A look at the upcoming future of Wall Street and global finance, a summarized briefing from CEO and Founder of RockTree LEX, Omer Ozden, drawing on his 30 years of legal and finance innovation experience and spanning two of the largest blockchain capital markets, North America and Asia.
INTERNET: is the “digital transfer of information and communication”.
BLOCKCHAIN: is the “digital transfer of value”.
If you do not already understand this, stop reading. This article is not for you.
So far, we have had four major applications in Blockchain. Through technology, these early applications are already disrupting the way the Finance world conducts transactions. The first was 10 years ago with the ingenious invention of Bitcoin. The second was ERC20 (Ethereum) and smart contracts. The third, we believe are Stablecoins. And now, we already started our path to the fourth major disruptive application: the Digital Representation of Securities. Some people call these “Security Tokens”, or “Digital Securities”, and many of us in the United States call this “Wall Street 2.0”. There is a complete transformation of how transactions are being conducted because of the invention and application of Blockchain. That transformation is now at our door step, and after you read this LEX View, you will understand why this transformation will be even bigger than the Internet’s “digital transfer of information”.
130 YEAR-OLD TECHNOLOGY
Although paper messages delivered manually have been around for centuries, the mass adoption of paper mail delivery for communication developed about 130 years ago. This process required a letter to be written on paper, you had to go and buy a stamp, deliver the letter to a postage office, and it took 2 or 3 weeks to deliver that communication to the recipient – and sometimes, the letter did not even arrive accurately to the destination. And although we have had other innovation in communication since that time, about 55 years ago, mass adoption of the facsimile machine began. You senior people reading this article may remember faxes. It took about 20 minutes to prepare a fax and transmit the information and for the person to receive it.
As a young University student, I remember email started developing about 30 years ago. I moved to China in 1991 to study Mandarin in Taipei, and I remember the incredible miracle it allowed for me to communicate with my Family and friends back home. Emails could be prepared, sent and received easily and cheaply in 2 to 3 minutes. What a gamechanger email was for everyone! Today, we are technologically past email. We are using peer-to-peer (P2P) communication, which is instant. In fact, I would say in China, we have graduated beyond email so that just about everyone is now using P2P, unlike other markets like the United States where many are still stuck in antiquated methods such as email, which for many purposes, is not as efficient as P2P-based messenger communication. It is only in very limited circumstances that today we utilize paper letter and stamp, a technology from over 130
years ago, for transmitting communication. Because the Internet has brought humans a geometric increase in productivity, opportunities, and wealth through the “digital transfer of information”.
PE/VC TRANSACTIONS
If you manage a Private Equity, Venture Capital, Angel, or another type of fund, or are a Lawyer, or Accountant or an Investment Banker, you will understand what it means to close a transaction. Unfortunately, we use the same technology we had over 130 years ago, similar to letter and postage stamp: Paper documents have to be signed. Paper share certificates have to be issued. Paper bank drafts (or wire transfers that sometimes take multiple days) have to be prepared as well. Everyone meets at the closing table to perform mindless manual tasks, which take up several days or even weeks of time to complete and deliver and acknowledge delivery. If you are receiving share certificates in a closing, someone has to then manually update the share ledger with the names of the new shareholders, and various other inefficient and expensive steps have to be taken that most of us in the traditional finance world have had to devote a significant amount of time and attention over our careers to manage.
However, today, with Blockchain, our technology for Financial transactions is at the P2P level. We no longer have to use 130 year old technology.
We can complete all of these steps outlined above digitally, instantly, and efficiently. Documents can be signed digitally. Settlement of the securities, whether equity, debt, real estate other otherwise, can occur instantly, and the ledger is updated automatically, and immutably on the Blockchain. Traditionally, VC transactions take days (and even weeks) to close. Debt and real estate transactions even longer. Even the most advanced electronic trading systems of major international stock exchanges operate under “T+2” or “T+3”. Many people do not realize that even with public stock exchanges, physical share certificates are being transferred with transfer of payment, similar to VC and PE private placement closings, in the background of the trades you make on the exchange (except, unlike private VC transactions, there are trust companies functioning as central securities depositories for clearing, settlement, and book entry of securities). For decades, settlement took at least a week (T+5) for the major public stock exchanges like the NYSE until the U.S. Securities & Exchange Commission (SEC) imposed in 2004 the “T+3” requirements - because of the major risks to markets that arise from delays in settling transactions – meaning, public security transactions were required to be settled within no longer than 3 business days. In 2017, the SEC imposed T+2. In China today, we are more advanced than the United States and settlement of shares and funds are generally T+1, partially because of various societal benefits that faster settlement provides the market, such as protecting against speculation, naked shorts, and other major market and economic risks (especially during periods of market volatility).
