Atomic Capital pioneers full-service model for security token offerings; secondary trading advances but may take longer
Friday, May 31, 2019
By John Hintze
The general buzz around blockchain revolves around its long‐term potential to disrupt or displace traditional business processes or transaction flows. The near-term reality is that building blocks and incremental steps must come first.
Alexander Blum is driven by a belief that “all securities will be held on blockchains,” and that the distributed ledger technology will ultimately replace Wall Street infrastructure. The early steps that his blockchain capital markets venture, Atomic Capital, is taking are those of a traditional broker‐dealer.
“We're doing what regular investment banks do, but we have more software expertise,” said Blum, CEO of the New York firm, which officially opened in June 2018 and in October said it raised $3.4 million in digital equity on its Helium issuance platform.
“We fund‐raise, and on the front end we get clients to market, both on the technical side and structuring the offering,” Blum explained.
Entering the blockchain space in 2013, Blum said he worked as a consultant to a venture capital firm and others on projects that included setting up a bitcoin mining operation and a hedge fund trading cryptocurrencies in secondary markets using artificial intelligence. He added that an earlier experience in the Peace Corps working with indigenous populations instilled a personal aspiration to facilitate access to money and financing.
Atomic Capital is currently focusing on two services: high loan‐to‐value (LTV) credits to participants in cryptocurrency markets; and enabling companies to issue security tokens, which derive their value from an external, tradable asset and are subject to federal securities laws.
On the issuance front, Blum said, the unique dynamics of the cryptocurrency markets require Atomic Capital to be particularly mindful of which issuers can successfully sell security tokens, and to provide hands on support.
At the start of this year, Atomic announced a security offering to fund a specific pharmaceutical product under development by biotech company Agenus, which trades on the Nasdaq market.
“Today, by announcing the first of its kind asset‐backed digital security offering in health care, we open the doors for a transformative financing vehicle,” Agenus chairman and CEO Garo Armen said in a statement. “We believe this unique structure will pave the way for allowing targeted investment by qualified investors in the development of therapeutic products.”
Each token issued represents a portion of the potential future U.S. sales of AGEN2034, an immune‐oncology therapy in clinical trials. Up to $100 million in anticipated proceeds will support development, commercialization and distribution.
If it does not gain Food and Drug Administration approval, Blum said, the tokens invested in by accredited investors “convert into the public equity of company, so there is some protection for the investors. In biotech especially, money is hard to come by. So we're moving forward with other companies in this field who are interested in this model.”
Agenus is taking advantage of Atomic Capital's three capital‐raising services: Oxygen provides guidance and expertise to pursue a digital securities offering; Helium the legal and technical structuring of the securities and integration with escrow, custody and secondary market solutions; and Nitrogen the marketing of securities to investors through FINRA‐registered broker‐dealer LoHi Securities.
The Reg D private placement will become available to trade in the secondary market as early as six months after the offering closes.
Clients in Banking, Ad Tech
Blum said Atomic is considering upwards of 600 proposals from companies interested in pursuing similar offerings. One that it is currently working on is an $8 million offering, yet to begin, for a new U.S. bank that, according to Blum, provides services similar to U.K.‐based fintech and payments company Revolut.
“Because it's a bank, people trust it more, and their accounts are insured,” he said.
Atomic Capital is also working on a $25 million Series A funding for MadHive, which uses blockchain technology to record ad placements and ensure there is no fraud.
“It did $8 million in revenue last year, and more than $9 million [as of mid‐April] this year,” Blum said of MadHive.
Atomic Capital's fintech competitors tend to focus on the software component, Blum said.
One exception is Overstock.com's tZERO, which is developing a trading environment for security tokens. It, too, has raised capital by issuing its own security tokens, and accredited investors have been able to trade them since January over its Pro Securities alternative trading system (ATS) by opening accounts at Dinosaur Financial Group, a third‐party introducing broker.
