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Episode 34: An interview with Juan Hernandez, CEO and founder of Crypto Disrupted https://www.openfinance.io _Episode 34: An interview with OpenFinance Network CEO Juan M. Hernandez https://www.openfinance.io_www.podbean.com Tokenizing the Financial World with Juan Hernandez of OpenFinance Network Also . available on iTunes For more episodes of , or . Crypto Disrupted subscribe on YouTube subscribe and listen on iTunes

Tokenizing the Financial World with Juan Hernandez of OpenFinance Network

How to check if a transfer of Security Tokens between wallets is valid Thanks to the , investors can now hold their securities ownership records in the form of tokens (also known as “Security Tokens”), and these tokens . This brings with it the advantages of fractional ownership, the ability to move those assets between different marketplaces , and direct access to trades between individuals by the simple mechanism of transferring those tokens. Digital Securities technology can be kept in any wallet that allow 24/7 trading But Digital Securities are different from other digital assets. Cryptocurrencies like Bitcoin or Ether can be transferred to any wallet in the world without any additional control, but , and as such ownership can only be transferred under certain circumstances. These circumstances will vary from one security to another, because they will depend on the specific kind of asset involved (for instance, equity in a company has different properties than a limited partnership in a venture fund), the way it has been registered (or is exempt from registration) and the current ownership structure (since some limits may have already been reached). securities are regulated instruments The way to ensure that only transactions that are consistent with the applicable regulation, or the constraints that the issuer has, is for Digital Securities to implement . Transfer restrictions are coded as part of the smart contract implementing the Digital Security, and are executed for every transaction requested, like transferring tokens from one wallet to another. In Securitize’s Digital Securities Protocol, these rules are part of the Compliance Service, transfer restrictions which I covered in some detail in a previous post. The result of these restrictions is that when a token holder tries to transfer their tokens to a new wallet address, the transaction may fail, and looking at the details in some block explorer like will show an error like this one: Etherscan A reverted transaction in a DS Token (note that the error is marked as Reverted. Different errors may have a transaction fail, which does not mean that it was restricted by the smart contract. An example for this is the “Out of gas” error, which means that the gas limit set for the transaction was too low for it to complete, and that provided more gas the transaction could have been completed). While the error above shows that the smart contract did not consider the transaction valid, a limitation here is that it is unclear why it was not approved. To improve this situation, provides a mechanism to allow for validating the transfer of tokens before attempting any specific transaction and without having to spend any gas. This is based on the preTransferCheck() method exposed by DS Tokens, which allows it to simulate a transfer between wallets, returning whether that transfer is valid, and if not a specific reason. Securitize’s DS Protocol How can we use these checks? The DS Protocol mechanisms allow these checks to understand immediately whether a transfer of tokens between wallets will be possible without having to spend any gas, and there are two main points in which its usage will improve the interaction with Digital Securities: , to facilitate the trading of Digital Securities, they manage the process behind the scenes. They only present orders that are available to be executed, and they perform all the checks (including using the preTransferCheck() method) so that when you try to sell or buy your tokens the process is executed smoothly. That is the case, for instance, with , a regulated marketplace that allows the trading of several DS Tokens and . In regulated marketplaces OpenFinance Networks has recently opened trading for US investors . Since the DS Token interfaces are public and preTransferCheck() can be used without any cost, we expect that wallet providers will integrate this into their experiences, so that when dealing with Digital Securities they will be able to inform users about the potential issues with token transfers before they are executed, and even suggest options that will facilitate transfers to be completed (like transferring a different amount of tokens or checking if the destination address is correct). Directly on wallets But even without these players, anyone can actually invoke these checks in the DS Tokens. This involves calling the preTransferCheck()method in a smart contract, which may sound like something very complex for someone not familiar with these concepts, but let’s look at how this can be done in three (relatively) simple steps. 