The digital assets platform Republic is touting plans to give retail investors access to the world’s hottest private companies starting with Elon Musk’s SpaceX via mirror tokens. From the description on its website, this seems like a comically bad idea — perhaps not so funny for investors — that screams for even a hands-off, crypto-friendly Securities and Exchange Commission to shut it down.
It’s possible, of course, that the full legal details, when revealed, will address some of my concerns, but there is a fundamental problem with the idea. And beyond this effort, there’s the bigger issue of rules for retail investors hungry for exposure to companies unwilling to comply with public security requirements.
I’ve spent a lot of time over the past 17 years explaining crypto to skeptical investors. Tokens are one of the easier aspects to understand, but mirror tokens always bring people up short. A token is simple enough. Everyone understands objects or pieces of paper that represent ownership of an asset, such as a stock certificate or automobile title. Tokens go one step further to make the object or paper the asset, not just something you can use to prove ownership. It’s like a dollar bill — if you have it, you own it. The dollar bill does not prove ownership of some other asset, it is the asset.
The advantage of cryptographic tokens is that they can be traded instantly with cryptographic security all over the world, in large or fractional amounts, without the delay, risk and expense of clearing and settlement. You don’t need any sort of status to buy or sell them. They cannot be garnished, seized by authorities, discovered by customs, destroyed or counterfeited. As long as you don’t reveal your private key, they cannot be stolen, and as long as you don’t forget it, they cannot be lost. Lots of people are working on tokenizing all sorts of assets.
A mirror token is like a token without the asset. Huh? You thought the token was the asset? Well, think of a mirror token as a mirror image of the asset. Why would anyone pay anything for a mirror image? mirror tokens are minted. To mint one, you must lock up collateral in cryptographically secure forms, typically equal to 150% of the value of the mirrored asset or more. The collateral is cryptographically locked into the mirror token, so the token owner does not have to trust anyone.
If the asset price rises to a certain point, say 25% so the collateral represents only 120% of value, the token is liquidated. The owner is paid the value of the asset, and the rest is returned to the minter. Some mirror tokens have more complicated mechanisms that involve buying up tokens or adding collateral.
So, the asset in a standard mirror token is a claim against collateral. The amount of the claim is equal to the value of some asset, say a share of Tesla Inc. stock. A holder has all the risk of Tesla stock going down, plus the risk that the stock will go up so much that the collateral will be insufficient to pay off in full. For many retail investors, the simplicity and convenience of executing via a token is worth the extra risk.
Republic Chief Executive Officer Kendrick Nguyen told the Wall Street Journal that the company plans to hold shares of or have some other exposure to the underlying security, but this was not promised on the website where Republic was taking “reservations” for its SpaceX tokens at the time of writing on Friday. The company is not collecting cash, but investors must provide access to a bank account, cryptocurrency or Apple Pay, without knowing the type or amount of collateral beyond the intention expressed by the CEO. The intention is even more remote because a special-purpose limited-liability corporation apparently created to mint and distribute the tokens is guaranteeing payment, not Republic itself.
The actual asset being mirrored is unsecured debt in RepublicX LLC, not Republic. It’s not clear what assets RepublicX has to pay off investors. Even if RepublicX holds adequate collateral, it won’t be locked up cryptographically for token holders. Token holders won’t even have a legally secured right to it, they get only unsecured debt in RepublicX.
It seems unlikely that RepublicX will be able to acquire SpaceX stock to hold as collateral. That requires the cooperation of SpaceX, which has discouraged retail distribution of its stock. RepublicX might get some indirect exposure by purchasing shares in special-purpose vehicles that hold SpaceX stock, but this is not easy and introduces additional legal risk. Moreover, such shares are generally available only at considerable premiums to the market price. And even if one of these things is possible, the assets could not be cryptographically locked to the mirror token.
Perhaps RepublicX has thought through these objections and will file financially sound, investor-friendly offering documents. Even so, the deeper problem is that it’s nearly impossible to buy official shares of SpaceX and other hot private technology companies. Due to extraordinary demand, people are willing to accept indirect forms of ownership, such as shares in a special-purpose vehicle that owns SpaceX shares, or that owns other SPVs, or that has some other claim or collateral. Scams exploiting this demand are rife. This is unhealthy for investor protection, corporate governance and transparency.
Back in 1986, the SEC was rumored to have pushed Bill Gates to take Microsoft Corp. public out of similar concerns. Like Elon Musk today, Gates could get all the capital he wanted without going public, and didn’t want the oversight, expense and loss of control that goes along with a public listing. But at some point, you have enough retail investors and enough market capitalization that staying out in the cold is a risk to everyone. I have no opinion on whether that means persuading SpaceX and companies like it to go public or creating some status short of public listing that allows retail investors to participate in legally vetted ways. But I am confident that if nothing is done, something bad will happen.
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