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Security Token Offerings (STO). What you need to know. Next “big thing” in crypto, or simply the next logical step?

At first, it was the IPO. The Initial Coin Offering.

Now, it’s all about the STO. The Security Token Offering. The new shiny thing in the cryptoverse. Many call it “the next big thing”. In reality, it’s just what was supposed to happen, anyway. Let me explain.

In 2009, the first cryptocurrency (Bitcoin) performed its initial transaction. After that, other cryptocurrencies followed.

The initial purpose of Bitcoin, was pretty straightforward. Enable access to financial services, to the unbanked. To those, who because of circumstance or because they were simply born in the “wrong” country, didn’t enjoy the services and facilities a lot of us do.

Financial services. Without the need of a third party to act as a middleman. Without trust being an issue. Anonymously.

The utopia of decentralization.

But then, things got a bit more complicated. New technologies started exploding. Blockchains, Artificial Intelligence, Virtual Reality… Resources like computing power, storage, data collection and manipulation became affordable. So many projects, and not enough funding. Teams all around the world started looking for a solution to their funding problems. And then, someone had an idea!

“Why don’t we use code to create and sell a token. Those who buy our tokens, are going to get a piece of the profits we realize from our project”.

That was it. The birth of the ICO. Teams creating tokens, selling them without even having a prototype ready (most of the times), and promising a piece of the project’s revenues.

The ICO market then boomed! Billions of dollars exchanged hands (and still do) every year with the hope of buying a piece of the next “big thing”. A lot of projects failed. A few succeeded. And some were just scams.

Finally, governments and authorities decided it was time to intervene.

Money were made. Profits were promised. This sounds a bit more than just a simple token, doesn’t it?

The SEC said, “This sounds like a security!”. The ICO teams replied, “No, these are just tokens!”.

The difference between a simple “utility” token and a security one, is quite significant. That’s because when a token is classified as a security, it has to adhere to very strict compliance, legal, and financial regulations imposed by local, state, and federal authorities.

Suddenly, crypto companies were forced to return the money they gathered back to their investors. Others, saw their owners being convicted and/or face jail time.

It was time to separate token introduction into ICOs and STOs. To separate tokens into “utility” and “security” ones. (By the way, we’re mainly talking about the US market, because this is where the majority of ICOs take place, as you can see in the below chart; courtesy of inwara.com).

You see, there are lots of different token “flavors”.

There are tokens that grant you rights. By holding them, you can -for example- have the right to vote inside the particular cryptocurrency’s ecosystem.

There are tokens that allow buyers and sellers to exchange value. Get rewards for example, for completing specific tasks (like the rewards of an online game).

They can be used as toll payments. To pay a toll for example, in order to access better resources inside a project.

Tokens can be used to add functionality or extra features to the project. For example, pay with tokens in order to remove all advertisements from a blockchain-based web browser.

They can be (of course) used as a currency. A store of value that allows transactions inside and outside the project’s ecosystem.

Finally, they can be used as a means of earnings distribution of the project’s profits or as other financial benefits.

Too many uses to be ignored. So, the SEC decided to use the Howie test, to determine which projects should be classified as securities.

The Howie Test is a test (duh!) created by the US Supreme Court in 1946. The test determines whether a transaction is an investment contract, or not. If it is, then it is subject to the securities’ registration requirements.

To make things simple, if a transaction is (a) an investment of money, (b) the investment is in a common enterprise (more than one people participate), and, (c) there is an expectation of profit from the work of the promoters, or a third party, then it is classified as a security and it must meet all regulatory requirements.

And there were additional reasons that forced this compliance. For example, companies obliged to follow KYC (Know-Your-Customer) and AML (Anti-money Laundering) regulations, wouldn’t “allow” new competitors to enter without (eventually) forcing them to adhere to the market rules. If you want to operate in an advanced economy, you need to follow the rules. Other companies also had to protect themselves against possible ramifications. Like Visa for example, that banned a lot of projects and cancelled transactions involving crypto purchases in the past months. A lot of cryptoexchanges, crypto debit cards, and other crypto projects employ the services of Visa to deposit and withdraw funds. But, if you don’t know where the money is coming from, how can you be sure you will avoid possible money laundering charges? Better be safe than sorry.

