The authors would like to thank Arnoud Star Busman, Chief Executive Officer of MineHub Technologies, Inc. (formerly Innovation Lead at ING), Alison Mangiero, President of the Tocqueville Group (TQ), Prat Vallabhaneni, partner, and Laura Kitchen, associate of White & Case LLP, for their contributions to this article.
Rapid advances in blockchain technology are reinventing the way companies operate and deliver products and services to their clients. These changes are particularly visible in the mining & metals industry, a sector that has been traditionally slow in adopting technological innovations. Yet blockchains and smart contracts, which to this point the sector has focused on as a source of productivity and transparency gains for the mining & metals global supply chain, could herald new sources of finance too. Miners face a persistently challenging environment to raise equity and equity-like capital to fund ventures. According to the State of Mining Finance 2019 Report produced by the Prospectors & Developers Association of Canada and junior financing tracker Oreninc, funds raised via equity in 2018 were at the lowest recorded level in the past decade, with equity funding dropping approximately 40 per cent from 2017 to 2018. Could blockchain-based digital finance techniques provide a funding solution to miners?
drop in equity funding in global mining finance from 2017 to 2018
Source: State of Mining Finance 2019 Report, Prospectors & Developers Association of Canada
Digital token offerings have emerged in the last few years as a new way to fund the development of emerging technologies. With their unique benefits, they are well placed to emerge as an alternative or a supplement to traditional financing options available to mining companies.
ICOs: a recap
The first example of a blockchain-based digital token offering was an initial coin offering (ICO) by Omni Layer, formerly known as Mastercoin, in early 2013. Omni is a digital currency and communications protocol built on the Bitcoin blockchain. Since the first ICO in 2013, ICOs have, in short, exploded. An ICO is a method of raising capital in which investors participate in the fundraising by transferring government currencies (fiat), and/or cryptocurrencies to the issuer in exchange for digital tokens. The tokens represent a holder's right of benefit or performance vis-à-vis the issuer.
We need to reinvent ourselves… we are an old industry and there is no doubt we have changed and modernised… But we have not changed to the same extent that we have seen other industries reinvent themselves…
Jean-Sébastien Jacques, Rio Tinto CEO, October 2018
The underlying technology of the tokens is based on blockchain, which is maintained by a distributed network of computers and participants. Using cryptography to record transactions, blockchains such as Bitcoin and Ethereum process, verify and track the trade of the relevant virtual currency (e.g., Bitcoin or Ethereum) securely across independent network components on a "peer-to-peer" basis. In summary, blockchains, and in particular public blockchains, can remove the need for a variety of intermediaries, at least from a technical point of view. Legally, what is necessary will be facts and circumstances specific and dependent on the jurisdictions involved (cf private blockchains, which are hosted by central parties and are by definition more controlled in a "walled-garden" style approach which can be desirable from a variety of standpoints, such as compliance).
From ICOs to STOs
Digital token offering structures have evolved—at a great pace—from initial coin offering to initial exchange offering (IEO) to security token offering (STO). ICOs have gained the most publicity out of those structures as an innovative "peer-to-peer" financing mechanism, raising more than US$5 billion in 2017 and more than US$11 billion in 2018, with some estimates of more than US$20 billion. But following the bursting of the "ICO bubble" in early 2018 and the negative press around various ICO scams, the (mostly unregulated) ICO market has been gradually drying out, while IEOs and STOs have been gaining traction. Issuers and investors are turning to more refined digital capital-raising solutions, giving more thought to compliance as regulators all around the world begin to formulate and crystallise their approaches to digital token offerings.
Digital token offerings are relatively easy to structure because of technologies like the ERC20 token— issued on the Ethereum blockchain—which simplifies the process necessary to create and distribute a new cryptographic asset. This allows issuers to prepare and launch token offerings quickly and effectively.
Miners keen on creative financing structures
As challenging financing conditions continue to persist, miners have been looking for creative financing options to fund their ventures, and in particular their growth projects. While traditional financing options—bonds, loans, project finance, prepayment, convertible bonds, equity—remain generally the most attractive and understood, it is now common for companies to access multiple financing sources to diversify their capital structure, combining traditional financing options with alternative financing sources—royalty, streaming and/ or private debt. Mining royalty and metal streaming financings have been particularly popular with miners in the last decade as an alternative financing source for growth projects, allowing access to early-stage capital without diluting equity ownership.
raised via ICOs in 2018 globally
What is mining royalty finance?
A mining royalty is a right to receive payment based on a percentage of mineral production or of the revenues or profits generated from the sale of those minerals at a mine. A royalty typically involves an up-front payment to the mining company from the royalty holder (i.e., investor) in return for a contractual undertaking from the mining company to pay a specified percentage of future revenue for a specified period. This can be based on a percentage revenue based on, for example, profit, net smelter return or production. The up-front payment received from a mining royalty investment can be used for many purposes, from general corporate purposes and capex to acquisitions and even exploration.