THINGS HAVE CHANGED EVEN MORE THAN JUST v.2 to v.3, It is T+NOW.
However, with Blockchain, we have the technology for T+Now. Whether it is a public transaction (such as on the Nasdaq or Hong Kong Stock Exchange) or a private transaction (such as for a VC, or a private share exchange), Blockchain technology allows for efficient instant settlement, 24/7, on a global basis, peer-to-peer, low cost, on the Blockchain. That is, Blockchain makes transactions ‘Frictionless’. Your documents can be signed and delivered digitally, your ownership of securities direct to your digital
wallet for you to own without an intermediary holding them on your behalf, your registration on the ledger is instant and immutable. Meanwhile, if a company wants to have a proxy vote, or pay a dividend, that all can be done instantly and efficiently through Blockchain mechanisms and through Stablecoins, instead of completely inefficient methods used today of preparing bank drafts and mailings to security holders that are excruciating in their backwardness. Our methods in Finance today are just as backwards as you or me trying to send an urgent written message to our Parents, who may live in another city, via letter and postage stamp. When the timing and accurate delivery of your message to your Parents are so critical, why would you ever go back to using letter and stamp that can take 2 weeks, when you can text them immediately with SMS or Wechat? In almost all circumstances, it would be stupid to use the old technology.
In Finance, we are still using this technology from over 130 years ago. Shuffling paper, delivering certificates manually, updating ledgers manually, and a whole host of other activities that are completely antiquated and inefficient. But that will soon be over. It is not a question of “if it will happen” it is only a question of “when it will happen”. And the answer is that it is happening now. It is happening fast. And as we saw from the lessons of the Internet, those that are early adopters usually win the race. It is an immense opportunity for those companies and nations that seize it. And a great disadvantage for those who lag behind.
ZHONGGUANCUN IN THE 1990s
I moved to Beijing’s Zhongguancun, the Silicon Valley of China, in 1996. We had an office at the Southgate of Tsinghua University (the MIT of China), and some of the roads nearby were still made of dirt! The Internet was starting to boom and people were talking about new exciting concepts such as B2B and B2C, amongst other internet jargon. Honestly, back in the 1990s, it was beyond many people’s imagination that B2C would work in China because very few consumers back then had credit cards, which was a major form of payment for B2C transactions, and also, I remember many horror stories from back then when someone would order an item, for example, a Palm Pilot (if you were around then, you will remember those) or a phone, and inside the delivered package the seller would deliver you a broken product, or even worse, a brick. Yet many government leaders, and business leaders in China, particularly Jack (Yuen) Ma, helped transformed the Nation so that within 10 to 20 years, China definitively has become the most advanced B2C market in the world today. What many of us in Zhongguancun could not imagine back in the 1990s became a reality, even greater than anyone’s expectation. People like me from New York, or from Silicon Valley are amazed today at how much you can do efficiently on mobile internet B2C applications in China: As we sometimes say in China “You Wenti, Zhao Taobao”!
“有问题，找淘宝”！
THE VIE STRUCTURE
About 19 years ago, I was working on the VC financings of some of the rising Internet companies in China, such as NetEase, Baidu and Alibaba, not to mention many other early-stage companies in the technology space and their IPOs. I was on the legal team that invented something known as the “Variable Interest Entity” (VIE) legal structure. Before that time, many activities in China related to the Internet were extremely sensitive. After all, we were dealing with the digital transfer of information, which for example, relates to news, media and culture. Many areas of operations of Internet companies
in places like Zhongguancun and Hangzhou were considered “grey” area under Chinese law, or even outright prohibited. For example, foreign investment into “value-added telecom” companies (i.e. internet companies) in China was 100% prohibited. China and the United States reached agreement for China’s accession to the World Trade Organization (WTO) in late 1999, and based on certain principles of the agreement, we believed China would start opening up foreign ownership of value-added telecom companies in the future (which started with China’s formal accession to the WTO in December 2001). So our VIE structure accounted for that future schedule, and other aspects for consolidating revenues and control under U.S. and other international legal and public company accounting rules, while staying within the framework of the laws in the People’s Republic of China. Our VIE structure was tacitly approved by various levels of government in China, including certain approvals for specific aspects of the structure being granted by the Ministry of Information Industry, or MII (today called: Ministry of Information Technology, MIIT), and China’s Ministry of Foreign Trade and Economic Co-operation, or MOFTEC (today called Ministry of Commerce, MOFCOM), and the approval of initial public offerings for Chinese Internet companies utilizing the VIE structure by the U.S. SEC that our legal team helped lead in the summer of 2000. This milestone allowed for foreign VC investment to legally invest into certain Internet-related and other sectors in China, and for Chinese companies to legally list on the Nasdaq and other international stock exchanges. The result was tens of billions of dollars of investment and strategic technological partnerships that helped drive the growth of Internet technology and other sectors in China.