So, token offerings were divided into 2 broad categories.

Utility and Security.

Hence the term STO; Security Token Offering. A security is any instrument (paper or digital) that proves you own rights to a debt or to the earnings of the entity that issued it. A token in our case is a digital representation of an asset. So in essence, a Security Token performs the exact same functions a traditional security issuance does. The difference is that it performs these functions by using blockchain transactions. Other than that, equity rights, dividend payouts, voting, they all remain the same.

The compliance and extra security features we find in security tokens, is the result of using multiple smart contracts. Unlike simple tokens where a single smart contract is enough for their creation, security tokens use multiple. In addition to the initial contract that manifests them, they use contracts that determine how they can be purchased, sold, traded, and whatever other feature is required by their use. (A smart contract by the way is a simple program –some code in essence- that executes as soon as a specific condition requires it to run).

Being the products of a blockchain of course, security tokens share all of the benefits of a blochain-based product. Immutable, transparent, and traceable transactions that make it very hard for Madoff wannabees to delete transaction records.

And there are even more perks for using a blockchain-based security token.

Let’s say for example that you want to buy into a commercial real estate opportunity. You only have a couple of thousand of dollars, and you want to put a little bit more next Christmas with your bonus. How can you do it in the traditional way? You can’t. You can’t buy 4 square feet this month and an extra three next Christmas. Ridiculous, right? Well, you can if the owners issue security tokens. They can issue a billion shares, and price them a cent a piece if they want to. So anybody can invest whatever amount they can afford.

The process can be used with other types of investments. An expensive diamond. Gold. Or a Van Gogh painting. You put your money, and you buy a percentage of the total securities issued.

Of course, the same idea works in the opposite direction, too. Let’s say you own a building and you need $20,000. You don’t have the time (or the credit score) to seek bank or any other sort of a loan. You can tokenize a percentage of your building, and sell the securities to the public.

Asset tokenization is an amazing tool, because it is very versatile. Unfortunately there are still issues that do not allow it to become a mainstream practice. For example, when you buy tokens of the building in our first example, you buy ownership of the asset. The security. You do not become a legal owner of the property. Blockchains are public, immune ledgers, and your transactions cannot be altered. You still have your rights intact. You enjoy your profits from the rise in the tokens’ value, and the profits from the building’s revenues. But that’s as far as your reach goes.

Let’s say now the owner of the building decides to sell it. You just own tokens, not the building. You have no rights over the property itself. You can see the problem, right? Smells like an expensive legal battle.

Then we have companies and their stocks. We can tokenize them and sell them, but not everywhere. A lot of countries do not allow the sale of fractional parts of company shares. It’s illegal. End of story.

So, security tokens are a very new, much more secure and versatile investment vehicle. They solve a lot of security, compliance, and trust problems that simple tokens and ICOs carry with them.

But, they have a long road ahead of them until they become mainstream alternatives. Countries have to adjust their laws. City, State, and Government bodies have to update their regulations in order to allow them to be defined, and operate legally.

Until then, we can only try to build better, more secure tokens. The good news is that the industry (and technology in general) moves so fast, that the governments have to work faster to keep up. Nobody wants to leave consumers exposed to bad products, incomplete services, and to the practice of fraudulent and money-laundering activities. It’s bad for us, and it’s bad for their re-election chances. So, let’s wait and see what happens!

Mining Cryptocurrencies explained in 7 simple steps.

Chances are you’ve heard about mining.

Not the one that involves people mining for rocks and minerals. I’m talking about crypto mining. The process of creating new currency, and validating transactions at the same time.

Perhaps you looked for more info but it was too vague or too technical. Or you simply didn’t have the time. But if you’re like me, you want to know. What is it? How is it done?

So, here’s a guide. Crypto mining in seven simple steps. Let’s begin.

