2021 Dialogue: DPO (Direct Public Offering), STO, and DeFi Will Overlap
January 11, 2021, Mr. Yan Meng, the initiator of China’s token economy and researcher on token economy and open finance, and Mr. Doer Qu, the founder of Magic Circle, had a discussion on DPO, STO and DeFi. Please refer to the original article below!
The Author: Yan Meng, Doer Qu, Xian Yu
Meng：On December 22, 2020, the U.S. Securities and Exchange Commission (SEC) announced its approval of the NYSE’s proposed Direct Listing Process (DLP), also known as the Direct Public Offering (DPO). It is also more popularly known as, the Direct Listing Program or “Direct Public Offering (DPO)”. The proposal’s main point is to eliminate the intermediary role of underwriters from the traditional IPO process, so that the price of shares on the listing day will no longer be determined by negotiations between underwriters and companies, but will be completely determined by the market. The SEC’s decision means that the rules of the secondary market will be broken before they are established. Professor Jiaming Zhu said“The ‘stand-up’ plan should have been prepared long ago. This sharp turn has put emerging markets in an unprecedented passivity.”
This major change comes at a time when crypto-digital assets are experiencing another huge explosion in three years, with the total value of crypto assets having reached $1.1 trillion, far surpassing the previous high in January 2018. At the same time, the DeFi market, which has been exploding since June 2020, has continued to grow at a rapid pace, with the total value of lockboxes increasing 33 times in seven months, making them one of the fastest growing segments of the digital economy. Of course, all of these things are tied together with the political turmoil following the US election, the currency flood in the midst of the pandemic, and the unexpected shift in attitude of regulatory authorities towards digital finance, which was dizzying for a short period of time. Nonetheless, we need to try to understand as much as we can and make a realistic analysis and prognosis of the relationship between them, especially the future trends and possible implications.
So I invited Mr. Doer Qu, the founder of Magic Circle, to study and discuss this matter. Mr. Qu has been my friend and partner for many years and is one of the most well-researched and experienced Chinese people I know on STOs. He is also very familiar with the traditional securities market, so he is the ideal person to discuss this issue. We are recently working together on the STO and token economy project with HGC Information Technology Co. Ltd., a Chinese SaaS company in the road freight industry. So, I asked Mr. Qu to have a long and in-depth conversation with me, and put together a text to share and discuss with the community.
Special thanks to Professor Jiaming Zhu of the Chinese Institute of Digital Assets (CIDA) for reading this article and writing the introduction.
I would like to also thank Dr. Qing Shao, Vice President of the Chinese Institute of Digital Assets (CIDA), who reviewed this article and my colleague, Xian Yu, who helped with the copyediting.
Professor Jiaming Zhu — Chairman, The Academic and Technical Committee of the Chinese Institute of Digital Assets (CIDA)
Professor Zhu：At the end of 2020, the U.S. SEC announced the approval of the NYSE’s “Direct Public Offering (DPO)”. On the same day, there was a lively discussion on this topic internally at the Chinese Institute of Digital Assets (CIDA). In my opinion, this approval was a major event in the modern history of finance, meaning that the new rules for secondary markets on a global scale were “broken before they were established”. However, perhaps because of the events that have followed, it seems that the domestic and international financial community has been significantly slow and inadequate in recognizing and reacting to the meaning of DPO. In particular, it should be noted that at a time of accelerated transformation of financial structures and systems, few traditional financial experts are able to understand the logical and practical relationship between DPOs and STOs, as well as DeFi, due to the rise of digital currencies.
Therefore, the dialogue between Mr. Yan Meng and Mr. Doer Qu on DPO, STO, and DeFi is of special significance. In it, the following four statements by the two authors are particularly worth noting: (1) DPO and STO are like two dimensions, opening up two new spaces for future innovative enterprises that are both different and accessible to one another. (2) Decentralized token financing, including “Safe Harbor” solutions, is likely to be a model for the evolution of the financial system. (3) STO and DeFi are complementary, and their combination will help each other mature and develop. (4) Due to the interpenetration of traditional and digital finance, global securities regulatory thinking and institutions are facing unprecedented changes.
For the foreseeable future, the holistic relationship and impact of DPOs, STOs, and DeFi will not only change the financial infrastructure, but help weaken and stop the super oligopolies that result from the integration of finance, technology, markets, and capital.