1. Go to the “Interact with Contract” section in MyEtherWallet Use a browser to go to . https://myetherwallet.com/interface/interact-with-contract The first thing you will see is that MyEtherWallet requires access to a wallet to allow you to interact with a contract. For checking the validity of transfers, you don’t need to use any specific wallet (it is not necessary to check using any of the wallets involved in the transaction) so any wallet will work, even a completely new wallet you can create in the MyEtherWallet site. I usually use for this, but this is not mandatory. MetaMask Give access to a wallet in MyEtherWallet After giving access to your wallet, you will see something like this (and if you don’t, make sure to go to Contract > Interact with Contract in the left-hand menu): Interacting with smart contracts using MyEtherWallet 2. Set the token address and the DSTokenInterface ABI Once you have accessed the “Interact with Contract” section, you will see a form with two fields: . This is the Ethereum address of the token you want to check for transfer restrictions. If you don’t know the token address, you can search for the token in and look for the “Contract” information. For instance, in the case of the token, their address is available : Contract Address Etherscan SPiCE VC here The contract address for a DS Token The ABI, or , is the way for a software component to indicate how to interact with it. In the case of a DS Token, it is the way to show that it has a preTransferCheck() method and how to use it. So in order to interact with a DS Token, we only need to provide the DS Token ABI, which luckily is available , and you simply need to copy and paste the code on that page. some weeks ago, and as part of that, the ABIs were also made available precisely to be able to work with the smart contracts, as shown in this post. ABI/JSON Interface. Application Binary Interface here Securitize’s DS protocol interfaces were published Once the contract address and the ABI have been provided, you will see a screen like this that will allow you to continue: Filling the contract address and ABI 3. Use preTransferCheck Once you hit Continue, you will be presented with the following screen, which allows you to select one of the methods offered by the DS Token to interact with it: Selecting the method to interact with the contract From the “Select an item” drop-down, you can select which of the DS Token methods you want to use. We will select preTransferCheck() which will present this screen: preTransferCheck() parameters The dialog allows you to provide the parameters that will be used to invoke in preTransferCheck() , in particular: which is the wallet address that will send tokens _from, , which is the wallet address that will receive tokens _to , the number of tokens to send _value (but bearing in mind decimals, so if a token has decimals we will need to add zeros to take this into account) Filling this and then hitting “Send” will invoke preTransferCheck() in the contract and will let you know of the result. But remember, , it will only perform the checks to determine whether the operation would be approved if the tokens were actually sent. So you can test this without fear, because no tokens will be moved and no gas will be spent by trying this. this will NOT send any tokens For instance, we can try to send one token (in the parameter we see 100000000 because this is a token with 8 decimals, so we have to use that value to represent 1 token) between two addresses as shown here: _value An invalid transaction The code response shows that the transfer would not be approved, with the ‘additional reason’ information stating “Wallet not in registry Service”. This is because the destination wallet has not been registered to any known investor, and one of the main restrictions imposed by Digital Securities is that all holders must be known, so this kind of arbitrary transfer is not allowed. If instead of checking with preTransferCheck() the sender wallet owner had directly tried to transfer the tokens, the transaction would have failed with a “Reverted” error as we saw before. A different test, with a different destination wallet (this time one that has been registered to be able to hold security tokens) would give a different result: A valid transaction In this case, the response is that this transaction would be “Valid”, so if the wallet owner tries to do the actual transfer of the tokens, this would be approved and the transaction would be successful. So, what next? As we have seen, the DS Protocol allows us to immediately check whether a transfer of tokens between wallets will be allowed — without having to spend any gas. The process described in the sections above is not very complex, but can clearly be a bit cumbersome, which shows that we still are in the early days of Digital Securities. As wallets integrate these mechanisms, and there are more improvements happening both in the experience and capabilities that this technology brings, little by little we will be making financial transactions more flexible and powerful. Securitize delivers trusted global solutions for creating compliant digital securities. The Securitize compliance platform and protocol provide a proven, full-stack solution for issuing and managing digital securities (security tokens). Securitize’s innovative DS Protocol has the highest adoption rate in the industry and enables seamless, fully compliant trading across multiple markets simultaneously. Multiple Securitize powered digital securities are already trading globally on public marketplaces with many more in the pipeline. You can learn more about Securitize at our website: www.securitize.io And you can join the conversation about the Digital Securities revolution in our Telegram channel .