Step 1:

Peter wants to send 0,5 Bitcoins to Sally. He opens his bitcoin wallet, and initiates the transaction. He asks to send 0,5 bitcoins from his wallet, to Sally’s wallet. For example:

Step 2:

The request goes to the underlying blockchain network (in our case, bitcoin) and then it’s inserted into a pool of unconfirmed transactions. This is the place where all pending (unconfirmed) transactions go.

Step 3:

Miners from this network, pick transactions and add them to their block.

A miner, is an entity with enough processing power to complete a transaction. It can be a single person, or a pool of miners sharing resources. Miners control nodes in order to complete the transactions. Nodes are physical or virtual servers that form a network.

A block is a collection of data. In our case, a collection of unconfirmed transactions and some metadata. Miners create their own blocks, and they can all add Peter’s transaction to their blocks. Blocks have also a maximum size. In our case, a bitcoin block can hold up to 1 MegaByte (Mb) of data.

Before they add any transaction to their blocks though, they check the balance of Peter’s account to see if he has enough bitcoin in his wallet. If he does, the transaction is valid, and any miner interested can add it to their block. Miners usually pick first the transactions with the highest fees offered. When you send crypto, you add an amount you are willing to pay for the transaction to be processed. The higher the fee, the faster your transaction will be completed.

Step 4:

When their blocks are filled with unconfirmed transactions, miners will try to solve a mathematical problem. Each miner will have a different problem, but the difficulty will be the same for all miners. This is the definition of mining. Solving this mathematical problem.

WARNING: GEEK PARAGRAPHS FOLLOWING.

(Just a couple of them, but if you are not in the mood, jump to Step 5.)

This problem is actually a hash function. A function that tries to map data of arbitrary size, to data of fixed size. In our case, the miner takes the data from all of the unconfirmed transactions inside the block, and tries to output a string of numbers and letters of fixed size. Especially for bitcoin, this string must start with a specific number of zeros. At the moment, it must start with 18 zeros. This is the only way for the block to be added to the blockchain.

Miners continue to change data inside the block, until the output starts with 18 zeros. But they can’t change the transaction data. Right? Otherwise, the transactions will make no sense. Instead, they change the data of something called the nonce. The nonce is a 4-byte field inside the block that the miners can change until they achieve the desired hash output. Eventually, a miner (or group of miners) finds an input string (transaction data + the nonce) that hashes to an acceptable output string. This is how the math problem is solved, and why it requires so much computational power to solve it. It’s not a difficult problem. It’s the number of tries and combinations a computer must perform in order to reach to that number starting with 18 zeros. This process also consumes a lot of resources (like electricity, or network bandwidth if we are talking about cloud servers). That’s why miners get paid for solving the problem.

(GEEK TALK OVER. BACK TO THE STEPS)

Step 5:

The miner who solves this problem, announces the solution to the network (all other miners).

Step 6:

The other miners will now make sure the solution is valid. If the hash output (number) corresponds to the problem (the input). This is the definition of Proof of Work. The miner who solves the problem, broadcasts the solution (proof that they worked and solved it). The rest of the nodes will check the integrity of the solution and verify it’s correct. They will also make sure that all transactions inside the block are still valid. After that, consensus is reached. We only need the majority of the network (miners) to reach consensus. Not the 100% of them.

Imagine going to a bank with 1000 branches all over the world, for a bank transfer. And half of the bank’s managers (at least), from all branches, all over the world must verify andco-sign for the transaction to be valid and completed. That’s how safe a blockchain transaction is, described in banking terms.

Step 7:

The block is added to the network. Every new block added on top, serves as a confirmation that our block is valid. It also makes it more difficult for malicious parties to alter the contents of it. The miners then, go back to work and start filling their blocks with the next unconfirmed transactions.

That’s it! It wasn’t hard, was it? Mining is a pretty straightforward and secure process. In another post we will explain Proof of Stake, which unlike Proof of Work (like bitcoin) rewards your belief in the success of the coin, and not your computational skills and resources.

Be safe and profitable,

Leo.