Finally, I believe that readers who care about the digital economy and the democratization of finance will appreciate the insightful dialogue between the two, as well as its academic and intellectual nature, which will help them face and participate in the increasingly unprecedented changes of the century.
1. The History of DPO
Meng: First, what is DPO? According to my research, the term DPO is not new, as IPOs and DPOs have long been listed in the U.S. as two ways for companies to go public and raise capital. The key difference between these two models is that an IPO requires the involvement of an underwriter, while in a DPO, the company goes public directly without the role of an underwriter. What do you know about the background of DPO?
Qu: In fact, DPO has been used in the United States for a long time, but the connotation is very different from the DPO plan approved by NYSE this time. Earlier DPOs only allowed companies to trade shares held by existing investors on the exchange, which means they could only sell old shares after listing and could not issue new shares through DPOs. The most famous cases are Spotify (SPOT.US) in 2018 and Slack (WORK.US) DPOs in 2019. The purpose of participating in such DPOs is to increase the liquidity of the shares held by shareholders, not to raise new capital. So at the time, such DPOs were more for the benefit of the shareholders and not very attractive to companies.
The DPO program approved by the SEC allows companies to issue new shares as part of the direct listing process, rather than just circulating shares held by original shareholders, which means they are allowed to raise money directly from investors. This is a revolutionary breakthrough, because it improves the pricing mechanism of IPOs. In the traditional IPO process, the investment bank (underwriter) would generally set a price with the issuer (company), who would generally not understand the buying demand of the capital market. So, the issue price is determined based on negotiations with the underwriter, and this price was generally artificially lowered by the underwriter. The company actually sells its shares to the underwriters and obtains financing from them. Then, on the day of the IPO, the shares purchased by investors on the exchange are actually sold by the underwriters. According to IPOScoop’s data and Reuters’ calculations, in 2020, the price of a newly listed company’s stock rose by an average of 38% on the first day of trading, meaning that the intermediary (underwriter) made 38% on the low risk, leaving the risk to the average trader and taking a large chunk of the financing company’s earnings at the same time.
There was a real case that caused a big stir at the time. After Dangdang’s (NYSE:DANG) IPO, its Chairman Mr. Li took to Weibo (China’s Twitter-like social media platform) to challenge the JP Morgan executive in charge of the IPO. Their war of words on the internet exposed to the public the long-standing conflict between listed companies and underwriters over IPO pricing, and it was by no means an isolated case. The passage of the DPO plan means that the intermediary (the underwriters) between the company and the public market investors has been removed, eliminating the possibility of underwriter arbitrage on the first day of the offering.
Meng: I can understand it as eliminating the information asymmetry between companies and market investors, thus advancing the market towards more efficiency, right?
Qu: Yes, it’s worth noting that the SEC had a tough time passing the proposal; why is that? Because DPO does not have a lock-up period for old shareholders, and it was a full flow-through. The vote ended up being three to two. Opponents believe that under the DPO mechanism, old shareholders may be motivated to commit fraud or maliciously inflate the market price. On the other hand, supporters believe that only a full-flow market can truly achieve fairness. In the case of limited supply, prices are more easily manipulated, which is not conducive to investor fairness. In addition, after NYSE, NASDAQ also submitted a similar DPO proposal on the same day. Unlike NYSE’s proposal, which took six months to be approved, NASDAQ’s proposal requires immediate effect.
Meng: So you think the NASDAQ proposal will be approved, right?
Qu: Yes, there are more innovative companies on NASDAQ than on NYSE, and DPOs offer a very friendly and attractive way for these companies to raise capital. I believe DPO is a very promising financial innovation.
Meng: When many people heard the news, they interpreted the DPO program as a lowering of the threshold for companies to go public and thought that the U.S. stock market would be “open for any kind of business” in the future. What is the actual situation?
Qu: In fact, the listing standards have not changed and the threshold has not been lowered. The NYSE has established minimum listing requirements specific to direct listings, and any company making a direct listing must also meet the NYSE’s listing standards. For example, companies using this method of accessing the public markets must sell at least $100 million of newly issued stocks in a direct listing or have a combined public float of at least $250 million of newly issued and existing stocks, in addition to operating income and profit requirements, which are not much different from a traditional IPO. In addition, taking a DPO is subject to SEC processes and standards, including disclosure of audited reports, etc.
