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Tokenizing mining, metals assets may open sector to fresh investor base

Blockchain-based digital financing could soon offer mining companies access to new funding by rolling out cryptocurrency tokens backed by a physical asset such as gold or other materials.

Challenging financial conditions are pushing miners to get creative about their financing options as more traditional sources of project capital become less accessible. Tokenized financing based on the intrinsic value of a mineral deposit or its extraction could be viewed by some investors as safer than cryptocurrencies such as Bitcoin that are not backed by a physical asset.

"This is very much at the cutting edge," said Rebecca Campbell, a partner with London-based White & Case who leads the law firm's global mining and metals industry group. Earlier this year, the law firm published a white paper on the use of blockchain-enabled cryptocurrencies as a means for tokenizing mining royalties and metals streams to unlock a new investor base. Several mining companies expressed interest, and the firm is working on a few possible transactions, Campbell said.

Blockchain, a digital technology that stores information across a peer-to-peer distributed ledger or database, can be used to securely and transparently generate tokens of virtual currency that investors may buy either directly or through a market. A variety of token offering structures have emerged that could be used to fund mine development, including initial coin offerings, sold by those backing a project; initial exchange offerings that sell tokens on an exchange; and security token offerings, a digital asset structured to comply with securities regulations.

"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," the White & Case whitepaper concluded.

While using blockchain and cryptocurrency techniques may be a new concept to some miners, royalty-based financing streams — in which an investor receives a right to payment based on the quantity of mineral produced — are not.

"It's more about bringing an old, tried and tested mining finance technique to a new capital-raising platform," Campbell said. "We like to think it shouldn't be too difficult to overcome the obstacles to get these transactions up and running."

Mining companies, particularly those on the junior side of the spectrum, have long attracted relatively high-risk capital investors. According to the "State of Mineral Finance 2019," a report from the Prospectors and Developers Association of Canada and Oreninc, the amount of financing made available to the global mineral industry bounced back in 2017 after falling for several years. Those figures retreated again in 2018, marking the lowest annual amount of funds raised via equity for the sector recorded in the last decade.

Due to a number of factors, including subdued commodity prices, the U.S.-China trade war, long lead times for mining projects to come into production and historical underperformance of mining companies, funding for miners' exploration and development has dried up, said Jonathan Brooks, partner and head of mining and metals at European law firm Fieldfisher.

"Faced with the choice of investing in mining and in other sectors, equity markets investors are more likely to fund technology, life sciences and even oil and gas companies," Brooks said. "A particularly extreme example of this has occurred on the Toronto Stock Exchange where investors have flocked to buy into cannabis companies, resulting in a complete dearth of interest in junior miners."

While private equity is filling up some of the vacuum left by traditional project finance banks, that has not completely taken up the slack, Brooks said. With physical assets to back their initial coin offering or initial token offering, a mining company could attract capital from those who have otherwise shied away from investing in cryptocurrencies.

"Cryptocurrencies cannot yet replace gold as the ultimate store of value, because they do not provide sufficient value stability," Brooks said. "However, tokens can be backed either by physical metal stored at a trusted third party warehouse or represent the right to receive a proportion of future mine production, structured in a similar way to royalty or streaming agreements, or contracts for physical delivery of metal."

However, the technology is also relatively untested, and in some jurisdictions, regulators have not sorted out the rules for treating cryptocurrencies and related investment mechanisms. Brooks pointed to recent problems encountered by Britain's Royal Mint in rolling out its eventually canceled Royal Mint Gold Currency, suggesting the market was not yet ready for a leap into "digital gold."

Brooks added that while cryptocurrencies launched to fund mining projects have been slow to get started, suggesting they may face similar obstacles as projects using conventional financing, cryptocurrencies such as Bitcoin are proving popular with investors even without the backing of a physical asset. Further, a cryptocurrency backed by metals or minerals could face "very big risks" from the historical boom and bust pricing trends long associated with the sector.

"Fundraising, conventional and otherwise, for mining projects has been subdued generally in 2019, and there seems to have been relatively little progress reported by those companies which launched mineral asset-backed cryptocurrencies last year. Companies offering gold-backed digital currencies, tethered to the price of bullion, seem to be proliferating, however, with tokens being launched and going bust on a monthly basis," Brooks said. "The market might still be in wait-and-see mode, or wider macroeconomic factors may be deterring investors from riskier ventures, or the mining industry could have already gone cold on this novel form of raising finance."