As founding CEO, Stein is leading Harbor's efforts to tokenize private securities and unlock access, value and liquidity for private investments such as commercial real estate, investment funds and more. He was previously general counsel and chief compliance officer at Zenefits, served as general counsel at OptumRx (a subsidiary of UnitedHealth Group), was an Assistant U.S. Attorney, a federal judicial clerk and an Intelligence Officer for the U.S. Army.
Harbor: the compliance platform for tokenizing private securities
Hi, I’m Adam Chapnick, with the Security Token Academy. Today we’re pleased to bring you a corporate member interview with Harbor. The company is a gold corporate member of the Security Token Academy. Harbor’s an institutional-grade digital securities platform for compliant fundraising, investor management and liquidity, powered by blockchain technology. For investors, the Harbor platform enables online access to quality private investments with unique potential for enhanced liquidity.
Today, we’re going to learn more about the company, their products, and much more and to do that we go to San Francisco, where I’m joined by none other than Joshua Stein, the co-founder and CEO of Harbor. Hey Josh, it’s great to be speaking with you again.
It’s great to speak to you again. Thanks for having me.
For those who might not know, can you tell everybody about Harbor and why it was created?
Sure. Harbor got going late 2017, and David Sacks was one of the original PayPal founders, was raising a VC fund. He was really into blockchain technology. He wanted to tokenize the fund to enable some liquidity amongst his investors, and as he dived into it, he realized there was no compliant way to do that. And he said, “Aha, there’s a business here.” He pulled in me and the other co-founders and we were off to the races.
Amazing. So over the past six months, the security token industry has definitely evolved. Where do you think the industry’s headed?
I think the industry is headed towards something very different than what everyone had in mind, to begin with. If we go back to the very beginning in 2017, ICOs took off. People in the security token industry, us, a number of other platforms got started in late 2017 to early 2018. We had several ideas, some of which were right and some of which were incorrect. The ideas that were right were ICOs would not last forever, that the compliance issues were going to cause them to get shut down, and those were both true. And then what we saw was a big investor demand for tokens. The security token industry idea was, well, if people are so interested in investing in tokens that aren’t backed by anything, not by a contractual promise or a security writer, perhaps even a functioning software protocol, then investors would really be interested in tokens backed by real-world assets.
Harbor got started by focusing on quality, real-world assets and institutional partners, that i.e. the highest quality segment of that security token market that we all thought was going to come to exist. And what happened was, is the mistake that everyone in the industry made is we thought that tokenization, the excitement around the liquidity, would draw in investors. And so the focus was on finding people with quality assets and compliance and getting them out into the hands of investors. What happened was that investor demand did not materialize. Investors who are interested in quality US real estate with 5% cash-on-cash returns, there’s almost zero overlap with investors who were really interested in the tokens and the ICOs of 2017. And so I think what Harbor’s pivoted and what the industry has pivoted to, but Harbor, in particular, is focusing on the needs of those investors, the people who were investing in quality US real estate, private debt, and those other alternative asset classes. Harbor has focused on, and we’ve revamped our platform, to enable those folks.
We went from a model of essentially crowdfunding, plus tokens, where everything was done under the Harbor brand name, to a white-labeled software product where the brand name and the color scheme is all focused on that sponsor, where the same tools are available to them and they’re enabling their investors.
Let’s talk about your recent announcement with iCap Equity. I know they’ve raised over 100 million dollars across four different funds, with 1,100 investors. Can you tell us more about the business challenges iCap was looking to solve with you guys at Harbor?
Sure. So iCap is really interesting and I think I would call them a reference implementation. They really show what Harbor can do and how we’ve changed. So iCap came to us, they did not recently raise $100 million. They’d raised that $100 million in the past, over time. And so they had 1,100 investors, in four different funds, that had come into them through 17 different broker-dealers and other placement agents. They were already seeing a demand for liquidity. Their real estate manager in the Pacific Northwest, they had extended the maturity of their funds, and so most of their investors were very satisfied with the return that they were getting and wanted to stay in the funds. But some of their investors wanted to get out. And so this was a world in which all the investors had signed, everything was on paper. The investors had no right to transfer. There was no easy way to find other people who might be interested in buying. And so they came to us and they were looking for a compliant way to enable better liquidity.
We’ve implemented the platform with them and their investors. There’s three components to it and I’ll end with the component that really enables the liquidity. One component of the Harbor platform is a fundraising platform, a way to manage the fundraising process more compliantly, more quickly, and more easily, a way to get investors through the necessary vetting checks, seeing and signing the documents and funding.
