An increasing number of non-bank lenders are looking to initial coin offerings (ICOs) as a source of funds for trade finance lending.
ICOs – also referred to as token sales – are unregulated means of crowdfunding, using cryptocurrency. In theory, through an ICO, you can raise money from anybody, anywhere in the world.
This is done by issuing digital tokens, which in turn gives investors a stake of the company. Early backers are usually motivated by a prospective return on their investment, as a startup’s success would often translate into a higher token value.
For trade finance lenders, it offers access to an unorthodox – and, theoretically, unlimited – pool of investors in a market that is booming. In July, a report by research firm Autonomous found that startups had raised in total a record US$1.27bn in the first half of 2017 through ICOs, while the top four ICOs of the year, according to research firm Smith and Crown, have to date raised US$660mn between them.
However, the market has come under intense scrutiny in recent weeks. Unlike mainstream fundraising activity, ICOs are unregulated. The anonymity of the market and the connections with the dark web have led to fears over money laundering and links to other sinister activity.
In September, China banned ICOs outright, saying they left investors unprotected and dismissing the entire practice as “illegal fundraising”.
The Hong Kong Monetary Authority (HKMA) chief executive Norman Chan followed this up by claiming that “bitcoin or other digital currencies do not require holders to trade under their real name, which allows them to be used for money laundering activities”. Similar warnings have come from the Monetary Authority of Singapore and the Securities and Exchange Commission in the US.
But while companies in the space say they have heeded the warnings of regulators, it seems not to have dampened enthusiasm for a fundraising model which, if used and managed correctly, can be much quicker and more efficient than traditional channels.
Trade finance ICOs
The trend of trade finance ICOs is already underway, with invoice financing company Populous raising US$10mn in this manner in July. In fact, the startup sold out of its customised tokens in just five days.
GTR has spoken to a number of other companies in the process of arranging ICOs as a means of kickstarting their own lending operations, with the eventual aim of attracting institutional investment further down the line.
Harveen Narulla is the CEO of Kommerce, a Singapore-based startup that will launch an ICO in October, with a view to raising US$30mn to US$50mn by the end of November. The proceeds will help fund a three-year programme of financing highly-liquid, fast-moving commodities such as cooking oil, coffee, sugar and rice into Africa.
Narulla is also the founder of Pan-African Logistics, a company that brings the same sorts of goods into Africa. He has seen the pain point, and thinks an ICO will provide Kommerce with the start-up capital to support small trading companies on a continent starved of bank debt.
“A container of cooking oil will cost you less than US$20,000. We want to put money towards a trade that churns frequently. It takes 45 days for an end to end transaction to complete. We want to build a stable of such regular transactions. If a merchant is bringing in five containers but thinks he can do 10, we can deploy the cash to acquire 10 for him. We don’t want to do ad hoc deals, but regular, repeatable deals,” he tells GTR.
Launching an ICO allows Kommerce to bypass the “venture capital dance”, says Narulla, who has been involved in that space for a decade.
He explains: “It’s a desire to bypass talking at people who don’t understand the subject or are already doing well enough financing developed markets, so it’s not worth their while looking at new markets. We can also bypass Africa sceptics, because there are many and with good reason. Our subset of people is very narrow, so instead of spending one or two years flying around the world, I’d much rather go to people who are willing to finance based on the potential of this upside. Because I know the institutional money will follow, it’s just waiting for a demonstration that this can be done.”
Another Singapore outfit looking to capitalise on the ICO boom is Trade Finance Market, which last month launched a blockchain-based solution with the aim of stopping the double financing of invoices. The tool allows banks and factors to check if another funder has already paid an invoice by cross-referencing it against a blockchain-based central registry. The company also provides funding to underbanked SMEs.
“Our experience in running the Trade Finance Market platform has shown that speed is of the essence in financing SMEs and is a competitive differentiator. The ability to be able to quickly fund transactions that have passed our diligence filters is the main reason we are doing an initial token sale. Transactions will be further de-risked through the use of security and smart contracts using blockchain technologies. This will also keep costs down and savings are then passed onto our SME clients,” executive director Raj Uttamchandani tells GTR.
The company will be starting with a pre-ICO in October, a period used to screen potential funders to ensure they comply with anti-money laundering (AML) standards. The funds will be raised by issuing the company’s own token, EximCoin.
Uttamchandani says: “Crypto investors are on the lookout for tokens that can provide a return through real world utility – having a social benefit also helps. Through our platform, EximCoin holders will be able to view in real time as trade deals are initiated, financed and completed – providing reassurance to all parties involved that their money is at work with SMEs and that they will see returns within a 120-day period.
“For non-crypto funders who are dissatisfied with their existing investment opportunities, EximCoin tokens also provide access to excellent returns via emerging market trade, always secured with a security or smart contract. Unlike other companies raising funds via an ICO, we have working products as well as an excellent track record in trade finance,” he adds.
