the study of the token economy, the first thing is that there is an important breakthrough in theory. Recently, I have come up with a new theoretical framework for the token economy, which is also a basic analytical tool that can greatly improve the computability and applicability of the token economy, cracking some of the problems that have plagued me for many years. We can fully test this new tool in cooperating on the HGC project.
Qu: Very much looking forward to it. What are your thoughts on applying ST to the token economy and what do you see as the potential future of the token economy?
Meng: For me, one of the most attractive parts of ST is compliance, and the second is the token incentives. We can try to use a new analytical framework to think about both the business and the user sides. The act of selling ST is for the business to get additional cash assets with the newly issued equity. The ideal token solution is to achieve joint growth in cash assets and equity token market value. ST’s natural compliance properties and wider circulation allow for greater leeway in token economic solution designs. For example, ST can be used as a tool to smooth out the friction between companies and their management, employees, partners, and users, which has been an impediment to the self-reliance of many companies.
Qu: Yes, and more importantly, ST provides an auditable, calculable way to rationalize these relationships.
Meng: That is right, and also many people now only think of tokens as a financing tool, which is too narrow of a view. Tokens bridge the traditional gap between companies and eco-users, and between companies and market investors. Tokens enable micro-payments and stream payments, and enterprises can provide appropriate incentives for each user’s contribution, truly achieving a synergy between enterprises and users. Through tokens, any decision made by enterprises can get timely and honest feedback from the market, which will greatly improve the efficiency of enterprises to test the effectiveness of their decisions, and is of great significance for their formulation and suitable adjustment of strategic planning.
In the new digital economy, entrepreneurs will need to consider the impact of market capitalization at the onset of the business. That is, the evaluation of the business by all users and potential users, investors and potential investors in the broader marketplace. There is every reason to predict that future corporate CFOs will need to take a new course: the token economy and token finance.
Qu: I strongly agree with you. The current technological infrastructure is evolving and gradually, the conditions are in place for the token economy to exert its energy. The margins of the future enterprise will be broken up and will spread to a wider public.
Meng: I know you have researched and participated in many corporate ST offerings, what kind of companies do you think are suitable for this transition?
Qu: I think Internet companies can easily achieve this transformation. Internet companies are mostly platform-based users, and users are inherently part of an ecology. Using token as user incentives can effectively enhance their user outreach and achieve ecological expansion. For example, in June 2020, HGC officially entered into a partnership with our team and plans to issue its digital securities, TrucPal to global investors using a STO. The HGC project is a typical case of the transformation of internet enterprises. Its platform focuses on truck asset data management services, and through the multilateral links between the platform and capacity purchasers, capacity suppliers, product suppliers, and financial suppliers, it forms a closed loop of transactions from operation collection, financial and taxation regulation, data management to credit assessment, and supply chain finance. HGC’s ecology brings together co-builders and investors, and TrucPal represents the dividend equity of its future incomes and earnings, and can be used as an economic incentive tool. A token incentive with real value support will effectively increase the contribution of each role within the ecology, and also allow investors to be more closely integrated with the development of enterprises.
HGC is our first STO partner in China. I admire the innovative spirit and courage of the founders, and I believe that helping them implement a successful STO will not only help them achieve their goal of supporting their business expansion, but will also serve as an effective model for Chinese companies. STOs enable innovation in existing financing methods through the adoption of blockchain technology, providing an efficient, compliant, and eco-enabling way for companies to raise capital.
Meng: In the new round of digital economy transformation, I think there are only two countries with opportunities: the United States and China. The U.S. has always been open to embracing new things, and in China, we have experienced the internet era that has educated an entire generation. The digital economy is in the DNA of both businesses and the general public. We can look at a country from both a “Tao” (a Chinese philosophical concept of ‘the way’) and an “Art” (a Chinese philosophical concept of ‘the technique’) perspectives. Some countries don’t have the “Art”, so they can only follow and study it, and embrace the self-evolution of innovation as the “Tao”, while DPOs, STOs, and the token economy are breakthroughs in the “Art”. It is conceivable that in the future, countries with the right “Tao” and the right “Art” will far outweigh those with one or without either.
04. The Right Restrictions Make DeFi More Free
Qu: I have talked about this before on other occasions — the combination of STO and DeFi is the part I am most excited about.