The second component is the investor relations management piece. These individual investors and their broker-dealers and placing agents have logins where they can see the PPM, where they originally invested. They can see their latest financial statements, and the sponsor iCap can communicate with those investors. And then the liquidity piece, power by ERC-20 stair tokens by the Ethereum blockchain is a private bulletin board or private marketplace system. These investors and their broker-dealers and advisors can indicate if they want to buy more of these existing funds or if they need to get out.
Before, what would happen is these investors didn’t have the legal right to get out. If they wanted to get out anyway, they would contact their broker-dealer, they’d contact iCap and someone would literally write down on a sticky and put it up on their computer monitor. And if someone later said they wanted to buy, they’d match them up by email. Instead, there’s an internal bulletin board. Individual investors can indicate whether they want to buy more of one of these funds or they want to sell what they have. It gets routed through their broker-dealer or RIA, who posts to this bulletin board. People match, just like in any bulletin board system, manually. They find somebody who they’re interested on the other side of the trade. They arrive at terms with the trade and then the trade goes through.
It’s all electronic, it’s all powered by the blockchain to ensure that every trade is compliant, every time. But you’re aggregating interest and you’re doing it in a controlled fashion that’s not only compliant but meets the needs of that fund manager.
That’s a ton right there that you guys just figured out how to solve. I know that for a long time that’s been sort of an obvious expectation that funds were going to need to handle all of those friction points that you mentioned. I mean, other than the fact that you’re putting the sticky note industry out of business, which I think is maybe the only downside here, do you see all of these sort of private funds like this in the world eventually going to this? Doesn’t it seem like there’s no reason not to?
I think that’s correct. I don’t think there’s a downside. Some of the nuances of why we’re offering this and why this is attractive, I think are interesting to the audience that’s going to be watching this video. This is on our private bulletin board system. This is not on an exchange where you have an order book, where you have a bid and an ask, and what’s called adapter, you can see all the orders. These things are going to trade relatively thinly. They’re not like a public security or a Reg A. This is not a fund manager that wants to publish their financials out to the world.
What they want to do is enable more liquidity than they have today, and I would call these things semi-liquid. We are aggregating the interest to help enable liquidity, and we are automating. We’re taking something that used to take weeks, now down two days, and we think eventually same-day. We’re taking a lot of the friction out that happens administratively, but these are not public securities, and a fund manager is not going to want their LP interests or their debentures trading in an open market with a bid-ask and a potential bid-ask spread. In other words, they want to enable liquidity, but not public price discovery. They want to enable liquidity amongst investors that they know and trust.
In this case, iCap is letting their 1,100 plus existing investors trade amongst themselves. They’re allowing those BDs and RIAs to bring in new buyers, but they’re not throwing it open to the public. They don’t want to deal with people that they don’t know. And if new people try to come in, they have to come in through one of the broker-dealers or RIAs that are already in there, or new broker-dealers or RIAs that want to become part of their private marketplace.
In other words, we’re providing a technology platform, but it’s their marketplace. It’s not Harbor’s marketplace. And I think that’s what’s really important. I think eventually we’ll get to what the original vision of the industry was, which is this vast sea of alternative private investments being semi-liquid and findable, easily, and there’s sort of being one large pool of liquidity. But I think it’s going to take a very long time to get there. I think the intermediate steps are for people to be able to have liquidity in a controlled fashion, amongst a group of people that they can trust. And they can open up who has access to it over time. But I think what you’ll see is early adopters, for the most part, are going to want to have that control.
That is so interesting, and it’s something that only someone who’s dug-in and sort of gotten into the nitty- gritty of execution would really understand, like you guys. I mean we talk about that a lot here in big picture, but you guys have been on the ground and are seeing sort of what the rate of adoption is going to be. To that point, do you think that these funds are going to end up opening themselves in a white-label environment that you’ve created to the public, or are they going to end up listing in some future situation? Are they going to end up listing on third-party exchanges so that people have access to these investment opportunities?
I think it’s going to vary by fund manager, it’s going to vary by the structure of the investment in the asset class. LP interests in a private fund will always trade very thinly, and that is because of the due diligence or the informational requirements to really understand the investment to get in. Those are always going to be really high. Those are generally long-term hold investments, so people want some liquidity, but they’re not going to be trading in or out.
Also, there are tax consequences, depending on the structure. iCap’s structure is they raised money from investors as debt notes. So investor investing in an iCap fund has a debenture paying a set interest rate. Those don’t have the same tax and structuring implications that limit the liquidity, so those can trade as often as you want, there’s no limit on the number of investors. If you think of an LP interest in a private fund in the US, there’s what’s called the publicly traded partnership rules, that can put some real limitations on how often this can turnover and what venues it’s in, so listing it on exchange is problematic.