He compares the noise around ICOs – not to mention blockchain – to the internet hype 20-odd years ago. There will be a lot of failures, but the cycle has also laid the grounds for companies such as Amazon, Google, Facebook, Alibaba – the cornerstones of the internet as it exists today.
Uttamchandani continues: “In time, crypto-based products and technology in general will evolve in ways we cannot fully realise now – for example the same way running ICQ or AOL/Yahoo messenger on a desktop computer via a dial up connection eventually spawned a video call on WhatsApp running on 4G mobile. The one thing we can say is that this is just the start of the journey for crypto technology and we are very excited to play our part in the process of its evolution.”
In Moscow, meanwhile, ModulTrade CEO Evgeny Kaplin is gearing up for another token sale in October – which is set to be a busy month for the nascent market. His initial expectation is to raise US$15mn to support the creation of a blockchain-based smart contract platform and to launch an SME lending solution in three EU countries. However, market demand may lead to an increase in the cap.
He tells GTR: “We will use MTRc – the ModulTrade token distributed during the token sale – to provide financing to SMEs to facilitate trade. Thus we will help solve the main problem for SMEs in trade – lack of financing.”
A former trade finance banker with Sberbank, Kaplin says the demand for SME financing is not being met by mainstream channels. This is a common theme among those interviewed for this report. Each has identified a gap in the SME lending market. And each has landed on an ICO as a way of solving this problem.
A minefield of risk
Each of the companies is also aware of the risks involved. They say that regulation of the nascent market is important and welcome the increased scrutiny from regulators. It will, they say, separate the “Mickey Mouse projects” from those that are worthwhile, and if regulation is enforced, give them clear parameters and boundaries to work within.
Understandably, legal experts are looking at the market keenly. Jolyon Ellwood Russell, a trade finance partner at Simmons & Simmons in Hong Kong, tells GTR that he is getting calls about ICOs and alternative fundraising, but has yet to see real movement in the market.
“We are seeing more and more platforms using bitcoin and other cryptocurrency as either a conversion platform in order for the ability to send money or even as a medium to settle payments for goods and services. Therefore, the extent to which such a platform provider can ICO against their particular technology then this might do very well. What might be more exciting is in the world of invoice exchanges. What we might see are players issuing their own coins or cryptocurrency linked to the purchase of invoices sitting on an exchange thereby creating a larger liquidity pool,” he says.
Regarding the risks involved, he is unequivocal: “There are inherent risks on the general unregulated nature of ICO. There is of course the sources of funds and financial crime issues. Bitcoin has not had the cleanest of reputations and given the mammoth appreciation recently, some regulators are monitoring whether ICOs might be an easy means to profit from illegal bitcoin accumulation and diversify into legitimate businesses.”
The other risk is regulatory, Ellwood Russell says. The law looks at substance over form. If the substance falls within an offering to the public and in return shares or an interest in the company is issued, then this is regulated as any stocks and shares market. “Whatever it might be called in techno-speak, if it looks like a duck and sounds like a duck, it usually is.”
There are, of course, ways in which one can mitigate this risk. ICOs are conducted on exchanges, which have varying degrees of scruples. In Hong Kong, Gatecoin has emerged as one of the more reputable, recovering strongly from a hack last year in which it lost US$2mn in cryptocurrency.
Thomas Glucksmann, head of marketing at the exchange, explains that Gatecoin will conduct thorough AML and KYC checks on all token buyers. “There are a lot of dodgy projects,” he tells GTR, but says that there is no reason why legitimate crypto investors can’t be a good fit for trade finance lenders. However, he says it takes careful planning and diligence to pull it off successfully.
Equally, Steve Ehrlich, lead emerging technology analyst for New York corporate advisory Spitzberg Partners, has heard a lot about trade-based ICOs, particularly in the logistics space, but has some advice for those hoping to do it within sound legal parameters.
“The short answer is to hire a good lawyer that has expertise in the relevant jurisdiction. They can help a company understand its regulatory requirements by assessing whether or not what it is issuing is considered to be a security. This determination is crucial because securities come with additional requirements and complications, such as limiting to whom you can market your ICO,” he says.
Every month there seems to be a new study or report citing the gap in financing for small businesses. Trade finance is not suffering a liquidity problem however, it is suffering from a dearth in risk appetite. Banks, chastened by regulations, are increasingly focused on the least risky transactions and it is essential that new sources of funds are harnessed.
Will this come from ICOs? The volumes discussed thus far are miniscule when stood next to the market gap. However, any legitimate source of funding should be encouraged (with “legitimate” being the operative word). The market is developing extremely quickly, with problems and opportunities revealing themselves daily. What’s clear is that this trend will not abate any time soon. Regulators should act quickly to ensure the potential is not lost, while those interested should tread carefully and choose their investors with extreme care.
