Neufund Report: The Pioneer of a Decentralized STO?
- Post by: bag2q
- November 1, 2018
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In this report we aim to conduct an in-depth analysis of the Neufund platform and its marketplace. Neufund aims to provide a blockchain-based platform for fundraising. It has the goal of replacing traditional stock exchanges such as NYSE with a fully transparent, decentralized and community-owned platform. The research draws upon the Neufund Whitepaper, its smart contracts and various web sources in order to provide an overview of the platform mechanism (Part 1) and elaborate on its smart contract execution (Part 2). Finally, we will perform a competitor analysis and discuss possible suggestions regarding the challenges facing Neufund (Part 3).
Neufund is a blockchain-based equity fundraising platform with the potential of becoming the leading Security Token Offerings (STO) platform in Europe. It seeks to provide a simple and transparent platform for Equity Token Offering (ETO). This special class of STO allows both off-chain and on-chain companies to issue regulated equity tokens on the Ethereum Blockchain.
Through the Neumark (NEU) token framework, STO investors are able to obtain a “share” of the underlying Neufund platform. NEU can be considered as a dividend-paying token, as every NEU holder gains a fee from every successful ETO on the platform. This is a key differentiator that seperates NEU from the access and utility tokens of other STO platforms.
Part 1: Neufund Overview
NEU is an ERC20 token that rewards token holders by giving them rights to the revenues generated by the platform, through fees and a portfolio of equity tokens. NEU is generated whenever Ethereum (ETH) or Euros (the stablecoin EUR-T on the platform) is committed by investors for ETOs completed on the Neufund platform.
The Neufund Whitepaper was published in September 2016, while its first public Neumark token offering took place in November 2017. Through this token offering, called Initial Capital Building Mechanism (ICBM), the platform has raised a total of around 12.5 mln Euros in a single month, which generated an equivalent of 55 million NEUs. We would like to note that the above-mentioned committed funds are NOT the property of Neufund. Rather, they still belong to the investors and are kept on their respective platform accounts for future ETOs.
In July this year, Neufund announced their strategic alliance with the Malta Stock Exchange for the eventual goal of building a “decentralized and global stock exchange”. At the same time, a partnership with Binance was announced, which may allow equity tokens of the Neufund platform to be traded on the Binance exchange in the future. In August 2018 NEU was listed on BitBay where it is now available in four trading pairs, including BTC and three FIAT currencies.
Equity Token Offering (ETO)
Equity Token Offering (ETO) is the fund-raising mechanism that is at the core of the Neufund platform. Neufund’s goal is to provide a platform where secure, regulated ICO-like token offerings can be undertaken.
Under German law, securities are divided into “Wertpapiere” (securities) and “Vermögensanlagen” (investments). The main difference between the two security classes is their transferability. “Securities” are freely transferable in the capital market, while “investments” require additional legal procedures for re-assignment to another party.
Neufund structures its tokenized assets as “investments”, as it is easier to register a public offering of investment assets with German Financial Authorities (BaFin). Such tokens are comparable to private equities. ETO is the public offering of such a token, subject to the German Banking Act (KWG) and the Investment Asset Act (VermAnIG). ETOs can be conducted by any incorporated entity worldwide, except those in the U.S. due to the ongoing regulatory uncertainty which has yet to be clarified by the CFTC and SEC, the primary U.S. commodities and securities regulators.
STO vs ETO
Security Token Offering (STO) is the catch-all term for similar token offerings and is the term used most often globally when referring to new token offering, so it is then natural to ask what is the difference between STO and ETO. Strictly speaking, ETO is a subclass of STO, the same way that an equity token is a specific type of a security token. However, their functionality is the same from the users’ perspective.
The Neufund Platform Mechanism
Currently, the Neufund platform is run by Fifth Force GmbH, a sub-unit under Neufund that act as the only platform operator. To incentivize investments, investors are rewarded with 50% of the NEU tokens generated for every successful ETO, in addition to the specific tokens they invested in. The platform operator gets the remaining 50% of the generated Neumarks as their sole source of income.
NEU supply is determined by the total amount of funds invested in ETOs through the platform. Early investments are encouraged through a diminishing NEU reward. For example, when there are no prior investments, an initial investment of 2 mln EUR-T will generate the first 12 943 829 NEUs, half of which will be distributed to investors and the other half to the platform operator. However, a subsequent 2 mln EUR-T invesment will only generate 12 832 133 NEU due to diminishing NEU reward.