Understanding transfer restrictions for Digital Securities

A Primer March 20, 2019 Last updated on - It all began with an investor-directed venture fund called . In May 2016, it set the record for the largest crowdfunding campaign in history, with a participation of 18,000+ stakeholders that raised 11.5 million Ether (ETH) or US $150 million. It was enabled by the Blockchain technology where the or at least it was until some bad actor(s) exploited a vulnerability concerning recursive calls in smart contract code, enabling them to divert one-third of the funds to a subsidiary account. The stolen funds were put in a 28-day holding period and the Ethereum community debated about possible solutions which resulted in a split of Ethereum network: where the hacker still has the funds and; the one in which they do not - .[1] The DAO Code is Law The DAO (ETC) Ethereum Classic (ETH) Ethereum Later on July 25th, 2017 - the ( ) concluding Tokens as securities. So, a computer code behind a decentralized autonomous organisation, essentially became a security in the eyes of SEC and government agencies around the world started taking note; issuing statements which resonates with those of SEC, and at times more generic resulting in a unclear stance on cryptocurrencies and tokens for the public.[2] US SEC SEC from here issued an investigative report The DAO We must understand that was a special token. It was and not tied to any particular nation state or country and embodied specific claims in its structure and that the code itself was the . The questions of how to deal with the governments was really hard to answer and it still is. Professionals in favor of cryptocurrency regulations are welcoming the stance of SEC to consider most tokens as security while still exploring exemptions (e.g. ) to raise funds for their businesses. provides a from US securities regulation if there are no direct selling efforts within US to US residents/companies. The DAO stateless prospectus SEC Form D Regulation S safe harbor to issuers A research paper entitled proposed two policies to mitigate legal uncertainty concerning token sales - Crypto-Securities Regulation First, we suggest tailoring disclosure requirements to the code-driven nature of token sales. Such an ICO-specific safe harbor would offer a clear and less burdensome path to EU law compliance for token sellers who suspect that their tokens may qualify as securities. This only requires the Commission to amend its delegated 2004 Commission Prospectus Regulation. Second, we propose that, on an international level, governments form a compact to bestow certainty about the application of their respective securities regulation regimes to token sales. This is, first, to avoid regulatory overkill on the one and regulatory lacunae on the other hand in online-mediated, global token sales. Second, overlapping, and partially contradicting, securities regulation regimes can even undermine each other. In the end, only a joint international regulatory regime can efficiently balance investor protection and investor access in the face of the novel generation of decentralized blockchain applications. [3] The paper also calls for an International Convention for crypto securities to help provide the investors and issuers a clear understanding of regulatory landscape. provided a nice summary of the STO Market in her which tells us that geographically, Tatiana Koffman article Due to the nature of complex regulatory environments, US is in the lead for total STOs in the market, with Switzerland taking the second spot. Additional activity is noticeable in European countries, while Asian markets, although leaders in ICOs, are yet to catch up to STO activity. We expect untapped markets to continue to be curious about STOs, following the regulatory lead of the US. while the securities on offer lead by with revenue-share, tokenized funds and asset-backed deals, equities and bonds trailing behind. So to summarize… STOs allow projects to raise funds in a regulated manner, provides investors with rights over assets, profits or revenue in a company and reduces legal risk. Security Token Standard The call to extend the popular and the has been in work for months resulting in describing it as having many of the characteristics of both fungible and non-fungible tokens . Security tokens are designed to represent complete or fractional ownership interests in assets and/or entities. While utility tokens have no limitations on who can send or receive the token, security tokens are subject to many restrictions based on identity, jurisdiction and asset category. [4] The token is believed to have incorporating differentiated ownership, error signalling, document references, gate keeper (operator) access control and issuance / redemption semantics. ERC-20 non-fungible ERC-721 ERC-1400 Supported by participating organisations and individuals including but not limited to - , , , , , , , , . The efforts for a standard will bring uniformity in its structure for the issuers to tokenize and issue various kinds of tokenized assets (securities on blockchain) easily. Polymath OpenFinance Tokeny.pl Vertalo ChronoLogic Scott Purcell Goldmoney Securitize.io celebrus strategies According to a report published in , the securities token platform and recently that tokens can be compliant on a decentralized exchange. CoinDesk Polymath Loopring demonstrated hooray! Recent STOs auctioning US $66 million building on Ethereum Blockchain; a occupied property in downtown Miami, Florida. The company is said to tokenize some US $260 million in four private real estate and debt transactions[6] Invenium Capital Partners WeWork - A real estate investment trust (REIT); single-asset REIT intends to only own the St. Regis Aspen Resort raised funds_[7]_ Aspen Digital - A late stage, pre-IPO technology growth fund; an effort to democratize investment [ ] Andra Capital