Morningstar Magazine - February/March 2018 - 61

Act1 and through the JOBS Act with technology
and innovation trying to intersect with
regulation. We looked at blockchain and felt déjà
vu: Technologists were talking about disrupting
financial services and didn't really understand
the implications. We took the view there is no such
thing as a decentralized ledger in financial
services. The moment that you're dealing with a
security or financial instrument, you need an SRO.2
You have regulated entities, broker-dealers,
alternative trading systems, licensed people, so
not just anyone can come in and participate when
you're dealing with transacting a security and
its clearance or settlement.
Blockchain, as amazing as it is, has not created
a new process. We're still trading, clearing,
and settling-maybe in a more efficient way. We
believed that you need a centralized location
that is transparent and regulated for secondary
liquidity of alternative instruments, and we
petitioned the SEC to amend Regulation ATS3 for
the purpose of unregistered securities. We were
approved for that in the summer of 2016. As a
quotation bureau, we are able to publish real-time
pricing on private, unregistered securities
having mark to market. We also have approval
as a qualified matching service to transact in
nontraded secondary limited partnership interests.
That swath of approvals led us to petition
the SEC this past March for another rule change
to declare digital assets, in most cases,
to be a security. The marketplace was born out
of utility tokens, but it is clearly a misperception
that these are not securities.
Sinegal: How do regulators define a security?

Molinari: The Howey test comes from a U.S.
Supreme Court ruling that said, in short, that any
time you're aggregating capital with an
expectation of a rate of return, and there's a
third-party manager or promoter, that constitutes
a security. The SEC said in the DAO report in
July that the DAO conducted securities transac-

tions.4 It was a warning shot. SEC chairman [Jay]
Clayton recently said very emphatically that
he hasn't seen an ICO that was conducted yet that
didn't meet the hallmark of a security.
That means that these ICOs were being distributed in a noncompliant way. We are seeing
enforcement actions weekly. Secondary
trading of utility tokens is happening on loosely
defined exchanges. When they're deemed
a security by the SEC, those exchanges can't
transact them anymore, so we're seeing delisting
of tokens across the spectrum.
Now there are tens of thousands, if not
hundreds of thousands, of investors who are
trapped because they bought into an instrument
that cannot transact on those exchanges
anymore. It doesn't meet the compliance or the
frameworks of a commodity to be governed by
the CFTC [Commodity Futures Trading Commission].
It certainly doesn't meet the requirements of a
security, so folks like ourselves with an alternative
trading system can't transact it. So, we've
petitioned the SEC for a remediation program
where these utility tokens, provided there was not
fraud, could ask for a redo. We proposed a
180-day period where these broken ICOs could be
repackaged as a security.
This is going to be an ongoing conversation
with the CFTC and the SEC in 2018, as these tokens
are either commodities or securities. To qualify
as a utility token when you're doing an ICO,
your technology and platform actually has to
already be built. If you can use that token on that
platform, it could very well be a utility token.
But when you're raising the capital to build that
platform, that becomes a security. Over the
next 10 years, the distribution of securities through
tokenized assets will dramatically change.
Sinegal: What rights as an investor do you get
with a regulated token offering? Do you get the right
to dividends, to cash flows, governance rights?

Molinari: It's up to the issuer. What does
the issuer think that the market is going to want?
Is it straight equity? Is it debt? The ability
within a smart contract to apportion it? Profit
participation? A piece of the deal? This is an
opportunity to create securities that are in keeping
what the marketplace may want, as Ashish
is doing now.

It's a Series A that is a tokenized security. It's a
beautiful mechanism: You can create a distribution
system and there's visibility to secondary
trading. Compared with our largely dysfunctional
IPO process for smaller companies, a private
marketplace is more efficient and has liquidity. This
is not just for technology companies. You
can tokenize real-estate assets, or any other
instrument. It's a game-changing phenomenon.

Monetizing Blockchain
Sinegal: Ashish, how are you monetizing
your technology?

Gadnis: We're a for-profit, for-purpose company.
The monetization model is straightforward:
We sell BanQu software to large corporations,
financial institutions, and banks that are
trying to get visibility and transparency into the
last mile of emerging markets. The farmer never
pays, the refugees never pay.

It's important to explain the use case. Marginalized producers pay high interest rates on
microfinance loans because they don't exist in the
supply chains. That farmer in the Congo brings
her bag of coffee to a broker who then brings it to
a washing-drying station, and there may be
seven or eight intermediaries before it gets to the
anchor buyer. That anchor buyer has limited
visibility into the supply chain and can't necessarily say that the coffee qualifies as "fair trade."
The farmer has been tilling that piece of land
for 40 years but is invisible and so continues to pay
a higher interest rate. In the country of Colombia,

1 The Jumpstart Our Business Startups Act was signed into law in 2012 with the aim of easing securities regulations to encourage funding of small businesses.
2 A self-regulatory organization, such as Finra.
3 Regulation ATS is designed to protect investors and resolve any concerns arising from alternative trading systems.
4 The DAO was a digital decentralized autonomous organization that aimed to provide a decentralized business model for organizing both commercial and nonprofit enterprises.
It was crowdfunded via a token sale. See: https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_coinofferings

global.morningstar.com/Morningstarmagazine

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Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2018

Contents
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