The value of NEU is determined by two factors— the direct fees charged on the platform and the token fees from platform portfolio in the following way:
- 3% of the amount raised by every successful ETO is deducted as a platform fee and distributed pro rata to every owner of NEU, including the Platform Operator.
- 2% of the tokens generated in each ETO is transferred to a platform portfolio pool, indirectly giving NEU owners a share in all companies tokenized on the platform.
It is expected that through these mechanisms, NEU owners have an incentive to further participate in the network. Also, the platform operator aligns its interest with the other ecosystem participants as its revenue is based solely on the value of NEU.
Despite the fact that seven ETOs have been scheduled on Neufund, there is currently no information available on when they will take place. Given that the earliest NEUs were generated in December 2017, the NEU holders have gone ten months without any of the aforementioned benefits.
Summary Part 1.
- Neufund aims to provide a blockchain-based platform for ETOs, a special class of STO.
- A platform token, NEU, is generated for each successful ETO to provide incentives for participation in the platform.
- NEU can be thought of as a dividend-paying token. Each NEU holder receives a share from every successful ETO.
- Equity token is structured as an “investment asset” under German regulations.
- The platform operator’s only source of income is its share of NEU rewards.
Part 2: Smart Contracts and Platform Implementation
In this Part, we discuss the technical aspects of smart contracts and some issues regarding the platform.
ERC20 vs ERC223
Both NEU and the Equity Tokens issued through Neufund platform use the ERC223 Interface, an advancement of the ERC20 token Standard. In practice, this means that any ERC20 compatible smart contract deployed to the Ethereum main-net (currently about 128000) also works with the ERC223 interface.
Furthermore, transactions with the ERC223 standard are more similar to Ether transactions, which are safer, solving the critical problem of accidental token losses. This is achieved by ERC223 standard’s new transfer method. To illustrate this point, we shall use an example. If one sends 50 ETH to a contract that is not intended to work with Ether, then the transaction will be rejected, preventing the tokens from getting stuck at the contracts balance and eventually getting lost forever, which often occurs for the ERC20 protocol.
On the Neufund platform, both off-chain and on-chain solutions are used in order to protect the interests of investors and ETO issuers. The on-chain solutions are smart contracts, while the traditional off-chain legal solutions are legal agreements which encapsulate the same legal terms but are written in English.
Agreement Contracts are the legally binding smart contracts of the platform. They are approved by the signature of the Platform Operator Representative and the related party (investors or companies) before they can be stored in the Immutable Storage (IPFS) as legal contracts. Among the various smart contracts for the ETO, the ETOCommitment and ETOTerms are two of the most important Contracts during the Equity Token Offering.
ETOCommitment is a legally binding agreement contract and represents the token offering organized by a company. This contract is an agreement that can be deployed by anyone and is signed once investors send a payment to the contract. The commitment requires all the payments by investors to be conducted only with ERC223 compatible payment tokens. The ETOTermscontract encapsulates the base terms of Equity Token Offering and is set by the company doing the ETO. It reflects pricing and discounts among other important investment terms (see Term Sheet Ninja).
Neufund tokens represent more complicated rights than simple token transfer rights, since NEU entitles its owner to revenue, voting and other rights. These rights depend on the amount of tokens stored in the wallet at a certain point in time. Therefore, it is natural to attach these rights to token holders’ balance at a particular point in time. For this purpose, Neumark is a Snapshot Token, which means that all the wallet balances are saved at a certain point in time. More specifically, in case of the NEU token, balances are being stored on a daily basis, and Neufund also provides snapshot storage via the Snapshotcontract.
A slight deviation from the Whitepaper?
It is interesting to observe how the platform actually operates in comparison with the original mechanism outlined in the Whitepaper. Here, we analysed three aspects where the Platform’s implementation seems to have deviated from the initial goal outlined in the Whitepaper.
Ether round ICBM
As a matter of fact, it was initially planned in the Whitepaper that commitments in the ICBM can be done using both EUR-T and Ether. Later on, however, it was announced that only ETH will be accepted as a commitment currency and that there is no public EUR-T ICBM for the platform. However, as we came to discover while exploring on-chain transactions, there have been actual EUR-T commitments during the ICBM phase.
In fact, the top two NEU owners other than Neufund obtain their share of NEU with EUR-T commitment instead of ETH. Moreover, there are in total about 100 EUR-T commitments throughout the whole ICBM period. This amounts to about 10% of the total ICBM transactions.
The readers are reminded that investing with the less volatile EUR-T in ICBM should be more preferred, as these invested funds are subjected to an 18-month liquidity risk before the investors may use them again.
Neufund Tokenized themselves with NEU?