This was a bold leap for China. And I feel honored that I was able to provide some humble small contribution to this milestone in China’s modern technological history.
In the West, we have an expression: “Hindsight is 20/20” – meaning, we can see things much more clearly with the advantage of looking back at what happened in the past. Based on this hindsight, if the VIE structure had not been tacitly approved, and the legal VC investments and IPOs of Chinese internet companies did not start in the summer of 2000 on the Nasdaq, things in China (and globally) would be different 19 years later. Or, if instead of approval in the year 2000, the VIE’s approval was delayed by one or two years, we would have entered the worst winter period of the Internet market and its likely, many of our star technology companies today in China would not have received the financings during those very cold periods and would likely would have had to wait till 2004 or 2005 when things warmed up again; and as struggling startups, many of them may not have survived. It is possible this would have set back China’s Internet industry by at least 5 years. And given the speed of Internet development, many of you Laosiji VC and PE professionals will agree with me that falling back 5 years in Internet is the equivalent of falling 10 to 15 years in any other traditional industry. Hence, speed of this process and other aspects of activities in opening up China’s Internet industry in the year 2000 turned out to be vital for the future we live in today. I personally witnessed that.
It was the boldness and long term vision of the Chinese Government that allowed for this. Plus co-operation with the U.S. Government (SEC), and the contribution of the Lawyers, VCs, technology company leaders, Bankers and Accountants on the ground, that helped with this transformation. China’s economic miracle would still be just as strong, but it is difficult to imagine without these steps of forward thinking openess and collective contribution occurring 19 years ago, that China would be the “yinxiang shijie fazhande, kaifang de Zhongguo” it developed to be in 2019. “影响世界发展的、开放的中国’’
In the late 1990s, a struggling Amazon was widely attacked in the U.S. press as “Amazon.con”, or “Amazon.bomb”, meaning, many people did not believe in it (In English, “Con” = “Fraud” and “Bomb” = “Failure”). Most traditional industry participants thought B2C and Internet companies were a fad, and worse, a fraud. Even when I went to Hangzhou for a due diligence trip on Alibaba back in those days, none of us fully understood what the business was. The potential scale and application was beyond our comprehension. But with “Hindsight being 20/20”, even with all the massive hype there was about the possibilities of the Internet that we heard in the 1990s in Silicon Valley and Zhongguancun - about how “the Internet will massively transform our society and have an immense economic impact on our future”, Internet technology and these early stage Internet companies 10 to 20 years later all overdelivered on their promises! The resulting growth and influence to make our economies, efficiencies and societies better were beyond any of our expectations back then.
LAW = TECHNOLOGY
LEX believes that in Blockchain, Law = Technology. As with the development of the VIE and other structures and legal concepts that helped transform China’s Internet industry, such as Anti-Dilution protections, Preferred Equity, ESOPs, ROFRs, and the promulgation of laws by various levels of Government etc., the development of legal technology is playing a central role in the development of Blockchain. One of the very clear major global trends in Blockchain is increasing regulation. And LEX believes that with increased regulation in Blockchain, there will also be increased institutional participation. Simply put, increased regulation means the Big Money will participate. This is a very good development for the Blockchain industry because it will help solve many of our challenges, such as Big Money liquidity, adoption, and the professional/responsible development of Blockchain projects. Governments are embracing Blockchain with supportive regulations, projects are becoming more compliant, and now more and more Big Money institutions and companies are entering the sector. Major governments, investors and institutions see the same hallmarks and trends they saw in the rise of the Internet, and they would not employ this much time and resources if Blockchain was simply a “fad” or a “fraud”. Just ask Mr. Jamie Dimon, who released JPMorgan’s Coin early this year.
And it is this process of increased regulation and the related institutional Big Money participation that we move from “Wall Street 1.0” to “Wall Street 2.0”.
