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The Importance of Self-Custody in the Security Token Industry

Expert Interview


 
Stephen McKeon: The Importance of Self-Custody in the Security Token Industry

Stephen McKeon

Stephen McKeon is an Associate Professor of Finance at University of Oregon and Chief Strategy Advisor at Security Token Academy. His research focuses on cryptoassets, security issuance, and M&A and appears regularly in top finance journals and major media outlets. His professional experience includes six years as a chief financial officer and involvement with several venture backed start-up firms and token projects as an advisor and board director. He has co-founded a venture fund, a real estate development firm, and Skyward, a commercial drone software company, which was acquired by Verizon. Prof. McKeon teaches valuation, FinTech, and venture capital at Univ. of Oregon, as well as blockchain regulation in UC Berkeley’s Blockchain Unlocked program.

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Transcript


 

Amy Wan:

This is Amy Wan reporting from the StartEngine Summit out here in LA, and I'm here with Stephen McKeon. Stephen, can you make a quick introduction of yourself?

Stephen McKeon:

Sure. I'm Stephen McKeon. I'm the chief strategy officer at Security Token Academy. I teach at University of Oregon. I'm a partner at Collaborative Fund. I wear a lot of hats in this space.

Amy Wan:

I'm going to ask you some more nuanced questions about the security token industry that I think a lot of people haven't quite thought about yet. Let's talk about public and private blockchains. The security token industry, there's a lot of laws, a lot of regulation involved. I think there's this increasing inquiry as to whether it's better to have these security tokens issued on a public or private blockchain. Can you review the pros and cons in both and what you think the future will be?

Stephen McKeon:

Sure, I'd be happy to. This is a question I get a lot. As I've stated previously, I am an advocate for public chains. The reason is because I think the open source is really powerful in terms of getting lots of people to build on top of it. If you look at what prompted the ICO boom in 2017, largely was driven by the ERC-20 standard on Ethereum. It created a standard that allowed for interoperability. It allowed all the wallets to custody the new assets that were being created. It allowed a lot of people to buy into a common standard because it was going to just automatically work with all the previous infrastructure that had been built.

The advocates for private chains will often point to the fact that the financial industry is heavily regulated and privacy is really important. I really sympathize with those arguments. I think that full transparency, sort of like what we have with Ethereum, is going to be difficult in the long run in terms of really seeing this space scale. In financial securities, people do not want other participants seeing what they're holding. They do not what other participants seeing their trades. There are going to have to be privacy solutions. Maybe that looks something like zk-SNARKs, or StarkWare, or maybe some implementation of Mimblewimble. There are privacy solutions that we could integrate onto pubic chains. I think those are the points of tension.

Amy Wan:

Fantastic. A lot of the current securities industry is literally written into laws and regulations, transfer agents, custodians, things of that sort. Sometimes when I talk to people in the STO industry, they wish we could just start from scratch and get rid of it. Do you have any thoughts about that?

Stephen McKeon:

I think we are starting from scratch to some degree in the sense that it is a parallel system that is being built, and it will collapse some of those layers down. It probably won't collapse all of them. I think self-custody is going to be important, but I think there are going to be some investors that don't necessarily want to self-custody. Certain institutional investors, for example, really need a custody solution just from a legal standpoint and from a fiduciary standpoint. I think it is going to collapse the system relative to the way we trade securities now, but I think you're going to see some mapping of some of those pieces into the crypto landscape.

Amy Wan:

Do you think the traditional or current roles of, for example, custodians and transfer agents is going to evolve or shift at all because of the STO industry?

Stephen McKeon:

Yeah. If you look at what transfer agents do in traditional securities, I think that function is going to be performed more by a compliance platform like a Harbor, or a Securitize, a Polymath. Those sorts of groups are probably going to perform that function of keeping track of the cap table and the various functions, moving the Reg D through Rule 144 and taking the legend off. I think that'll be performed by these platforms. Again, I think the idea is some of these things are just going to get collapsed into a more efficient version in crypto.

Amy Wan:

I saw a very interesting question on Twitter the other day. Someone asked, "Hey, if I am holding my own security token but I lost my private keys, what's going to happen?" In the STO industry, it's interesting because you actually have AML KYC. What's your answer to that question?

Stephen McKeon:

I think in order for the security token industry to scale, there's going to have to be cancel and reissue features. I understand fully that that goes against the immutability aspects that we appreciate and really value in the currencies like Bitcoin. The issue is that these are regulated securities, so they're a little bit of a different animal. It's unclear whether that will be performed by the compliance platforms or whether they're going to want to outsource that service. It's possible they want to outsource it to a third party. Maybe Sagewise will be interested in that aspect. I think there is going to need to be some form of key recovery and a process around that because let's face it, as soon as you open a key recovery mechanism, that is another attack vector for hackers. The way in which that's executed needs to be done very carefully.

Amy Wan:

Right now outside of the US there's still a lot of ICOs happening, and they're all playing regulatory arbitrage. You have the US SEC, which has taken a very particular stance on regulation of tokens. I often hear some concerns around we're stifling innovation. There's going to be Brian drain from the US. There's going to be less innovation here. We are pushing the financial services industry away from the US. Do you have any comments around that?

Stephen McKeon:

Yeah. This is a topic I've thought about a lot because I was involved in the commercial drone industry before crypto. It was also a regulatory issue. We went through all of these same comments. The idea was commercial drones were illegal in the US. We were literally witnessing a brain drain. Projects were moving to Canada. They were moving to Europe. They were moving to Africa. They were moving to places where the regulation wasn't going to stifle what they were trying to do. Eventually the FA consulted industry experts. They came up with some thoughtful regulation. It was called Part 107. I don't think the SEC has been stifling to the same degree. If you look at the enforcement actions, they have been pretty targeted. They haven't made industry-wide proclamations that are binding in any way. I think the jury is still out. I think some increased regulatory clarity would actually be welcomed at this point.

Amy Wan:

Fantastic. We're approaching the end of the year. Do you have any specific wishes for how you want the industry to evolve in 2019?

Stephen McKeon:

Yeah. I think the big piece right now is the buy side. I think the supply side in terms of security tokens is pretty robust. There's a lot of issuers that are interested in generating liquidity. There's a lot of issuers in every asset class, in fixed income, in real estate, early stage equity. I think the important part is developing the buy side. Most crypto investors are looking for venture-like returns, so they may be less interested in real estate, although I think they should be. As a finance professor, we like to talk about diversifying portfolios. You look at a lot of the traditional real estate investors, they're not yet comfortable with the platforms, digital wallets and so on. I think bridging that gap is going to be the big effort over the next 12 to 24 months.

Amy Wan:

Fantastic. Thank you so much for joining us, Stephen.

Stephen McKeon:

Absolutely, thanks for having me.

Amy Wan:

This is Amy Wan from StartEngine Summit in LA.