We mentioned in Part 1 that Security Tokens are structured as “investments” under the German Regulation. So how about NEU tokens? Is NEU the security token of the Neufund platform, or something else?
The properties of NEU tokens are in fact very similar to securities. In the Whitepaper NEU is described as representing a share of the ecosystem and a token representing network value. Additionally, it has dividend-like features, with NEU holders getting a fee for every successful ETO (see Part 1). In fact, Neufund even described NEU as being their own “stock”.
The legal framework of NEU is described in the Neumark holder agreement. However, no specific legal structure on NEU is detailed. Given the emphasis of Neufund on legal compliance, the regulatory ambiguity of NEU is inconsistent with Neufund’s legislative expertise.
NEU burning and NEU reward
It is stated in the Neumark holder agreement that NEU can be burned. A possible reason for allowing NEU owners to burn their NEU is to allow for the use of the escape hatch, a mechanism that allows investors to take back their funds committed in the ICBM (ETH or EUR-T) immediately with a cost (10%).
However, burning NEU resets the NEU reward to a higher value. As explained in Part 1, NEU reward depends on the total NEU supply. Burning NEU reduces the total NEU supply, thereby reverting the NEU reward back to an earlier (and higher) rate.
A highlighted incentive for early investors of Neufund is the high NEU-reward rate. However, through burning a substantial amount of NEU, Neufund may reset the NEU reward curve to attract future investors. Thus, the fact that NEU can be burned compromises the promise of early investor incentives.
Summary Part 2
- Neufund’s Equity tokens are ERC223 token, an advancement to ERC20 in terms of token transfer.
- The ETO smart contracts are paired with off-chain legal contracts, ensuring legal compliance in the off-chain world.
- EUR-T was used in ICBM even though Neufund only allows ETH investment from the public.
- It is unclear whether the NEU token is a equity token or just another type of instrument.
- NEU reward can be altered by burning NEU.
Part 3: STO Ecosystem & Competitor Analysis: Polymath vs Neufund
In the final part of the report, we will present an overview of the STO ecosystem and compare Neufund with Polymath and other STO issuers.
There is no doubt that the STO ecosystem has been growing rapidly in the last few months, attracting the interest of key players in the crypto space as well as institutional investors. At Kintaro Capital, we are not only keeping a close eye on Neufund, the object of this report, but also on the entire STO Ecosystem. In the following graphic, we summarise the STO Ecosystem:
We have identified Polymath as one of the primary competitors to Neufund in the STO platform space. Polymath distinguishes itself from Neufund in a number of aspects.
Neufund vs Polymath
As STO issuers, Polymath emerged from a crowd of competitors and gained widespread attention from the crypto community. Here, we give a detailed competitor analysis between Neufund and Polymath platforms. Some other noteworthy STO platforms are also mentioned at the end of the report.
Fundamentally, both projects are based on Ethereum. However, they use different token standards. Neufund Security tokens use ERC-223 while Polymath’s security tokens use ST-20, a token standard developed by themselves which is specialised for security token applications.
The main difference between the ST-20 and ERC-20 standard is the addition of a verifyTransfer function. This function determines whether the token transfer will be completed or not based on a set of criteria like an investor’s qualification. Every time an ST-20 token is sent from one address to another, this function is called.
The verifyTransfer functionis vital for a security token that needs to comply with the US regulatory requirements. Every transaction is checked by the function to ensure that it complies with all requirements. These include checking the category of the investor (whether it is accredited in the US or not) and setting certain lock-up requirements in the STO. Readers may refer to a detailed article by Harbor that presents the regulatory landscape in the US for more information.
Even in the case when the STO is not done in the US, the versatility of this protocol enables embedding necessary regulatory requirements into the tokens. Considering the fact that the Neufund platform does not incorporate such a verifying function, it is not easy for Neufund’s equity tokens to comply with US laws. On the other hand, with appropriate supplements, it is possible for an STO based on ST-20 tokens to comply with EU regulations.
Neufund’s STO has a structure that is compliant with EU regulations, notably the EU prospectus directive. More specifically, Neufund’s STOs are structured as “investment” under German regulations (see part 1). STOs structured by Neufund allow EU investors to participate in the platform. However, US investors are unable to participate due to “regulations ambiguity”.
Polymath has a strong focus on US regulation instead. In particular, STOs under Polymath’s framework should be compliant with US Reg D 506(c), which allows the participation of US accredited investors . The inclusion of non-US investors, however, may require additional legal structures.
In short, their geographical difference translates to differences of their legal structure, and hence their potential target market.