The flexibility and profit-sharing mechanism of mining royalty finance is particularly attractive as it allows mining companies, at various stages of their life cycle, to access up-front funding as a substitute to an equity raise to fund feasibility studies or debt in order to fund the development and construction of an asset.
Taking the traditional mining royalty finance model and combining it with an innovative digital financing wrapper in the form of an STO could provide a very attractive business model for both mining companies wishing to raise capital and for investors. Similarly, the mining stream financing model—a metals prepayment structure commonly used in the sector—would be potentially amenable to tokenisation. This may require the investor to accept a physical commodity settlement and is likely to evolve after "royalty tokenisation" has taken hold.
Royalty mining token: Structure and legal framework for an STO
There are many ways and options to structure a mining royalty token which includes investment from both US investors and non-US investors. For instance, a mining royalty token issuance could be split into two simultaneous token offerings—"Series A Tokens" and "Series B Tokens"—to ensure a "light regulatory burden" in compliance with US Securities Regulations. Series A Tokens could be issued only in the US to specific targeted investors who do not need an immediate liquid market and would be happy to hold onto the tokens, while Series B Tokens could be issued in another jurisdiction with favourable token issuance regulations towards non-US investors.
…maybe there needs to be a new way of funding mining projects…
Jean-Sébastien Jacques, Rio Tinto CEO, October 2018
Series A Tokens could be issued privately in the US by way of an STO to a select few investors through Regulation D Rule 506(c). In such a private US issuance, there is no limit on the amount of money that can be raised. It also allows the company to access a larger pool of investors via general solicitation. In addition, the filing process is relatively light. One limitation of this structure is that it's only open to accredited investors—investors earning above US$200,000 or with a net worth above US$1 million. The other one is that such securities would also be "restricted securities"—the investors would only be able to resell the security tokens into the market by using an effective registration statement under the Securities Act or a valid exemption from registration for the resale, such as via so-called Rule 144.
Series B Tokens could be issued to non-US investors in reliance on US Regulation S through an STO. Series B Tokens can be potentially listed on an exchange in a non-US "token friendly" jurisdiction, where such an issuance may allow for quick secondary market liquidity. Under US Regulation S, there is also no limit on the amount of money that can be raised, and general solicitation is allowed as long as it does not target any US investors. The cons are that Series B Tokens have resale restrictions on them with respect to US investors.
The royalty token offering gives greater control to the mining company in raising royalty-linked capital and potentially diversifies the sources of royalty finance away from the select group of listed royalty companies and specialist funds that have traditionally dominated this realm of mining finance.
All hype and speculation?
The recent rise of blockchain-powered digital financing tools in the form of ICOs created considerable hype and fuelled significant speculation. Some ICO scams tarnished the reputation of the underlying technology underpinning these digital financing tools.
The beauty of gold is that it's a solid asset. It’s been around for a very long time and will continue to be around. The problem with cryptocurrencies is that the market is always changing and you constantly have to watch it.
Randy Smallwood, CEO, Silver Wheaton
However, blockchain and the digital financing tools built on it are showing signs of a paradigm shift from speculation to application. We are entering a phase in which there is a realisation that unregulated— and in certain cases—speculative ICOs without any economic rationale may not be best suited to succeed as a widely adopted digital financing structure, especially by traditional investors. Rather, digital financing structures, such as STOs compliant with regulation and structured with a sound economic purpose, are more likely to succeed.
Recent tokenisation of real-world assets by Elevated Returns—a financial group focused on digitising traditional financial assets—through an US$18 million STO is a sign that regulated blockchain-powered digital financing tools will be embraced to raise capital by financing "real-world assets" and not only to raise capital for technological innovations, such as funding the development of source code.
Tokenisation will also come to the mining & metals industry. Traditional mining royalty financings, wrapped in an STO, are likely the first blockchain-based digital financing structures that will be widely applied in the mining & metals industry.
However, imagine the powerful combination of solid mining assets underpinning tokens (cryptocurrencies)…
A question of when, not if
The rise of digital financing structures will have profound implications for the mining & metals industry. Miners will be able to access alternative funding methods, which will be a welcome development, given the decline in equity funding into the sector. Industry players will now need to fully understand digital financing structures before engaging with miners who are raising such capital. For example, royalties and streams already give rise to unique inter-creditor considerations, as the interests of royalty and stream holders do not always sit comfortably with those of traditional senior creditors in an enforcement scenario. The added STO wrapper may further give rise to potential complications that may be important to the various financiers, and any implications should be dealt with as early as possible in the financing. Similarly, M&A transactions involving a mining company with an existing tokenised royalty in its capital structure will involve a slightly different due diligence process, which is likely to involve a blockchain technical adviser.
Will digital financing structures based on blockchain technology disrupt the mining sector ecosystem? It may take some time for the traditional ecosystem to change, but it's a question of when, not if.
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