In a World of Tokens, Who Needs COIN?

Coinbase hit the public markets on Wednesday, with a direct listing trading under the ticker COIN. Many herald this as the first opportunity for outside investors to get exposure to digital asset exchanges — the infrastructure at the center of the crypto revolution. But for many investors, jumping into this market happened a long time ago, via sales of centralized exchange tokens, which include high profile tokens like Binance’s BNB and FTX’s FTT. 

As institutional investors and their retail counterparts mainstreamed digital assets over the last year, exchange’s corresponding utility tokens—which give users benefits for holding them while also being a measure of the platform’s value—mooned. 

According to CoinGecko data, the category market cap is worth $117 billion. In the last year, Binance’s eponymous token, BNB, posted gains of approximately 3756% hitting a market cap of nearly $90 billion with trading volume of $9 billion. FTX, a smaller derivative-focused exchange which recently purchased naming rights to Miami’s basketball arena, has a market cap of $5 billion via its FTT token and posts trading volume of $355.5 million.

Solving problems

“Exchange tokens such as Binance Coin and FTX’s FTT both solve problems that IPOs are not yet structured to solve,” said Singapore-based Michael Conn, chairman of Zilliqa Capital. “More specifically, these tokens provide access to markets and assets that the current regulated IPO markets are not yet fully embracing on both sides of the equation.”

All the while, smaller exchanges like derivatives exchange Delta raised $5 million in a token offering led by crypto-friendly high-profile investors like Sino Global. 

So why is Coinbase pursuing a direct listing when token sales seem viable from both a retail and institutional perspective?

“There are advantages and disadvantages to a token sale versus IPO and equity offerings,” Sino Global’s Ian Wittkopp told Blockworks. “From the project perspective when compared to an IPO or significant equity round, token raises are also often easier to execute which is important for projects in a bootstrapping phase.”

Investor alignment is also a driver toward token sales, said Whitkopp. 

“Token funding models share the platform value with users who are driving that value; IPOs largely have not been able to create a similar type of incentive alignment,” he said. “Now investors can purchase exchange tokens which accrue value as trading volumes of the exchange increase.” 

Zilliqa Capital’s Conn said that a “well-planned” token offering that brings in ‘new’ institutional money on the back of a business that is in demand “can certainly raise in the hundreds of millions to potentially even over a billion dollars in a single offering.”

“We’ve seen early-stage token rounds oversubscribed by five times or more; this is because the combined market cap of crypto assets has risen significantly meaning that current investors have more to invest,” added Sino Global’s Wittkopp.

Not entirely smooth sailing

Despite a bull market, plenty of precedent of token sales closing with well-known funds participating, there are also downsides and challenges to this model. It’s not entirely smooth sailing. Investment mandates of many institutional investors do not allow token investments, Wittkopp explained, with one reason being tax complexities for some fund’s limited partners.  “Projects that are looking for strategic investors with more traditional backgrounds may find themselves unable to onboard these partners,” he said.

Braden Perry, a former CFTC enforcement attorney and a partner with Kennyhertz Perry, said a big barrier for companies raising capital through token listings and investors jumping onboard is the shaky regulatory ground they operate on in the US.

“There is currently no generally accepted, standardized model, and each token offering has unique aspects,” he told Blockworks. “Regulatory analysis must be conducted on a case-by-case basis, and the laws of the jurisdiction in which the entity issuing or generating the tokens is incorporated or established must be considered.”

And, of course, the laws where the token will be offered need to also be considered. This is where the age-old question of “is the token considered a security” comes into play, Perry explained, citing the case the SEC has against Ripple. While the SEC issued some guidance, although non-binding, “it gives it a significant roadmap in deciding how to apply the Howey test to digital assets like XRP”.  

“The CFTC also raised interest last year when openly questioning if XRP was a commodity. It could be the regulators are at odds as to which agency may have jurisdiction for many tokens,” he said. “The last thing any industry wants is regulation by enforcement, where agencies decide that some practices should have been illegal, and instead of declaring it illegal from now on through rulemaking.”

It’s Not For Everyone, Yet

Despite the challenges, Zilliqa Capital’s Conn points to regulatory burdens in the public market as creating a hostile environment for companies in the industry — which creates demand for alternative vehicles like exchange tokens. 

“Despite the fact that you have companies, such as Coinbase, now going public, the vast majority of crypto-focused and digital asset-based businesses either have not been welcomed with open arms by the IPO markets, or the cost of doing so is too restrictive,” he said. “It can cost several million dollars to take a company public in the US in a traditional IPO — this is just not possible for most businesses.”

At the same time, there’s the question of ownership. What rights does a token confer, and how does that impact the investors’ decision to invest? This is a challenging regulatory question that needs to be treated carefully in order to stay compliant with securities laws. Having ownership of a company via a security and a token with its value tied to demand for the company’s product might seem analogous but isn’t the same in the eyes of the law. 

“With an IPO, there will be an ownership transfer from the company to the investor. With a token offering, there is no ownership transfer, which may be a positive or negative depending on the company’s outlook,” Perry said.

That idea might spook some investors, which is why Sam Bankman Fried, founder of FTX, says a big issue is just figuring out who to market this to while staying in compliance with the law. FTX’s FTT token, for instance, is not available to those residing in the US. 

“I think the big thing there is: who is your audience? Is it crypto traders, or other financial entities? If you’re a non-US based active crypto trader, exchange tokens are easier; if you’re a US-based, non-crypto-native financial institution, equity is a lot easier,” he told Blockworks. “As we start to see more of the financial ecosystem getting interested in crypto, the demand for crypto equities is going up.”