AndraCapital - Fine Art - Andy Warhol’s 14SEC through dutch auction bidding on platform Maecenas sold Maecenas - Real Estate; investors offered to receive either analog or digital interests in the property in partnership with using 436 & 442 East 14th St, Manhattan propellr AirSwap Ltd - Gaming/Gambling (revenue share token structure) [ ] Lottery.com Lottery.com - STO Exchange (offered equity with revenue participation) tZero - Venture Capital Fund (allowing investors to own up to 10% equity) [ ] 22x 22xFund , , , , , , , , , , , are also worth looking at. SPiCE VC Blockchain Capital Neufund Monetizr (MTZ) INDX Capital BlockEstate TrustToken Corl Gainfy Leaseum Partners Vertalo Hypd Securities Agencies’ crackdown on crypto crowdfunding , a bitcoin futures firm which got its domain seized by US authorities back in September 2018 recently announced -“ Funds of the investors will be returned and founder Patrick Brunner would also be required to pay US $26,000 in disgorgement fees. [9] 1Broker registered in Marshall Islands We are pleased to let you know that we settled the two lawsuits without admitting or denying the factual allegations of their complaints on March 4th 2019.” SEC did not bring any charges against (or ) but made it clear that federal securities law applies to anyone who offers securities in the US or to US citizens.[8] The DAO Slock.it [ ] ICO planned on August 1, 2017. Harbour not Harbor cancelled ether raised after SEC’s investigation several days after the ICO. Protostarr refunded ICO that promised 13x profit was . PlexCoin halted by SEC **Munchee’**s MUN Token was described as multiple times in their whitepaper, but it to be a . Munchee stopped the ICO ( ) and returned the proceeds while cooperating with the investigation. utility SEC concluded security which raised US $15 million In Conclusion Yes. Startups and Small & Medium Sized Enterprises (SMEs) are often facing cash crunch barriers for them to access capital markets doesn’t help. Young and innovative firms should not be restricted by existing system. Should STOs exist? Security tokens can have a huge impact on the financial system and society at large, as they combine the elements of blockchain technology, especially transparency and security, with the legal certainty of traditional financial instruments. This allows firms of any size to securely enter this new evolving ecosystem. Security tokens promise to provide startups and SMEs with an alternative form of financing that gives rise to a new capital market with 24/7 trading that obviates the need for brokers and bank custody of securities.[5] Perhaps. STO projects are usually registered entity which add to the legitimacy of the project and have the issuers accountable for their actions. Are they better than ICO? Does regulations mean Security Tokens will see upward-only growth ? Not really, but sure they are a regulated form of crowdfunding and have tremendous potential to change the securities markets. A on tells us that even the highly regulated traditional market is also driven by hype. is still feared among the investors. should be a lesson that even though the businesses are at times legit, the valuation should be accessed with utmost care. Just because the offering is now called ICO or IEO or STO - it still is risky, and being informed is important. Netflix documentary The China Hustle Financial crisis of 2007–2008 Dot-com bubble There is an old joke that the biggest lie on the Wall Street is that - This Time, It’s Different. — [Disclaimer] This article is not a legal advice. The views are personal and the ones that refer to external sources belong to them. Sources The DAO (organisation), wiki - https://en.wikipedia.org/wiki/The_DAO_(organization) Cryptocurrency Regulations - https://medium.com/@rahulmanuwas/cryptocurrency-regulations-a-complete-summary-912e6de0c7a4 Hacker, Philipp and Thomale, Chris, Crypto-Securities Regulation: ICOs, Token Sales and Cryptocurrencies under EU Financial Law (November 22, 2017). European Company and Financial Law Review Forthcoming. Available at SSRN: or https://ssrn.com/abstract=3075820 http://dx.doi.org/10.2139/ssrn.3075820 The Security Token Standard - https://thesecuritytokenstandard.org Ante, Lennart & Fiedler, Ingo. (2019). Security Token Offerings on the Blockchain: Capital Market Access for SMEs?. 10.13140/RG.2.2.21378.94408. Invenium Capital Partners - https://www.coindesk.com/66-million-building-to-be-tokenized-on-ethereum-blockchain-in-record-deal Coindesk report on Templum hosting token sale — https://www.coindesk.com/regulated-trader-templum-hosts-security-token-sale-for-luxury-resort Sean Au & Thomas Power (2018) Tokenomics - https://www.packtpub.com/big-data-and-business-intelligence/tokenomics Coindesk report on 1Broker - https://www.coindesk.com/sec-cftc-charge-bitcoin-futures-firm-1broker-with-securities-law-violations

Security Token Offerings (STOs)

OVERVIEW: A tokenized version of assets should be able to demonstrate three key properties on the blockchain: the underlying asset: the virtual representation of the asset; the ownership of the asset: the identity of the asset owners; and the compliance rules of the asset: the set of regulatory and compliance rules governing the ownership and transaction of the asset. Currently, privacy and compliance seem to be the major challenges in launching STOs. Depending on the jurisdiction, investors have to go through strict Know Your Customer (KYC) and Anti-Money Laundering (AML) processes to be compliant and eligible to invest and trade securities. However, due to the borderless, peer-to-peer, transparent and decentralized natures of cryptocurrency, some frictions exist between tokenized assets and compliance. These challenges will have to be solved for the legacy system to transition into a tokenized system. Currently, a few issuance platforms are offering solutions for tokenizing