UTILITY TOKENS vs. SECURITY TOKENS
Many people equate Blockchain with only Bitcoin and ICOs (ERC20). Yet Blockchain is the “digital transfer of value” and there will be many applications arising over the coming years to transform how we conduct “transactions” that are infinitely greater than just these two applications.
ICOs were largely the offering of “Utility Tokens” (sometimes referred to as Alt-Coins). “Utility Tokens” are for usage – they are supposed to be sold and purchased in order to gain access to a utility or services within a platform – somewhat similar to when you purchase a gift card at Starbucks which has credits on it to buy coffee or food. When properly structured and used, they are usually not regulated by securities laws in most countries. They are like a forward sale of services or products, categorized as sales revenue for accounting purposes. However, many Blockchain projects over the past few years used “Utility Tokens” for the purpose of raising capital, investment, with the purchasers of the Utility Tokens
expecting to make a profit off the efforts of the project team. Many of these Utility Tokens did not even have a proper “use-case”, that is, there was no store selling coffee or food or any other service. Many just involved a whitepaper with an idea for usage in the distant future. When tokens are generated in this way, Utility Tokens are considered to be regulated under “Securities Laws” in some jurisdictions such as the United States, because their purpose is investment and profit, not utility.
“Utility Tokens” are a critical part of many Blockchain ecosystems, when used properly. And their proper use will bring back the popularity of “Utility Tokens” in the future. However, it will be difficult to return to what we experienced in 2017 and 2018 when projects were using them for the sole purpose of raising capital, investment and expectation of profit without a proper “use-case”.
It is the LEX View that ICOs were a signal of what is coming in the future world of Finance. They were a small “Blip” on the radar screen that showed us the massive transformation that is coming in the years ahead through the power of Blockchain technology to bring an efficient, frictionless system to Financial transactions. Large institutional investors with Big Money are responsible to their LPs, and cannot trade on unlicensed exchanges, nor can they invest in projects that are not legally compliant. As token exchanges obtain licenses to operate digital security trading, and projects become compliant under securities laws, then the larger Big Money investors will enter the market and bring waves of liquidity that will dwarf what we saw in the “Blip” of 2017 and 2018.
WALL STREET 2.0
Security tokens are simply just another application of Blockchain, allowing for the digital representation of securities on the Blockchain that are generated and distributed in a legally compliant manner under existing securities laws. Securities laws that have already existed for decades, in most jurisdictions.
RockTree LEX is working with projects that are building the infrastructure for Wall Street 2.0. For example, our client Sharespost from Silicon Valley is a regulated market in the United States for investing and trading private shares of unicorns such as Tesla and Facebook prior to their IPO, as well as for investing and trading the new wave of security tokens that are just starting to list in the United States in 2019. It is licensed by the SEC and the Financial Industry Regulatory Authority (FINRA) in the United States as an Alternative Trading System (ATS), similar to Coinbase and tZero, which are trading markets limited to accredited investors. Yet Sharespost recently received similar approvals from the regulators in Singapore and Dubai, and has applications pending in Hong Kong, so it is anticipated to be the first truly global Security Token market place and exchange operating in North America, Asia and the Middle East.
A key takeaway for VC and PE fund managers is that through a licensed trading platform like Sharespost, and the rise of security tokens, early stage companies can start to trade amongst accredited investors (wealthy and sophisticated investors that meet certain regulatory standards and KYC requirements) well prior to IPO. High growth companies can issue security tokens at an earlier stage, such as at Series B or Series C funding, which provides liquidity for VCs and other early stage investors, thus reducing significant risk of your Angel and VC investments in the future. Exits that normally took 6 to 10 years under current systems through IPO or trade sale, can be available in 1 to 3 years on security token markets like Sharespost. Another advantage is that a wider-base of accredited investors can have access
to high growth projects, instead of the same group of the top 20 to 50 famous VCs and Angel funds investing into each and every deal. This provides high growth projects access to a wider base of capital, and funding on a global basis, which was made evident by the Billions of dollars made available for early stage companies through ICOs in 2017 and 2018; During this period, ICOs raised more money than traditional VC for early stage companies, and the largest offerings, like EOS raising $4B and challenging the size of the largest IPOs underwritten by the major investment banks during this period. We should be clear in this LEX View, that with security tokens, such offerings and their resales should be conducted in a regulated way, such as on regulated markets with licenses, and with regulated projects that are compliant under already established securities laws, unlike how many ICOs in the past were conducted. Yet our main point is that it was the power of frictionless Blockchain technology that allowed for this liquidity, which we call on Wall Street the “Democratization of Investment”; wider access to quality projects and more liquidity through technology. Furthermore, all the mindless work and expense dedicated to closing transactions like they have been conducted for decades via paper can be efficiently, cheaply, and intelligently conducted digitally.