Meng: In 2019, the digital currency world was once popular with so-called “initial exchange offerings”, or IEOs, where projects were listed directly on exchanges without an ICO and project owners raise money through the secondary market. Many people think that a DPO is a SEC-approved IEO, what do you think of this idea?
Qu: There are similarities and differences. In a traditional IPO, the direct source of funds is the underwriter, whereas in a DPO, the fundraising venue is switched to an exchange, so the fundraising venue is indeed the same as an IEO. But the differences are more substantial and important — DPOs are regulated and require that at least 400 investors have already purchased the company’s shares. Regulators need companies to ensure that the source of financing is sufficiently diversified to show that the company is widely accepted by the market, thereby reducing risks such as financial fraud. So overall, it is not feasible to compare DPOs to IEOs in the cryptocurrency world.
2. STO vs. DPO: Friend or Foe?
Meng: Let’s discuss the relationship between STO and DPO. You are an STO expert. In the beginning, a lot of people focused on STOs, but in 2018–2019, STOs were too weak. The trading volume was barely anything, and a lot of people exited the space. I know you’ve been in the blockchain industry since 2014 and have focused on STOs since 2017. I don’t think this is anything great, but what’s great is that you kept going, and didn’t retreat even in 2018 or 2019. Why do you believe STO has a future?
Qu: STO has its unique advantages and it is an essential tool for the democratization of finance. Its potential is fully evidenced by ICOs, and the main directions to address are: issuance compliance (to prevent fraud and inducements), and transaction compliance (to prevent market manipulation), which are essential to protect investors and trading fairness.
To be specific, firstly, STOs change the traditional way of expressing securities. They can run on a global public chain and trade 24x7, enabling them to circulate globally across borders and exchanges, which allows companies to reach a wider range of investors and have fair competition within a larger market.
Secondly, compared with traditional securities, the properties of ST (security token) are more flexible and diversified. It can be a hybrid form; the most common one is both security token and utility token, which is the most common form of ST in STO cases. The application scenario of traditional securities is very limited. For example, securities cannot be used for corporate eco-incentives. STs can be used as eco-incentives for the token economy, an area where you have a lot of say. This is a very practical application.
For example, in Japan, listed companies often give shareholders gifts, such as a free train voucher if you buy shares of a railway company. If you buy shares of Tobu (Tobu is a very large conglomerate), then you can get coupons for Haruka Tower, group restaurants, Tobu department stores, supermarkets, convenience stores, etc., because each company has special shareholder benefits. Some people may buy shares not only to obtain interest, but to be able to enjoy shareholder benefits.
This provides a glimpse of how other benefits attached to a stock can be an effective way for companies to attract investors. ST is able to combine a stock with such type of coupons to extend equity incentives to the entire ecosystem, which is difficult to do with traditional stocks.
Thirdly, ST can express direct ownership. Traditional securities require intermediaries to complete a series of processes such as registration and clearing, and users do not actually hold ownership of the securities they purchase. ST returns direct ownership to the individual, which means that any peer-to-peer transaction can be circulated, and cross-exchange and cross-country is not a problem.
Meng: In the past, I have elaborated more from the technical perspective on the superiority of tokens over traditional securities features, such as the token enabling smaller units and more precise payments, such as micropayments and stream payments. Now, it is not only on the technical level, but also on the regulatory level. You mentioned securities registration, clearing, and other systems. These intermediaries exist essentially to prevent irregularities, and ST solves this problem at the compliance level, which allows us to apply the token economy with a lot less concern and fetter.
Qu: Yes, ST has built-in regulations, and any operation that is not legal cannot be executed at all. It uses technology to ensure that transactions and flows are legal and more in line with regulations than traditional institutions with layers of supervision.
Also, I don’t think STOs went through a waning phase. The reason why you didn’t hear a lot about STOs during 2018–2019 is because it was a phase of building technical infrastructure. STOs need to complete a complete logic of securities, including meeting compliance conditions, etc. This is a very complex logic that places high demands on technology. Common utility token standards, such as ERC-20, have uncontrolled transactions and flows that do not meet the requirements of a STO. Most teams working on STOs, including ours, have realized that the technical infrastructure is the foundation that drives everything, so we dived into the infrastructure development.