securities. We have divided them into 3 categories: Protocols on Ethereum, Side-chains on Ethereum, and a Security Token blockchain. We then analyze the pros and cons of these different type of solutions, and discuss how the space could evolve. Introduction: As the hype for Initial Coin Offerings (ICOs) is weakening, the attention is now shifted toward the Security Token (ST) industry. The ST industry is currently at its nascent stage, in which many startups are trying to revolutionize the traditional financial ecosystem. The transition from traditional assets to tokenized assets involves a set of requirements on both technological and compliance perspectives, making the tokenization process more complicated than simple tokenization through ERC-20 like we’ve seen for ICOs in the past. In my research, I will discuss the various components and challenges in tokenizing securities, evaluate the pros/cons of other solutions, and create a thesis around how the space could evolve in the next couple of years. From a fundamental perspective, a tokenized version of assets should be able to demonstrate these key properties on the blockchain: The underlying asset: the virtual representation of the asset. The ownership of the asset: the identity of the asset owners. The compliance rules of the asset: the set of regulatory and compliance rules governing the ownership and transaction of the asset. Other desired properties include privacy, programmability, governance, disclosure, liquidity, and scalability. Smart contract introduced programmability, allowing the implementation of more complex assets, such as bonds, commodities or derivatives. For example, Tokenized real estate investment trust (tREIT) involves a series of real estate debt and equity assets in a single tradeable unit. In this case, smart contracts can support for complex dynamics such as risk, rebalancing, debt defaults, in addition to just simple ownership on the blockchain. Currently, privacy and compliance seem to be the major challenges in launching STOs. Financial securities are currently regulated and controlled by centralized authorities, following strict regulations such as GDPR, SWIFT, and FINRA, who ensure the privacy and protection of investors. Depending on the jurisdiction, investors have to go through strict Know Your Customer (KYC) and Anti-Money Laundering (AML) processes to be compliant and eligible to invest and trade securities. However, due to the borderless, peer-to-peer, transparent and decentralized natures of cryptocurrency, some frictions exist between tokenized assets and compliance. For instance, cryptocurrency uses pseudonymization, in which the investors’ addresses are not directly reflecting their real identities. However, FINRA and SEC require that the identity of the investors are fully known and their transactions and holdings are reported periodically by the companies and exchanges. In the tokenized securities space, a list of eligible investors who passed KYC and AML would have to depend on third parties to connect their real identities to their public addresses. Only then, the investor addresses are valid for investments and trades as they are approved at the code level and automatically compliant. Another example is that German laws require the data of tokenized assets issued in Germany to be traded among German parties and cannot leave the jurisdiction, which contradicts the way data is currently stored across nodes around the world on public blockchains. Moreover, privacy isn’t completely available to the investors because all the transactions and token holdings are visible and traceable on public blockchains. These challenges will have to be solved for the legacy system to transition into a tokenized system. Currently, a few issuance platforms are offering solutions for tokenizing securities. We have divided them into 3 categories: Protocols on Ethereum, Side-chains on , and a Security Token blockchain. Next, we will analyze the pros and cons of these different type of solutions, and discuss how the space could evolve. ethereum 1) Protocols Built on Ethereum: Currently, the most advanced Security Token issuance platforms, notably , and , are building their solutions on the top of existing blockchains, with Ethereum being the most utilized blockchain. STOs are issued through their token standards, respectively DS-Protocol, ST-20, and R-Token. These projects are operating as centralized entities and working with third-party compliance validators for KYC and AML. Securitize.io Polymath Harbor Ethereum, released in 2015, is the first and most proven secure blockchain with smart contract capabilities, allowing for more complex use cases to be implemented on the blockchain. Issuing STOs on the top of an existing blockchain does have its benefits, such as having access to the interoperability among different protocols, existing tools, developer community, and smart contract functionalities. Smart contracts can be used to define trading and governance rules, as well as dividend mechanisms. Pros and cons of protocols built on Ethereum Figure 1: On the other hand, addresses on are under pseudonyms, in which the identity of the token holders is hidden, causing friction with compliance. To solve this problem, issuance platforms have to verify that the investors actually own the addresses themselves by 1) Asking the investors to submit their addresses and link back to their email 2) Create an address directly for the investors 3) Utilize an address verification tool (like the one provided by ), in which the ownership of addresses are verified by asking investors to conduct micro-transactions through . After all the investors are verified, the list of approved addresses (whitelist) is included into a smart contract for the token issuance, specifying the list of eligible investors for investing/trading as well as other trading permissions. For any