Meanwhile, another of LEX’s projects, Infinigon from New York is building the new Blockchain for the Financial world. The founders have already built high frequency digital trading systems for the major exchanges and investment banks for the past 25 years, including Morgan Stanley, TD Securities, Chicago Board Options Exchange (CBOE), and New York Stock Exchange (NYSE). They also invented and hold the patent for the first electronic ETF. Now they are taking their digital trading systems, and building the first-layer protocol combining both Blockchain and Artificial Intelligence for a multi-tiered Blockchain that meets the extremely high standards of security and scalability needed specifically for the financial world to run Trillions of dollars of transactions – just like their current non-Blockchain digital trading systems already run. The trading systems built by Infinigon’s founders have never been hacked in 25 years, which is the standard needed by major hedge funds and investment banks to trust their Billions of dollars.
Many of those in the crypto world wonder why many of the major investment institutions have yet to enter trading on the Blockchain. One answer is that projects and markets/exchanges need to be regulated and licensed, for which Sharespost provides a solution for the future. The other answer is that current Blockchains lack the security and scalability required to run Trillions of dollars of transactions, for which Infinigon is building the solution for the future, because they have already built the digital systems these major institutions trust and use today.
These are some of the exciting infrastructure projects that are emerging to transform the Financial world into a secure, scalable and legally compliant Wall Street 2.0 that Big Money can enter.
How long will it take securities to move from the 130 year-old technology of paper securities and manual ledger to the technology we posses today of digital securities, P2P on the Blockchain? It may take 20 years, it may happen in 10. It may occur as fast as 5 years, or possibly even sooner. Delaware, the U.S. state that most corporations domicile in the United States, already allows for the issuance of digital securities under their laws. I recently asked the Nasdaq how long it would take. I told them that I predicted that Nasdaq would establish their security token exchange 3 years from now. Their response was that 3 years is way too conservative! They are moving much faster than that and expect to open it significantly earlier. Because, as they said to me, they have to embrace Blockchain technology and security tokens, or be eliminated.
How big will this transformation of Financial transactions be? As mentioned earlier, it is the LEX View that what transpired recently through the application of Blockchain with Bitcoin and ICOs are a “Blip”: they are a signal of the future to come. Over the past three years, we saw token offerings raise more capital for start-ups than traditional VC. We should remember that it took Internet companies decades after the invention of the Internet to start generating income. It took Blockchain companies less than 5 years to do the same. It took Internet companies years, or even decades, after their establishment to achieve profitability. It took some Blockchain companies only months to achieve profitability. There is a complete transformation of how transactions are being conducted because of the technology we now posses. That transformation is occurring now, and is bringing a paradigm shift to Financial markets and our economies. This LEX View only discussed a small portion of that transformation related to VC investment in high growth companies, but we have not even touched upon bonds and debt, derivatives, and the largest and most illiquid asset class in the world, real estate. These markets will all be transformed and redefined by Blockchain technology over the next decade, but those applications are for discussion 2 or 3 years from now; It is the Lex View that security tokens for high growth companies and trading thereof are the next major disruptive application. And although the transformation we saw from the Internet’s digital transfer of information was big, the transformation of transactions and how that impacts our economies, wealth and efficiencies will even be bigger. Because the digital transfer of information is certainly big and valuable, but nothing is bigger and more valuable than the digital transfer of value. Welcome to Wall Street 2.0.
Omer Ozden Bio:
Mr. Omer Ozden is CEO and Founder of RockTree LEX, a legal and finance professional service platform focused on the blockchain industry. Mr. Ozden is also co-founder and International Expansion Partner of UCommune, China’s largest co-working company with over 200 locations globally, Partner of DGroup, and its investment arm, DFund, one of the most active Blockchain cryptofunds in Asia, currently invested in over 70 blockchain projects, as well as International Partner of ZhenFund, China’s top Angel investment fund. Mr. Ozden is an international securities lawyer and former Partner with Baker & McKenzie LLP in New York and associate with Morrison & Foerster LLP in Hong Kong. His career spans over 450 transactions totaling over $30 Billion and includes venture capital investments, initial public offerings and other transactions for such companies as NetEase, Alibaba, Baidu, New Oriental and Facebook. Mr. Ozden was on the legal team that invented the Variable Interest Entity (VIE) structure, which opened up China’s internet industry to foreign investment and overseas public listings.