The fall of Bernie Madoff in 2008 after a $65 billion Ponzi scheme devastated Wall Street. In fact, nearly 15 years after headlines first emerged about his crimes, investors in Madoff’s funds are still seeking to recoup their losses. From retirement funds to grandparents, that nest egg can be gone forever.
While creditors and court-appointed trustees in the Madoff case can still recover more of their losses, the process is slow, complicated and inefficient — with many investors receiving only a fraction of what was stolen from them.
Renata Szkoda is the chief financial officer of INX, which offers a trading platform for security tokens.
What if those same people had access to security tokens to recover from losses and even profit from business recovery with the promise of future cash flow? Whether it’s Madoff or crypto lender Celsius Network, security tokens can be a solution to democratize and simplify bankruptcy recovery efforts for creditors and investors.
The new ‘fail-safe’ tool in finance
To fully understand the benefits of security tokens, you need to understand what they are and what they are not. A security token is a regulated token asset issued on a public blockchain that represents an investment in a company that provides profit or equity shares to its holders. They are sold publicly in regulated markets and interact with smart contracts, which reduce costs and increase efficiency. That said, security tokens are not cryptocurrencies.
Security tokens mimic the market for traditional equities. But unlike stocks, for example, securities are available for trading 24 hours a day, every day of the year and go directly to the investor’s wallet.
Due to their versatile nature, design flexibility and regulatory setting, security tokens could be the answer to bankruptcy recovery that investors (and creditors) have been looking for and waiting for.
Bankruptcy doesn’t mean it’s over for tokens
In a typical corporate bankruptcy process, the creditors of the cash-strapped company tend to lack the initial investment. Courts and trustees are appointed to repay these investors as assets recover over time.
Traditionally, if a bankrupt company files for restructuring the remaining assets will be transferred to the bankruptcy estate. These assets are available for distribution to creditors, who usually have no right to new and restructured companies. This process shuts investors out of future profits.
Instead of the status quo, what if lenders harnessed the power and flexibility of security tokens? This asset regulated by the Security and Exchange Commission (SEC) will be a tool for token holders to participate in the future equity appreciation and profits of the restructured company.
More often than not, businesses that file for bankruptcy today prove profitable over time. Why should creditors and investors be blocked from the future of rewarding companies?
Issuing security tokens to investors allows them to participate in the future cash flow or revenue of the company, but does not necessarily lead to voting rights. In addition, tokens can be designed to act like preferred equity, thus giving priority to certain token holders in the distribution of profits and aligning closely with preferred shares of traditional companies.
The crypto industry is currently seeing several bankruptcies – including failed lenders Celsius and Hodlnaut. Every lender should carefully consider security tokens as an option.
Tokenized profit sharing: how it works
When issuing a security token, the issuing company registers the token with the SEC as a private offering or as a publicly traded equity token issuer. The issuer is a public company under the supervision of the SEC, as is the case for all other public entities.
After a company completes an initial coin offering (ICO), tokens are deposited directly into each participant’s wallet and trading begins on a public market offered by an SEC-registered broker-dealer. Any token holder is free to offer tokens to sell or collect more on the market.
This registration process is robust and follows the traditional SEC-approved protocol for issuing equity. As with traditional registration, each company must present a prospectus that accurately describes the entity’s nature, risk factors and token offering characteristics.
Security token initial coin offerings (ICOs) and distributions are registered on a public blockchain and recorded and monitored by an SEC-regulated transfer agent. Token holders must also complete know-your-customer (KYC) onboarding to the broker-dealer.
Once this documentation is complete, the issued security instrument (security token) provides the same regulatory protections that the SEC offers to any public security holder. This level of transparency and the benefits of blockchain-powered self-custody make it an attractive asset class.
ICOs through IPOs
Security tokens are not new and have proven to be a safe and effective digital financial solution in a variety of use cases. It has also been proven many times that ICOs provide a superior issuance process and secondary market over initial public offerings (IPOs).
A peer-to-peer system – where issuers are connected directly with security token holders on a fully regulated, end-to-end trading platform for issuing, minting and fast settlement – simplifies the process.
As traditional market structures continue to evolve through automated blockchain technology offered in a regulated environment, new digital systems are becoming more effective and important.
Instead of closing the door in the face of creditors from shortfalls in bankruptcy, security tokens give access to the public market and are organized to show unpaid debts – giving the opportunity to recover losses through equity shares in restructured companies.
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