An Introduction To Smart Contracts

When most of us hear the word “blockchain”, our minds usually go to Bitcoin.

In fact, a lot of people still think that Bitcoin and the Blockchains are one and the same. This is of course, a mistake. Bitcoin is a cryptocurrency. Blockchain on the other hand, is the technology Bitcoin and all other cryptocurrencies are built on.

Cryptocurrencies are just one application of the Blockchain technology. In this article though, we are going to introduce another very important application.

The smart contract.

A little bit of History…

The idea of smart contracts was introduced in 1996 by a computer and cryptography scientist, called Nick Szabo. Szabo saw the digital revolution that was coming.

He realized that the rapid technological innovations that people would experience in the future, would inevitably change the relationships they have. Both in business and in their personal lives.

So, he theorized about the introduction of new institutions and new ways to formalize our relationships in this future environment.

His theories became a reality in 2015, with the launch of the Ethereum blockchain. Ethereum is today the second biggest blockchain in the world.

It was mainly created by Vitalik Buterin for one reason: Smart contracts.

What is a smart contract?

A smart contract is essentially a piece of code. It holds the rules of an agreement between two or more parties. It also makes sure the agreement is fulfilled. Finally, it executes the terms that the parties agreed upon.

Smart contracts help two or more counterparts to make an agreement directly with each other, without the need of a third party to guarantee the transaction.

By doing so, it allows people to trust a digital contract –a few lines of code actually-, instead of an institution (like a bank), or a human. It’s like a vending machine. You put in a dollar, press a button, and you get your coffee.

If your dollar is in bad shape, you get it back, but no coffee. If you press the wrong button, again, no coffee. As long as you keep your end of the deal, the machine delivers a cup of coffee. This is how a smart contract works, more or less.

Why should I trust smart contracts?

Well, mainly because they possess two very distinct characteristics. The first one is what we call immutability. Because they exist on the Blockchain, it is very hard to change them.

Unlike their physical counterparts (paper or electronic contracts which can be altered a lot easier), you can’t just change smart contracts once they are deployed.

Smart contracts are also, distributed. The moment a contract goes live, every step of it is validated by everyone on the network. Everyone has to agree that step one is fulfilled in order to go to step two.

For example, if the landlord doesn’t get the rent and security payment agreed by the tenant, the contract doesn’t release the code to unlock the front door of the apartment rented. This specific characteristic has another advantage. Nobody can go and change the terms of the deal after its completion.

For example, you can’t just go to the city’s Office of Register and change public records. Because it will take the creation of a new smart contract to change such an agreement, it makes any effort to tamper with it, futile.

Let’s talk about benefits.

Cost

As we said earlier, smart contracts eliminate the need of an intermediary. So, if we don’t need a third party when we are making a deal with someone, the cost of processing and finalizing that deal will be lower.

In some cases, not paying legal, accounting and other fees has a substantial effect on the final price of the underlying product or service.

Freedom

You and your counterpart are the only ones who deal with your agreement. You agree on the terms of your contract, and the network you are on goes ahead and executes it. No one else interferes. No third party needs to give permission for you to proceed.

Error-Free

Smart contracts are executed automatically. So, if you have reviewed the steps it will follow during its creation, you can be certain that there will be no mistakes. No human errors. Things like “I forgot to go”, or “the traffic was crazy”, are a thing of the past. The contact is always error-free, and nobody can debate that.

Hacker and Bad actor-Free

Since these contracts are distributed among the network of participants, there is no central location to keep them. They are not stored inside a file cabinet, or a computer.

So, without a point-of-entrance or point-of-access, it becomes really hard for anyone to access your documents. If you add the security cryptography offers (a native ingredient of any Blockchain), cracking such a network is an even harder effort for any potential bad actor.

Assurance

Encryption and distribution make sure that any contract you issue is safe. Those attributes also create the feeling of trust to all participating entities, that the contracts they signed cannot be altered by any external party.

Substitute

Smart contracts can be duplicated. As long as they are deployed on the blockchain, they are available at any given time. So, even if a party loses any document attached to the contract, a copy of it is stored, and ready to be used.