new addition or subtraction of investors, the smart contract will have to be updated through various mechanisms. ethereum Vertalo MetaMask Additionally, Ethereum is a general purpose blockchain, which doesn’t have functionalities specifically catered towards the needs of STs. Ethereum can easily represent fractional ownership on the blockchain through ERC-20, as well as transfer restrictions and simple dividend mechanisms through smart contracts. However, adapting to the legacy system, standard securities laws and more complex use cases such as debt, derivatives, disclosures, and voting would require a significant amount of coding efforts to bypass the challenges from the constrained code-semantics of smart contracts. Moreover, smart contracts have limitation in size due to the higher cost of deploying larger smart contracts for more complex use cases and limitation in portability as Solidity cannot be carried over to other blockchains’ smart contracts. This could impact the overall scalability for conducting transactions, building new functionalities, and providing trust in the system. 2) Side-Chain Built on Ethereum: While we haven’t seen a side-chain focused on STs, some existing Ethereum sidechain solutions include , Loom ( / @mcu11inan), Skalelabs ( / ), etc. A sidechain is a separate blockchain that is attached to its parent blockchain using a two-way peg, that enables interchangeability of assets at a predetermined rate between the parent blockchain and the sidechain. POA Network 👽 Dilanka @ LOOM Jack O’Holleran Chadwick Strange Specialized side-chains on can be an interesting alternative, as it can offload specific sets of computation to isolated environments then reflect the results back to the main-chain. As not every process needs to live on-chain, components such as disclosures, compliance, voting/governance, and integration with external sources can be achieved with a side-chain, making transactions more scalable while utilizing the security of Ethereum. Additionally, the challenges around privacy can be solved on side-chains. The cost, time and effort of creating a side chain are also much less than creating a new blockchain. Side chains also allow cryptocurrencies to interact with each other. For example, an issuer can test out the tokens on the sidechain, before pushing them on to the main chain. ethereum Pros and cons of side chain built on Ethereum Figure 2: Some of the cons of side-chains are around the requirements for its security. Sidechains need their own miners, and without enough mining power, they could be compromised. Therefore, there’s an initial requirement for an extensive network of miners to help secure side-chains. Additionally, a federation needs to be assigned by the side-chain developers to serve as an intermediate point between the main chain and the side-chains. This designated centralized group has the power to lock and release tokens, creating a risk for attack or bribery. 3) A Blockchain Focused on Security Token: A Security Token focused blockchain can help solve some of the fundamental challenges around privacy and governance, as well as improve trust and scalability. The co-founder and managing director of , who also previously launched Securitize, , is a major proponent of the idea of creating a blockchain for Security Tokens. He recently introduced his new project, Ownerna, which offers a new blockchain infrastructure solely focused on Security Tokens. SPiCE VC Ami Ben-David The nodes are composed of experts who are financial and commercial entities (for example. SEC approved in the US), understand the legal ramifications of securities, and authorized to do ownership management, KYC (Know-Your-Customer), KYA (Know-Your-Asset) and transactions. In the proof-of-ownership system, the chosen primary node takes care of KYA, a full set of documents that legally define the ownership of off-chain asset and the rights of token holders, stakes its reputation, uploads the asset onto the blockchain and writes all the transactions to the blocks. In return, the primary node is rewarded with the asset’s lifetime revenues for helping validate its transactions. This way, only the primary node can access the details, allowing for privacy for the investors. Owners and assets can also manage their privacy level as needed. Additionally, having specific nodes validating transactions can allow for higher transaction speed, providing a more scalable infrastructure that can support a larger volume of transactions required in traditional exchanges such as . Nasdaq Ownera also plans on offering an open-source regulation repository containing regulation Add-Ons, each covering a specific regulation per country, asset type, etc. Any asset can choose which regulations to enable, saving the effort for different protocols that go through this process themselves. Additionally, exchanges can save energy from supporting different issuance protocols separately by directly supporting the Security Token blockchain instead. New consensus models can also be implemented to be optimized for Security Tokens at the blockchain level, instead of creating artificial consensus mechanisms on the top of existing blockchains. Pros and cons of Security Token focused Blockchain Figure 3: Although a new blockchain might sound to be the better solution, the creation of a new blockchain will take significant effort and time to be built out, meaning that it can take years before any applications are built out. A new blockchain would also require the design of a new native cryptocurrency to incentivize network participants, in which the token economics will have to be well defined to ensure sustainability. Also, once deployed, the viability and security of the new blockchain will also have to be tested over time. Furthermore, the development of the developer community, and tools would also have to start from nothing. Conclusion: Most of the current solutions are protocols built on the top of Ethereum, and some new projects are looking to develop an ST-focused blockchain. We believe that the privacy issue will take time to be solved in different phases, as we are in the early stage of the STO revolution. First, privacy will most likely be off-chain, heavily relying on trusted centralized authorities that have access to the investor information and keeping them stored locally. Next, privacy solutions based on side-chains could help segregate data into different sets, hiding them from the public network as a whole. Finally, privacy can directly live on-chain on a more specialized Security Token blockchain, which can allow owners and assets to control their privacy access level. Evolution of privacy for Security Tokens Figure 4: As of now, the issuance solutions offered are protocols based on Ethereum, allowing for simpler use cases of tokenization. Although we believe that a more specialized blockchain will eventually appear, it doesn’t mean that previous Ethereum-based protocols are not valuable and will go out of use in the future. For instance, the privacy issue in public blockchains might also be solved in the future if privacy solutions such as ZKP (Zero Knowledge Proof) technology, or Bulletproof are successfully implemented. Some of the companies who are exploring ways to implement ZKP on Ethereum include , and Ernst & Young ( ). The existing protocols can also transition to different blockchains if they prove to be better. For example, Securitize’s first protocol implementation will work over the Ethereum blockchain, but they also plan on transferring its architectural model to additional distributed ledger systems. Zcoin Project EY Ops Chain Public Edition prototype Evolution of Apps and infrastructure from Figure 5: Union Square Ventures On a side note, recently introduced an interesting relationship theory between infrastructure and applications. We think that the space will evolve in a similar way in which breakthrough applications in specific verticals, for example, real estate, will appear first to disrupt the space and inspire for a new protocol or blockchain to be developed to allow for similar applications to be built at scale. This process will be repeated among different verticals that are related to securities. Over time, the one size fits all protocol or blockchain will emerge as different use cases are fully explored and understood, providing a more powerful and scalable platform that would be the equivalent of AWS for securities. Union Square Ventures Hype cycle of the Security Token industry Figure 6: As of now, we are still in the early stages of the Security Token ecosystem, in which different issuance solutions are still being developed and tested. We believe that it will take at least another 4 years for the STO ecosystem to grow and mature from both a technical and regulatory perspective, allowing for a sustainable transition from the traditional securities system into a tokenized system. Until the space becomes more mature and viable, the majority of the early adopters of STs are going to be from the cryptocurrency space rather than the traditional players. As the different STOs and exchanges launch next year, we predict that the lack of liquidity and challenges around implementing complex use cases and securities laws will bring us closer to the reality and decrease the overall hype and expectations around STOs. Over time, more efficient technology and new regulations will appear and help drive the growth and adoption from the traditional players. Please let me know your comments, and feel free to reach me out at remi@8dcapital.com if you have any more questions about this topic. Sources White Papers: , , , Harbor Securitize.io Polymath OpenFinance Dani Grant & from Union Square Ventures: Nick Grossman https://www.usv.com/blog/the-myth-of-the-infrastructure-phase from : Yogita Khatri CoinDesk https://www.coindesk.com/ey-reveals-zero-knowledge-proof-privacy-solution-for-ethereum of / : Sebastian Wurst Zcoin ($XZC) Cryptocurrency Zcoin Project https://zcoin.io/zcoin-implement-zero-knowledge-proofs-ethereum/ from : vasa Hackernoon https://hackernoon.com/difference-between-sidechains-and-state-channels-2f5dfbd10707 Owerna: https://ownera.io/wp-content/uploads/2018/10/Ownera-Presentation.pdf from : Jesus Rodriguez Hackernoon https://hackernoon.com/do-security-tokens-need-a-new-blockchain-benefits-challenges-part-i-48f281f5101e from : Jesus Rodriguez Hackernoon https://hackernoon.com/do-security-tokens-need-a-new-blockchain-benefits-and-challenges-part-ii-de480e54c12a from : Jesus Rodriguez Hackernoon https://hackernoon.com/do-security-tokens-need-a-new-blockchain-part-iii-the-building-blocks-7adfa7239bb0 from : Jesus Rodriguez Hackernoon https://hackernoon.com/do-security-tokens-need-a-new-blockchain-part-iv-how-about-a-sidechain-acd8686d8fae from : Jesus Rodriguez Hackernoon https://hackernoon.com/security-token-2-0-some-thoughts-off-chain-vs-on-chain-governance-2cba087389ab from : Jesus Rodriguez Hackernoon https://hackernoon.com/some-cool-protocols-to-consider-for-the-next-generation-of-security-token-platforms-98697f0c55e6 from : Jesus Rodriguez Hackernoon https://hackernoon.com/the-elephant-in-the-room-security-and-privacy-protocols-in-security-tokens-a6687af8d1d6 from : Julianne Sloane Hackernoon https://hackernoon.com/can-security-tokens-fulfill-their-promise-of-liquidity-938022e53133 from : Deepa Sathaye @Fluidity https://medium.com/fluidity/automatic-regulatory-compliance-with-ethereum-892f01ef9eaa from : Jesus Rodriguez Hackernoon https://medium.com/@jrodthoughts/about-disclosures-and-information-asymmetry-in-security-tokens-fc83c350548a from : Julianne Sloane Hackernoon https://hackernoon.com/can-security-tokens-fulfill-their-promise-of-liquidity-938022e53133

Should There Be a Blockchain for Security Tokens?