I think of debt as a great asset class just in general, on a macro level, that can trade far more often. That debt, I think will tend to list on exchanges over time, as this builds up. I think that certain types of REITs, like private REITs and others, and these funds, they will just tend to trade in these private marketplaces amongst limited groups of parties, because there are sound business reasons why these fund managers do not want to open it up to the public at large. Whereas with debt, you don’t have those same concerns.
Yeah, I love that you’re mentioning debt. I agree with you. I think that has a lot of potential that’s unencumbered by a lot of the things you’re talking about. That’s a great point.
So shifting gears, what are your thoughts on SEC and the regulations and rules here in the US as they’ve evolved to this point? As being someone who’s really deep in it, do you think we’re too harsh here or not enough regulation? Where do you think they sit?
If I was king for a day, I mean sure, there are changes I’d make. There are some detailed policy changes I think could still protect investors, but really enable better private markets. But I would say on a high level, overall, the SEC’s doing a pretty good job. From an industry point of view, they’re not moving fast enough. They’re not being specific enough. From an SEC point of view, I don’t speak for them, but I feel confident that they feel like they’re moving very quickly, and they’re doing their best to help industry along. Some of this is just a necessary and inherent tension because each side has a different job to do and different imperatives that drive what they do. And some of is just, there’s a speed of change whenever there’s technology-driven changes, there’s a speed there, that’s just different for regulators, and it’s different for what the financial industry is used to. I’d say overall, the SEC’s doing a pretty good job.
That’s great. Okay. Can you explain some of the different types of investors that you’re coming across? What’s the profile?
So I think what’s interesting is if you look at iCap’s investors, it’s mostly individuals, some small institutions, but it’s mostly individuals making average investments of 50, 100, couple $100,000 dollars. Those are precisely the kinds of investors in these private placements that have to be accredited, but think doctors, dentists, lawyers, professionals. It is a relatively large group of folks in the US and abroad who can invest in it. I think those are precisely the kinds of people that do need liquidity, where they’re investing to pay for their kids or their grandkids’ education. And if that fund extends their maturity from three years to five years, or four years to seven years, that’s a big deal to them, they might need that liquidity. I think that’s the sort of thing that iCap was seeing.
But I think long-term, they’ll be really interesting because as you enable more liquidity, as you use technologies so that you can break minimum check sizes, you can break the face amount of these debentures down into smaller amounts, you allow a broader group of credit investors to come in, and on the secondary markets you can allow non-accrediteds to get in, which I think is really exciting. In the US, after the securities are held for a year, under Rule 144, they’re no longer restricted securities and non-accrediteds can buy. Now, you can open this up to a broader group of investors. I think that’s really exciting for the industry, it’s really exciting for the sponsors, and I think it’s exciting for those investors.
Yeah, that’s definitely the sort of Holy Grail of this whole enterprise, is trying to figure out how to unlock all that liquidity out on Main Street, I guess is what they would say. So we’re eager to see how that plays out. On the topic of tokenization though, how does Harbor tokenize existing cap tables? Why is that a good use case for blockchain?
Well, it’s the same use case for blockchain. I think it’s the evolution of the industry. Originally, everyone thought yelling the word token, would cause investors to rush in. What we’ve seen is that’s not the case. So using the word token or blockchain, it’s not a good marketing gimmick for raising money. It is a good use of the technology to unlock or enable greater liquidity down the road. If you think about it, the liquidity in tokens was exciting to a certain type of investor who is speculating in those ICOS or those utility tokens. It’s not exciting to the traditional investors coming into traditional private placements, because they’re coming in generally with an extended timeline. They’re generally not forward adopters of technology.
Tokenizing existing cap tables, i.e., applying digital technology to make transfers more efficient, and easy, and compliant to exist in cap tables, is providing liquidity exactly when investors might need it. So rather than saying, “Hey, you’re going to have liquidity down the road whether you need it or not, when you may or may not, at some point in the far future,” and using it as a marketing gimmick to raise funds. What you’re saying to investors is, “You’re already in this fund. I’m now enabling greater liquidity for you, at no cost to you. I’m giving you something of value, at no cost to you, precisely when it is that you need it.” And I think that’s what’s exciting, from the point of view of Harbor as a technology company, is by focusing on existing cap tables, you get out of this issue of a marketing angle and you get into applying technology at the point of need, to people who need it and value it.
Yeah, it makes so much sense. I think as a marketing angle, the buyer has to understand the benefit. I think that’s been a hurdle that we’ve observed through a lot of guests recounting their stories that the buyers just had trouble grasping the whole benefit of tokenization, but once you just hand them the benefit, they can’t live without it, it sounds like.