In fact, we have been supported by a lot of capital during this period, including SAIF Fund. In 2018 years, there were only single-digit STO cases, in 2019 there are more than 100 cases, and in 2020 there are more than 100 cases as well.The amount of STO funding has grown from a few million dollars in 2018, tens of millions of dollars in 2019, to hundreds of millions of dollars in 2020, all driven by the technology infrastructure.
Meng: The public’s understanding of the concept of STOs is still very vague, and many people think that the various compliance requirements of STOs have greatly reduced their practical significance. First of all, there is a view that the circulation of STOs will be severely restricted by “qualified investors”. What exactly is a “qualified investor”?
Qu: The restriction of “accredit investors” and liquidity are two sides of the same coin. Firstly, for risk control reasons, investors need to have a certain risk tolerance. So, it is necessary to set a certain threshold, but the higher the threshold, the less the liquidity. However, setting certain thresholds is essential for risk control. In fact, the traditional securities market also has restrictions on investor qualifications, such as income level, basic financial knowledge, and operational ability. In addition, the SEC has begun to expand the compliance investor restrictions, which means that the regulator is also adjusting the investor threshold. The regulator also sees more and more companies adopt STO and realizes that its risks are not so high. Now, the SEC has lowered the requirements for the investor’s property, but increased its ability requirements, such as investment experience.
Meng: In fact, there is no need to make a fuss about setting investor thresholds. After all, the traditional stock market also has thresholds. I personally also believe that a complete lack of rules is not conducive to the healthy development of a market.
Qu: Take our partner, INX, as an example. INX is the first company in the world to conduct an IPO by way of STO and has already completed its registration with the SEC. Its tokens will be issued on the Etherum blockchain using the ERC-1404 standard, with no restrictions on accredit investors, and can be traded on any exchange, including traditional stock exchanges.
Meng: I think it’s a major breakthrough that INX’s STs are being issued on Ethereum. Some people previously asserted that no country’s regulator would allow compliant STs to be issued on public chains, but now it seems that this argument can be put to an end. I believe that once this example is set, the majority of STs will choose public chains like Ethereum to be issued on in the future. My second question is regarding the limitation of ST to accredited investors and the number of holders, will it restrict us to use ST for ecological incentives within the platform?
Qu: In fact, this is a common misconception nowadays. While it is true that there are regulatory restrictions in our country that do not allow ST to be used as an eco-incentive, it is actually allowed in most countries on a global scale.
Regarding the number of investors, from a global perspective, there is no such problem. Only the United States’ REG-D 506 (b) limits the number of accredited investors, while most other regulations allow selling to the public. There is no limitation on the number of people, only on the financing ceiling. Of course, for reasons such as anti-terrorism, the necessary KYC / AML procedures for the necessary identification are still required, but there is no traditional limitations such as the financial requirements of investors.
Meng: Third question, we noticed that ST trading volume has been particularly low so far, when do you think this situation will improve?
Qu: In essence, this is actually a technical issue. At this stage, companies have proposed different technical solutions for STOs and are in the process of competing with different sides. Earlier, exchanges were even using different ST asset standards, and the liquidity of the market was fragmented. Cross-exchange ST trading was not possible, limiting the flow of ST transactions, and it was not surprising that the trading volume was small.
That has already started to change this year, with the first national standard for ST assets having emerged in December 2020. The U.K. released PAS19668, a national standard that will go a long way towards making STs liquid across exchanges and countries. We are already seeing examples of STs being issued in multiple locations. Besides, as you said, in the case of INX mentioned earlier, the regulatory layer represented by SEC has accepted ERC-1404, which means STs are allowed to circulate on public chains like Ethereum, which is a very positive signal. Next, other exchanges will also accept ERC-1404 in order to expand trading. In the future, we can fully expect STs to circulate among different ST exchanges, circulate on stock exchanges, and conduct P2P (peer-to-peer) transfers. Traditionally, liquidity is the depth of an exchange, but ST liquidity is the sum of the depths of the global markets. I believe that ST trading volumes will soon increase significantly this year.
Meng: In the future, it might also be possible to implement STO exchanges on DeFi for borderless circulation.
Qu: I completely agree, the combination of STO and DeFi has been one of the most exciting parts for me.