Meng: My partner Wei Wang has made a point of dividing the financial system into two parts: “computational” and “credit”. He believes that DeFi’s contribution to the financial system will be to achieve the “computational” part efficiently and accurately. But DeFi itself will not solve the problem of credit expansion.
The privilege of traditional central banks to issue money with a choice of left-end assets is in fact the general source of all credit expansion. In the year 2020, the United States issued a fifth of its total existing currency, a privilege that many see and celebrate as resilience in response to a crisis. Personally, I am very wary of this and, at least in my opinion, this event shows that the modern monetary system has no real oversight mechanism for the central bank, which is an institutional deficiency. Any country will experience various crises in a long cycle. If each response to a crisis is used as an excuse to break the monetary discipline, then it is the same as the central bank taking the blame for the real cause. In the long run, the failure of the central bank system will be a probable event. Global central bankers with the ability to think independently should start considering how to improve or even change this system, rather than blindly defending it.
However, I think it would be a much better model for DeFi to expand credit by injecting real value from the traditional world into DeFi through STs. I would certainly expect DeFi to have not just equity tokens, but also lower risk STs like bonds. To use that framework, DeFi is focused on computability, but not credit expansion, and STOs are the perfect fit to lend a hand in this area and complement DeFi’s shortcomings.
Also, in my opinion, the DeFi world would benefit greatly from the compliance properties of ST. Being completely unrestricted has not proven to be conducive to a healthy market in the long run. The cryptocurrency market has now become a speculative market, most notably because all parties, investors, teams, and contributors alike, will sell off and crash the market as soon as they get their hands on a liquid token. This is not helpful for the development of quality projects and teams in DeFi. Startup teams want to raise money through tokens, which represent the future revenue that the business can realize. Startup teams want to “borrow money from the future” to grow their businesses, but if everyone is selling off their tokens as soon as they get them, the funding loses its meaning.
There is also the case of arbitrage by large institutions through price manipulation. I don not deny that short-term arbitrage in the market can help with price discovery, but it is hard for the industry to grow if speculation is the primary objective. Our team is also fully engaged in developing the DeFi project, and as a hands-on builder of DeFi, we want the market to have the right limits that will allow the market to shift its value orientation from speculation to investment. When we talk about decentralization, there is an original assumption: centralizing money is bad, so we want to build a decentralized world. But then we now find that decentralization leads to market degradation. Therefore, the market cries out for benign regulation, even for the so-called DeFi market.
In fact, in addition to STOs and DPOs, there is another solution that deserves a lot of attention, the so-called “Token Safe Harbor”. This is a bill led by SEC Commissioner, Ms. Hester Peirce and has been updated twice in a row in the last year and is expected to be voted on in a year or two. If passed, decentralized organizations could raise money by issuing tokens, with even more streamlined processes and requirements than STOs.
Qu: Rules on the ruins, we see that the current market has no rules of its own; we see a variety of irrational phenomena. Nevertheless, we cannot ignore that there is a rational side to human nature, except for the current speculative market environment causes it to be in a vortex. This type of environment can only lead to opportunistic behaviors.
I think the fundamental reason is that the values of the crypto world are not yet unified, except for the value of Bitcoin which is widely accepted and recognized. Many tokens are not strong enough to convince people of its value. As a result, no matter what the price of the token is, its image will not be able to change. On the contrary, in the traditional stock market, corporate stocks are volatile, but they are backed by real value, so they are much more resilient than tokens.
This again reminds me of the early days of the internet, the business model of internet companies and traditional enterprises are also very different. When people also cannot recognize it, the so-called users of internet companies have no value at all, internet companies’ stocks are similarly not accepted by the market.
Meng: Yes, I remember that NetEase’s stock had crashed to a few cents.
Qu: Yes, the turning point for this situation was when the i-mode model was launched by NTT Docomo, the largest mobile operator in Japan at that time. Also, the China Mobile “Dream Network Plan” saved the entire internet in China, combining the internet with communication channels and converting user traffic into money. Finally, people saw that the internet business model could generate value. Now the cryptocurrency market is also in such an early stage where value consensus has not yet been reached. I think that by introducing ST, real asset value may play a role of an anchor. Later, as the industry develops and improves, the market will reach a new value consensus, so that the market will also shift from short-term speculation to value investment. In terms of the recent rise in Bitcoin prices, the main reason is still the power of traditional financial institutions involved. These institutions are valued investors.