Legal support is the area in which Neufund has stark contrasts with Polymath. Neufund provides close legal guidance, both on-chain and off-chain, to companies that would like to do an ETO (the STO on Neufund’s platform, see part 1) on their platform. To make sure that every ETO is compliant with German regulations, Neufund provides templates of the necessary legal documents (prospectus, term sheets and more) themselves and acts as the legal representative for various contracts (see part 2 for more details). Moreover, an ETO on Neufund can only be done with the consent of Neufund. From the companies’ perspective, especially off-chain companies, this eliminates the burden of having to dive deep into the complex legislations, while still being able to raise funds in a promising crowdsale. A good example is given by the case of Emflux, an Indian motorcycle start-up which plans to do one of the first ETOs on Neufund platform. To comply with regulations both in India and Germany, they have to set-up a GmbH in Germany to do an ETO. They confirmed to our research team that they received substantial legal advice from Neufund.
Polymath, on the other hand, is more decentralized in this aspect. Although it has a sub-unit called Matador which provides advisory services, their support is not mandatory to issue an STO on the platform. Anyone (with sufficient knowledge in blockchain technology) can create their STO based on Polymath’s GitHub or the Polymath Tokenstudio. This, however, brings forth legal compliance risks for companies planning to do an STO, as they might not have enough legal expertise to structure their STO. For instance, they may happen to miss out a lock-up date for the token settings, leading to violations of certain regulations they overlooked. Finding a suitable legal consultant for an STO themselves is, however, not easy at such an early stage in this crowdfunding method.
Therefore we believe that at this stage Neufund provides more comprehensive support to STOs. However, Polymath’s platform provides more flexibility to companies willing to do an STO in different jurisdictions.
Neufund has built a marketplace where companies and investors can participate together on a unique platform. To join this marketplace, investors and companies need an account on the platform. A comparable example is the STO platform of Swarm Fund. Such a marketplace is easy to assess for investors and it also allows the comparison among different projects. Investors can participate in multiple ETOs while going through a single AML/KYC process.
Please make note that a platform fee is reduced from the ETO proceedings of every ETO to reward NEU owners. In this sense, any investor (who is then also a NEU owner) that invests in one ETO, is also indirectly making investments in all the other projects of the platform. Thus, the quality of every company on the platform affects investors’ willingness to invest. To ensure the credibility of the projects, only selected companies are allowed to participate in ETOs. The due diligence on projects listed on the platform is performed directly by Neufund.
Polymath, on the other hand, does not offer a centralized marketplace. Instead, it provides facilities like Polymath Tokenstudio to help companies create their tailor-made STO. This has the advantage of flexibility, allowing the company to implement the STO and develop their specialized platform. Also, all STOs are independent from each other.
In short, Neufund provides a more user-friendly marketplace and stronger support to companies planning to conduct a STO. The trade-off is higher centralization of the marketplace and scrutiny of companies and investors that would like to join the platform.
From token standard to legal structure on how the STO is made, Neufund and Polymath have very different perspectives. This, in part, is due to how they positioned themselves in the STO environment. Neufund’s focus is on being a user-friendly service and advice provider, while Polymath emphasizes the versatility of their token standard. Polymath has a more adaptable security token protocol, whereas Neufund sets a good example of how blockchain expertise helps off-chain companies smoothly onboard and create a token offering.
Other notable mentions
Securitize: Provides comprehensive tools and advice for companies planning to do a STO. Several STOs were done and some are on-going, notably the SPICE VC STO which raised $40 M, and an on-going STO for Lottery.com.
Swarm fund: Launched an STO platform where STOs are “listed” with information of the companies, their vision etc. Their marketplace is similar to what Neufund is planning to do.
Tokeny: Based in Luxembourg, also compliant with EU regulations, and it has two announced STOs in the future. However, they do not provide too many details on how their STOs are structured both on-chain and off-chain.
Harbor: Provides clear explanation how they achieve regulatory compliance and a detailed github for their R-token. However, there are no known STOs planned/done.
With this Kintaro report we want to shed light on the mechanism, challenges and limitations of the Neufund Platform. Our goal is to enable investors and those interested in equity fundraising on blockchain to have a better understanding of STOs performed through the Neufund platform.
What is Kintaro Capital?
Kintaro Capital is a collective investment scheme soon to be established under the laws of Malta as an investment company with variable share capital. At Kintaro we are true believers in the long-term value of blockchain protocols and crypto-assets. Our goal is to offer an alternative to fiat based financial instruments, leveraging our crypto-economic experience, our research and data analytics expertise to yield higher returns, while reducing and managing the inherent firm-specific and market risk.