Well, the other thing I’d say too though, is the liquidity benefits from tokenization, I believe in it, the industry obviously believes in it, the people who are throwing capital to invest in the companies believe in it, but it’s not real yet. And so it’s problematic to try and sell investors on the story to use it, to have them invest capital in the first place, being reliant on a belief in liquidity that isn’t real yet.
That’s a great point.
Right? And that’s problematic, and that’s why investors aren’t valuing it. There are regulatory implications, disclosure obligations, there’s a whole bunch of things. It’s a lot easier to just go to folks and say, “Hey, you’re going to have the ability to transfer this. The GPs going to... If you use this platform like Harbor, you’re going to be allowed to transfer. It’s going to be a lot easier. You’re going to have to follow the securities rules, a lot of those are going to be baked into the platform. That’s a lot better sell and in fact, if you look at Harbor’s website today, we have scrubbed the word token. It doesn’t appear anywhere near us. The word blockchain is still there, but it’s much more downplayed. It’s precisely because the investors, they’re not interested in the blockchain, they’re not interested in tokens. What they are interested in is if they need to get out, they want to be able to get out, and they don’t want to take four weeks and a ton of paperwork and that’s what we enable.
We’re not selling investors on blockchain, we’re selling fund sponsors on a platform that gives their investor a better experience while they’re in the fund, i.e., they’ve got this portal, they can go in, and they can see their statements, and they can interact, and we’re providing them a way to make transfers quicker, and more efficient and more compliant.
I love it. Given that you understand this space so well now, for those watching, can you explain why real estate particularly is a good asset for tokenization, and if there’re types of real estate in particular, that are ideal?
I think real estate is a great asset class because it’s so large, so fragmented, and so illiquid, and it’s also one that a lot of the smaller end of a credit investors is very interested in. You can see that throughout a number of the real estate crowdfunding platforms. You can see that in these syndicated club deals, that the same group of folks will do again and again, and we think club deals is a good market. We’re able to get 20 folks who will pool their funds into one real estate investment, than overlapping group of 30 folks in the next one, and overlapping group of 40 in another opportunity.
Enabling liquidity in an asset class that historically has had pretty good returns, a good risk-return profile, and that’s very understandable to investors. You invest in real estate, you have a much better understanding of that as the average investor and you’ve just been so illiquid. That’s in part, what has kept people out of investing in real estate is the minimum check sizes have been too large, and you’re locked in for such a long period of time. We provide a platform that makes getting into the investment a lot easier from a paperwork perspective, staying in it, you’ve got this investor relations portal, it’s a lot easier to manage those investors, whether you’re a club deal or otherwise a fund sponsor. And then finally, that liquidity piece is powered by the blockchain, because most folks going in, tend to hold the entire time. But everybody, but especially individuals, need liquidity from time to time. So real estate’s a great one.
Then, I think debt just generally. Debt will be more liquid for regulatory tax and informational reasons. Debt will be more liquid because from a regulatory standpoint in the US, there’s not a limit on the number of holders. From a tax perspective, turnover and holders of the debts does not present difficulties or problems in the same way it does with equity and partnerships, for example. And then finally, debt informational, it’s a lot easier to understand the investment. With debt, you need to understand maturity, interest rate and credit risk, and that does require a fair amount of due diligence, but a lot less due diligence than taking an equity stake, for example, in a fund.
Yeah, that’s a great point. So Harbor was in the news earlier this year because of a new partnership with Gemini. Can you tell us a little about that?
Sure. Gemini has the Gemini USD, GUSD stable coin. We struck a partnership with them, where they’re our preferred stable coin providers, so folks can invest in investments using GUSD, and they can do that today if we’re the fundraising platform. If an issuer wants to extend out dividends using our platform, they’re enabled to do it using GUSD.
We chose them because we think they are the premiere sort of institutionally-oriented platform out there in terms of stable coins. You can see it, they have had regulations and compatibility with folks that are concerned about stability and sort of the things that institutions need and that regulatory compliance, they’ve been leaders in the space, and so we were very excited to partner with them.
Yeah, that’s great. Can you talk a little more about exactly what is the role of a stable coin, like a Gemini dollar, how does that work out in a security token use case?
I think short-term, it’s a great funding mechanism. Instead of wiring in funds, folks can use Gemini USD and so the payment is instantaneous. You don’t have the same fees that you do with wiring. It’s a lot easier for everyone to track and deal with. It’s an incrementally better step than using wires for getting into an investment. Unlike using Bitcoin or Ethereum, there isn’t that currency risk. If someone’s investing into investment using Bitcoin or Ethereum, someone’s taking currency risks because that fund manager is investing using dollars or some other type of fiat. So, either the fund manager takes the currency risk or the investor takes the currency risk, but somebody’s taking that currency risk. With Gemini USD, you don’t have that.