Where can we use smart contracts?

The applications for smart contracts are almost as many as the industries we have today and the ones that are not created yet. Collaterals, blockchain mortgages, finance, media, reward applications, health, e-commerce. These are just a few examples of possible uses one can think of.

The most prominent examples though are those of healthcare, banking, and government. Three institutions that affect the quality of our lives every day. In healthcare, we can use contracts and the blockchain to provide access to medical data to doctors all over the world.

So, if you live in Sweden and you get sick in Singapore, your physician could have your whole history in a matter of seconds, without wasting time with telephone calls and emails. You could also have your medical insurance as a smart contract, providing additional data to doctors and all other interested parties with a permission and selective access to your medical history.

In the banking sector, smart contracts can reduce unnecessary costs for all sorts of banking transactions. At the same time, they can serve as a barrier to fraudulent transactions that cost every year millions to banks all around the world and affect the lives of people that fall prey to such criminal activities.

Finally, governments can use them to deliver their services faster, and more efficiently. Without the red tape and the introduction of automation, citizens will be able to receive services and fulfill their obligations a lot quicker.

Smart contracts will also help governments fight fraudulent activities from their employees because they will be able to verify all transactions the moment they occur.

Smart contracts are here to stay. They were introduced as a concept more than two decades ago, but with the evolution of technology and the application of the Blockchain, they are now available to all of us.

They will make our transactions safer, faster, and more efficient. They have obvious advantages over traditional contracts, and their further development is necessary in order to perfect them and make them more flexible. They are not without problems, of course.

For example, it is very difficult (or impossible) to correct a mistake recorded in such a contract. It will most probably have to be declared void and create a new one, an action that could cost a lot of money and work hours. But we are still at the beginning. As Blockchain technology evolves, so do these contracts become better, safer, and error-free.

I am sure that a lot of industries and professional associations will fight to keep them from becoming legal alternatives, but I believe that like all other technological innovations, they will lose. Spectacularly and beyond any doubt. Because you cannot stop progress. It’s that simple.

Bitcoin: The case of Utility

If you are an adult living in an organized society, you conduct your every day business with some sort of money (unless a witch doctor or a mentalist has convinced you that bartering in chickens and bananas is the way to live your life, which is totally fine by me.. whatever makes you happy!).

And chances are you’ve heard of Bitcoin.

Funny money for lots of people.

Here’s the thing, though,

Bitcoin (like all the other cryptocurrencies) is not money.

Cryptos are actually validators of processes and enablers of transactions.

But that’s a different story…

Maybe we’ll talk about it some other time. Not today.

Today, let’s talk about Bitcoin’s price.

I am sure you’ve heard or read all those expert opinions from mainstream and fringe media panelists, journalists, and experts of sorts.

“How can a virtual currency with no real value, have a price of 10,000 American dollars?”

“It’s a bubble filled with speculators that will burst.”

“Even at a thousand bucks, it’s a bubble”.

Right?

Well, let’s see..

It’s true that Bitcoin’s price (as the price of other cryptos), has experienced a meteoric rise in the last couple of years.

No doubt there’s speculation in there..

People buying and selling coins in Crypto Exchanges for the pure purpose of making money.

But each one of these cryptocurrencies, has also a utility value.

It is created to serve a purpose.

– Like securing transactions…

– Validating medical records…

– Or making sure, the money you donated to a charity, are delivered to the hurricane victim you chose, and not into the pockets of a crooked politician.

That’s the real value behind cryptos.

Utility.

But, most of us are only hearing about “how much Bitcoin’s price has risen this week”.

Just like financial derivatives.

You know, options and futures.

Buy something by paying a fraction of its price.

Derivatives exist to hedge your risk.

Invest 900 dollars in Apple stock, and buy an Apple put option for 50 dollars.

If the price of the stock falls, you balance your losses with the profits from the option contract.

But most traders used them to speculate.

Because derivatives use leverage.