A tZERO spokesperson said that a benefit of SpeedRoute, an order routing broker-dealer acquired by Overstock.com in 2015, is that it “has allowed tZERO to have relationships with over 150 BDs, and many of them are already expressing interest in trading security tokens.”
tZERO obtained a patent for the crypto‐integration platform it pioneered with Pro Securities to permit secondary‐market trading of security tokens. It will be licensed to its joint venture with BOX Digital to create the Boston Security Token Exchange, anticipated to be launched by year‐end, the spokesperson said. And the firm is in discussions with several offshore exchanges in Europe and Asia.
Trading Through Partners
Blum said that Atomic Capital's FINRA license covers initial fundraising issuance but not secondary trading. He acknowledged the importance of secondary trading from a business-strategy standpoint, and his firm has entered partnerships with a few groups that have the necessary licenses and platforms.
But, security‐token issuance has been minimal so far, Blum added, and there is typically a significant delay after they close before Reg D-type offerings can be traded in the secondary market.
Exchanges have been among the more profitable businesses in the cryptocurrency market, Blum said, and so companies setting up the trading infrastructure may see a similar trend unfolding for security tokens.
“However, the regulatory aspects [to issue tokens] are far more complicated, so I think that market is at least 18 to 24 months away,” Blum said.
That may be true in terms of more widespread security‐token trading. However, tZERO announced in its May 9 earnings call that ETC Brokerage Services will also provide accounts permitting trading over Pro Securities. The spokesperson said tZERO anticipates other issuers' tokens trading over Pro Securities by early third quarter.
tZERO plans to file to become a retail brokerage, enabling trading in security tokens and cryptocurrencies including Bitcoin and Ethereum. The company expects initially to “work with [third‐party introducing brokers], but down the road we will likely use our broker‐dealer to do private placements and investment banking,” the spokesperson said.
Blum said another approach to secondary trading may be to establish an over-the-counter trading desk to engage in bilateral trading between two parties.
“You may be able to create something where people can communicate via messaging and not need licenses, especially because these are lower-value offerings and small market-cap companies. That might achieve some of the issuers' goals, at least in the short term.”
Blum pointed out that most of Atomic Capital's software is not blockchain per se, but aims to streamline the process of compliance and onboarding issuers. For example, it automates functions relating to know-your-customer (KYC), anti-money-laundering (AML) and suitability requirements. Atomic Capital built that capability on top of the Ethereum blockchain, Blum said, although the platform is not wedded to any specific blockchain.
Because Ethereum is a public blockchain, Atomic Capital has set up gates to restrict security-token offerings to approved investors. Private blockchain networks also permit issuers to revoke the tokens in the event of a catastrophic event that could cause investors to lose access to their accounts and lose their security-token investments - a risk in public blockchains.
On the lending front, Atomic Capital is acting as an intermediary, providing technical and origination expertise, between borrowers and an institutional partner that will assume the risk and take custody of borrowers' cryptocurrency collateral. Blum said borrowers can obtain loans with LTVs as high as 85%, though the interest rate on those loans will be between 11% and 13%.
The lending entity is reportedly Lockwood Group of Luxembourg. Atomic Capital declined to confirm that, nor how the institutional partner would custody the collateral, or its margin-call or other procedures should the cryptocurrency collateral fall significantly in value.
Blum said likely borrowers include individuals who are seeking capital without having to sell their existing cryptocurrency holdings, and Bitcoin miners in need of cash to finance their resource-intensive operations. Atomic Capital said it has received requests for 12‐ and 24‐month loans totaling $120 million, the largest at $80 million, and funding started the week of May 6.
More Access to Capital
Blum said that long term, he envisions Atomic Capital helping build the pipes via blockchain technology to provide greater access to capital for people around the world.
“When people have good ideas and they're motivated, their access to capital shouldn't be a function of which country they live in and their socio-economic status,” he said.
He expects transfer agents and custodians to disappear over time, their roles in engendering trust in the financial system being replaced by distributed ledgers that apply predetermined protocols to maintain the validity of transactions.
“I strongly believe all securities will be held on blockchains, and the type of technology we're building will determine the way money moves around the world,” Blum said. “As the future infrastructure of capital markets, blockchain is innately better, since you can provide what traditional securities offer and add important features on top.”