But I think what’s interesting is in the future as you get more and more adoption of blockchain technology, as the UX and UI gets much better, I could see distributions happening using GUSD. So if you think of an iCap for example, as they allow lower and lower face sizes for these debentures and they trade more and more often, there’s practical logistical limits to that today because you have to generate ACH payments or wire payments to make all those monthly interest payments. If say, for example, you lowered those face amounts to $1,000 and you’re making interest payment of $10 bucks a month, that’s not economical to do via wires. Even doing ACH, then it becomes logistically difficult to track all these people, to do withholdings, and to send all the payments and take the charges.
A world in which you can do all of that on the blockchain, at almost zero transactional cost, is a world in which you can lower the face sizes, more folks can come in and invest, you can get more liquidity, and you can more efficiently make your distributions. And so that, I think of stable coins, a crypto dollar, being very important for that longterm vision of a more granular, more liquid, more accessible marketplace for these alternative investments.
Yeah, it’s starting to paint a picture of all the benefits to both of the stakeholders’ sides, really knitting together. It’s fun to hear you describe it as someone who’s doing it. I hope people are absorbing that as we’re sharing it because it’s exciting. As the space does evolve and become more integrated with the legacy finance world, like we’re discussing, where do you see Harbor fitting in among the other systems and processes in private capital markets?
I think where we’re fitting in today, so we provide a software platform on which people can conduct private placements, their brand name, their color scheme, but that makes it all. They can raise money from more investors, from more countries, more quickly and more efficiently because administratively, they can process them through, they can get the compliance done, they can get people in, and dollars aren’t slipping away because folks are balking at a lengthy and difficult logistical process.
On the sponsor side, if you’ve ever tried to raise for more than a dozen people using manual processes, emails, you’ve wanted to blow your brains out. It’s just too difficult. I think we fit into the current structure today. It’s this large fragmented industry measuring in the trillions of dollars in private capital. I don’t think we fit in, frankly in the largest players. Everything’s going great for them today.
If you’re a Blackstone, they’re going to be late adopters of something like this, and they may or may not end up just developing their own platform. I think if you are a small to mid-sized sponsor, you’re not interested in spending millions or tens of millions of dollars to develop your own platform. You’re interested in plugging into standard technology, standard platforms, that then can plug in the way Harbor can, to that whole Ethereum or other blockchain ecosystems, where we’re plug and play with custodians. We’re plug and play with stable coins like Gemini. We’re plug and play with ATSs like Openfinance, or SharesPost or others. We’re plug and play with these really interesting technologies like derivatives with DuyDX, and margin lending with a Maker Dao, or a Compound, or others. Dharma or others. I think that’s what’s really exciting.
I think, where do we fit in the ecosystem? We fit in with the small to midsize players, folks for whom adopting technology early gives them a competitive advantage and providing a better for their investors and enabling types of investment opportunities down the road that they couldn’t otherwise offer. Because now you can break down the sizes, and you can combine and recombine these things in interesting ways.
No doubt. So all that having been said, what is next for you and the folks at Harbor? What goals did the company have, as we look ahead at a 2020?
Right now, I think we’re facing a very different set of challenges than we were, say, six to nine months ago, but they’re exciting challenges. The challenges before during crypto winter or in the early part of this year was, okay, where is adoption going to come from? Now what we’re seeing is, we think with the private marketplace concept, with taking out the hype around blockchain, but focusing on the actual value that’s delivered to the fund sponsor, the investor, we’re starting to see real adoption.
I think the challenges are all around scalability and standardization and we’re excited. We think what you’re going to see initially are these silos of liquidity, these fund sponsors with their own private marketplaces. You’ll see a few folks that are more interested in publicly accessible, tokenized investments, but then we think over time, you’ll see these start to knit together. And eventually, you’ll see that what we’re talking about, which is that world in which the blockchain is the DNS system, it’s the open addressable system of all these investments, and folks can more seamlessly get in and out of them.
Josh Stein, the co-founder and CEO of Harbor. Thanks so much for speaking with us today. We wish you and everybody at Harbor the best of luck.
Thanks, Adam. Really appreciate you having me.
Harbor is a gold corporate member of the Security Token Academy. To learn more, go to our website, securitytokenacademy.com, click on the directory tab, and then select, corporate member. For everyone here at the Security Token Academy, I’m Adam Chapnick. Bye bye.
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