So you can enjoy the full profits of an asset, by paying only a fraction of its value.

Derivatives destroyed many companies, and careers back in the 2000’s.

Because they were used for speculation.

And the same thing has happened with Bitcoin.

During the last few weeks, the price of many cryptocurrencies fell by A LOT!

And a lot of speculators looking for another easy profit, got hit badly.

Funny money, right?

The party is over..

Well, not quite.

Because the price of Bitcoin reflects a lot more than just what speculators do in Crypto Exchanges.

Traders are just one part of the equation to determine Bitcoin’s price.

There are also those who consider it an investment.

Those who have bought (and are still buying) Bitcoin, to keep.

This amount of Bitcoins therefore, is removed from daily circulation.

Less coins around to buy and sell.

And then, we have those who use Bitcoin for actual transactions.

Because as we have already said, Bitcoin is a transaction enabler.

Here’s an example:

Let’s say there’s a guy in Chile that produces refrigerators.

Our guy needs steel to make them, right?

He finds a steel manufacturer in China that has dropped the wholesale price by 40%.

But the offer expires tomorrow..

The money must be in their bank accounts (cleared) by tomorrow morning.

And the minimum order to get it at this price, is 200,000 tons.

Our guy needs this desperately. The profit margins for him will be I-N-S-A-N-E.

How can he pull this off?

To clear a transaction worth millions with someone he has never done business before?

How long will it take? 2 days? 3 days? A week?

What about foreign exchange rates, bank transfer costs? How much is all that?

5%..10%? More? Remember.. it’s only a day..

But if the two parties agree to complete this transaction with Bitcoin:

1) The transaction will be over in an hour (instead of up to a week).

2)The cost will be as low as 2% for both parties (the traditional route will be a lot more expensive).

How much would you pay for that?

To buy your raw materials 40% cheaper?

To sell with a 400% profit margin bacause of that cheap purchase?

And to pay a ridiculously low amount of money to complete this transaction with a country that has very strict rules for foreign businesses?

Does 10,000 dollars sound too much now?

OK, let’s say it still sounds like a lot (for the sake of the argument)..

But our guy is not alone in this world..

During the same day there are 100 more businesses that want to conduct transactions of the same magnitude..

100 million dollars each.

That’s 10 Billion Dollars worth of demand for Bitcoin.

And there are also those who want to buy a pizza..

Or an iPhone..

And the numbers keep growing..

How many Bitcoins do we have in circulation?

According to the Bitcoin ledger, there are only 16,9 million bitcoin outstanding.

Roughly 5.5 million bitcoin is held by the top 1000 addresses in the blockchain (the bitcoin ledger).

Between that, and about 10 million bitcoin needed by merchants , there are only 1,400,000 bitcoins free for people to use.

Not so many, right?

So a market is created automatically to facilitate all this new demand.

And the price can increase significantly, because there are simply not enough coins to satisfy the growing demand globally.

And by the way, you can’t just go and “print” new Bitcoins like the FED prints dollars.

Because the total sum of Bitcoin, is finite.

Only 21 million Bitcoins will be mined, to be exact.

With every new Bitcoin “mined”, the process becomes more difficult. It takes more time and resources to produce the next one..

So, you get the picture now?

It’s true, there is a speculative percentage incorporated in the daily price of Bitcoin, and that of many other cryptocurrencies.

But speculation alone does not tell the whole story.

There is a whole world of investors and businesses that generate transactions worth billions of dollars everyday.

These transactions also have a great impact on the final price you see printed in the charts.

So before you decide to buy or condemn any crypto, you should do your own due dilligence.

Emotions and self-proclaimed gurus, are mostly bad advisors for any decision that could impact your personal and financial future.

And you’re too smart to fall for that..

Be safe, everybody,

Leo.

The Blockchain and the Artist.

Artists are screwed..

Traditionally and historically. Most of the times.

I mean, where to begin and where to end…

They have to face (among others) bad reviews coming from all directions.

Constant advice to “find a decend job”, or study something that will “put food into your mouth”.

[TBC]