Meng: Yes, as you said, ST can bring new players to the DeFi world. Traditional institutional investors are more professional investors who distinguish themselves from the speculators in the cryptocurrency world.
05. DeFi Will be the Future of ST’s Critical Infrastructure
Meng: I have a view that DeFi will become the main infrastructure of ST in the future, I don’t know what you think, and also, will there be barriers for traditional enterprises to accept DeFi?
Qu: I agree with you, I always believe that the impact of finance on the market is divided into two parts. The first part lies in the value creation of capital participation in the product itself, and the second part lies in the innovation of trading behavior. I think the biggest driver of future financial market transaction innovation comes from DeFi. The Maker minting stable coin and Compound lending protocol from DeFi source show something very different from the traditional market, and the borderless circulation and interoperability brought by DeFi will greatly amplify the energy of ST.
As for the barriers to corporate acceptance of DeFi, the fact is that the companies I follow that are issuing STOs are all moving towards DeFi. These entrepreneurs are very innovative and have not yet to see once take the ST and never use it again. They have taken the step of STO and will continue to take the step forward to DeFi.
Meng: In addition to helping improve the liquidity of STs, I think one of the valuable aspects of DeFi is its ability to provide transparency in the entire process of STs from issuance to trading. For the user, buying a ST is an operation on the left side of the balance sheet, exchanging cash for assets. For the business, it is an increase in liabilities on the right side and cash on the left side. If all statements of individuals and enterprises, including ST algorithms, are moved to the chain in the future, it can truly achieve transparency, break the information asymmetry between enterprises, users, and investors, and realize an effective market.
Qu: Now that the technology infrastructure is gradually completed, I think both STO and the token economy have reached a critical point in time to exert their energy.
Meng: Yes, 2021 is critical.
About the Authors
Zhu Jiaming
Professor Zhu is the chairman of the Academic and Technical Committee of the the Chinese Institute of Digital Assets (CIDA) a well-known economist, has served as an economist at the United Nations Industrial Development Organization(UNIDO), and has taught at the University of Vienna and Taiwan University.
His representative works include “Structural Theory of National Economy” and “ From Laissez-faire to Monopoly: The Monetary of China -Past and Present” and “Libra: A Financial Innovation Experiment”, etc. Since 2012, he has focused on the research of digital economy, digital assets and digital currency, and has created many systematic ideas and new theoretical systems.
Meng Yan
Mr Meng is the vice president of the Academic and Technical Committee of the the Chinese Institute of Digital Assets (CIDA), the co-founder of Unizon, the former senior manager of IBM Greater China, and one of the authors of the monograph “Industrial Blockchain”. Since 2015, he has conducted in-depth research on blockchain and cryptographic engineering. In 2017, as one of the initiators of China’s “Token Economy”, he received a lot of attention. In 2018, he proposed to study “token economy” as a new business subject, and study the design methods and basic laws of the blockchain token incentive mechanism according to the practical needs of various industries independently. Since 2020,he has committed to the research and development of DeFi products.
Doer Qu
Mr Qu is a senior expert in blockchain industry and the founder of Magic Circle Technology Limited, which focuses on technology development services in the digital securities space, becoming the world’s leading blockchain services company with underlying technology development, as well as providing secure and reliable digital identity generation tool services to digital securities investors worldwide.Magic Circle is the first overseas member of Japan Security Token Offering Association（JSTOA）. He is also the founder of CryptoFin Lab, a digital securities media platform.
Reference：
[1] Doer Qu :A few key thoughts and perspectives on STO.https://mp.weixin.qq.com/s/Vp4GtH-OdL-vFx-B5-arEw
[2] BSI，Introducing a cross-chain standard on how security tokens are structured and presented,https://www.bsigroup.com/en-GB/standards/pas-196682020/
[3] NYSE,SECURITIES AND EXCHANGE COMMISSION (Release №34–90768; File No. SR-NYSE-2019–67)
[4] Magic Circle Forms Strategic Partnership with INX Limited ,an Issuer of the First Security Token IPO Approved by the US SEC https://magiccircletech.medium.com/magic-circle-forms-strategic-partnership-with-inx-limited-an-issuer-of-the-first-security-token-ab89759ebb19
[5 ]Magic Circle to Help HGC Launch the First-Ever STO for a Chinese Company https://magiccircletech.medium.com/magic-circle-to-help-hgc-launch-the-first-ever-sto-for-a-chinese-company-646643eb7430
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