Meng: Some people think that one of the advantages of STOs is that they lower the threshold for companies to raise capital in the public market, and the arrival of DPOs will greatly reduce the attractiveness of STOs to companies.
Qu: STO and DPO are actually two different dimensions of digital finance, which do not suppress each other, but can be combined to promote one another. STO belongs to the dimension of securities expression, i.e., the capitalization and global circulation across borders and exchanges through tokens, which are free from the restrictions of a single exchange. The DPO is the issuance model dimension, i.e., the rules that are followed to achieve the transaction and raise capital. DPO allows a broader range of investors in the market to enjoy equal opportunities with traditional securities underwriters.
Meng: Then can I think of STO and DPO as two orthogonal dimensions, which can be opened up into a new space?
Qu: Yes, that analogy is very enlightening, similar to the concept of space in mathematics, and gives us a tool to think. Now there is INX, the first company to achieve an IPO with a STO, and it is entirely possible that there will be companies that achieve a DPO with a STO next.
Meng: Since DPO and STO are two dimensions, what are the advantages and disadvantages for companies to choose STO or not choose STO?
Qu: Firstly, a company using traditional securities for DPO is simply a change in the issuance model, where the securities issued are still stocks issued and traded on a single exchange (i.e., exchange dependent). STOs, on the other hand, allow STs to be listed and traded simultaneously in multiple locations and can be traded without relying on an exchange (e.g., 24x7, P2P trading) or even interoperate directly with cryptocurrencies.
Secondly, STOs offer significant cost savings. DPOs still require some intermediary costs, while STOs can reach investors directly, saving the associated costs. At the same time, compliance costs vary depending on the compliance requirements followed. For example, attorney and audit costs are significantly higher for a DPO than for a STO.
Thirdly, STOs can improve the efficiency of traditional companies going public. It now takes about 190 days for a company to go through the entire STO process, and the total cost may only be a few hundred thousand dollars, which is a significant improvement in efficiency compared to traditional securities offerings.
Lastly, is the token economy. As I said earlier, ST can be used directly or indirectly in the token economy, which is something that traditional stocks cannot do.
The president of the NYSE said DPO is a major step forward in the democratization of finance, which is an important context and aspiration. The logic behind both STO and DPO is the democratization of finance, and in this value, the two are consistent. I believe we can see a closer integration of the two in the future.
Meng: Many people think that Wall Street has already taken care of the U.S. regulators, but the regulators’ enlightened perspectives on digital assets later this year are unexpected, what do you think about this?
Qu: Going back many years in the United States, the establishment of NASDAQ — the world’s first electronic securities market — in 1971 was also a groundbreaking and adventurous attempt at the time. So the United States has never lacked the gene of innovation. In addition, this year’s series of regulatory policies is actually the result of the accumulation of time. The U.S. SEC has long invested in blockchain research, and in 2016, it spent half a year studying The DAO event and released a long report. We do not need to be too pessimistic about the U.S. regulators. They are also taking the initiative to learn new things about blockchain, and the gradual maturity of technical infrastructure will slowly allow them to put down their worries.
Also look at our country, in the early days of the internet, what seems natural to us now was also a stone-cold shock at the time. Traditional regulation is also driven by the times and technology, gradually progressing and embracing innovation.
Meng: What do you think about the SEC’s emergency shutdown of Telegram’s TON program, and the recent indictment of Ripple?
Qu: In fact, the early companies had some small original sin — they did not communicate with the regulatory level. The SEC has been guided by the principle of fraud prevention and investor protection, requiring companies to disclose truthfully, even if the risk is high, as long as the disclosure is truthful. The main problem with Telegram and Ripple is that they did not disclose as required by regulation.
Meng: So this also reminds us that companies should focus on full communication with the regulator, with truthfulness and full disclosure.
3. 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.
4. 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.
5. 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
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.
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.
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.
 Doer Qu :A few key thoughts and perspectives on STO.https://mp.weixin.qq.com/s/Vp4GtH-OdL-vFx-B5-arEw
 BSI，Introducing a cross-chain standard on how security tokens are structured and presented,https://www.bsigroup.com/en-GB/standards/pas-196682020/
 NYSE,SECURITIES AND EXCHANGE COMMISSION (Release №34–90768; File No. SR-NYSE-2019–67)
 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