Overview: 8 Decimal Capital The evolution of digital tokens has coincided with a great deal of risk from being in the financial market ecosystem. But in the future with the development of RegTech, a compliance layer will be created to automatically ensure KYC/AML along with other compliance requirements. Then, the cross-border regulatory synergies will be likely to emerge. Although the Security Token industry is currently still in its nascent stage, many organizations and companies are debating how this new technology can be used. However, by investing early-on, investors can help to accelerate this process and help the industry maximize its potential. In the future, financial agents and regulatory agents will still exist. But the funds in the industry will provide more than just capital and there are more roles for them to fill. Writer: Ran Wei Translator: Zoe Qian Editor: Brian Hough predicts that the tokenization of assets will likely catalyze future adoption of cryptocurrencies and blockchain technology. With the development of this new technology, the regulations of different countries will be programmed into tokens, and regulatory collaboration between countries will also occur. 8 Decimal Capital This digital transformation is why 8 Decimal Capital is bullish on the Security Token space and investing across different segments of the market to help the industry grow. The Development of Security Tokens Overview The tokenization of securities will likely take place among more diverse types of assets. Some of these assets include mixtures of stocks and bonds, dividend rights, and non-traditional financial assets, such as real estate and art, which used to be difficult to trade. The evolution of digital tokens has coincided with a great deal of risk from being in the financial market ecosystem. This proves why more regulations must be built at the protocol level. But in the future with the development of RegTech, a compliance layer will be created to automatically ensure KYC/AML (Know Your Customer / Anti-Money Laundering) along with other compliance requirements. Then, the cross-border regulatory synergies will be likely to emerge. In China, the typical investor is familiar with public funding, IPOs and stocks. However, they are not used to, nor ever get the chance to, invest in the larger and more diverse market of private funding, private equity, debt, and alternative investments. Once the market is open to more participation from investors, then the liquidity of trade will provide investors with more opportunities to diversify their portfolios. Some people would argue that by mandating the KYC process for every investor and requiring only accredited investors in the game would initially raise the bar for participation and in turn lower the liquidity of cryptocurrency. 8 Decimal Capital will argue that this is not the case. The size of the U.S.’s private equity market is 22 times larger than the public market. Through being more compliant and including more institutional investors, the cryptocurrency market is opening up to an expanding market instead of a shrinking one. As PwC and Securitize highlight in the graph above, private funding (in billions) is 22x larger for private offerings than IPOs. Although the Security Token industry is currently still in its nascent stage, many organizations and companies are debating over how this new technology can be used. However, by investing early-on, 8 Decimal can accelerate this process and help the industry maximize its potential. The Security Token Offering Process and the Main Platforms The Security Token industry includes distribution platforms and rating agencies, payment platforms and stable currencies, exchanges, KYC, consulting services companies, and liquidity providers, among many others. The most important participants are the projects, the distribution platforms, and the ST exchanges. At 8 Decimal Capital, we believe a successful Security Token Offering (STO) requires a legitimate company to launch a compliant Security Token, which will be traded by whitelisted investors on compliant exchanges. Industry Segments Issuers Issuance Platform Investment Banks Smart Contracts to Track Spending and Revenue Payment Platform and Stable Coin Investing Exchange KYC/AML Governance Platform SaaS (Software-As-A-Service) Platform to Allow Investors to Vote Help with Company Charter Agencies Custodian Liquidity Providers Media/PR Agencies Rating Agencies Compliance, Law & Accounting Information Platforms Admin Consoles Moving from Pre-STO to Issuance (release) to lifecycle-management (full process management), we are finding the best projects that deliver the required services and invest in them. Beyond Capital 1.) Legal — Partnership with Tackett Bartlett Regulation drives innovation locally and globally. Within the global market, various “blockchain friendly” countries have emerged which boast government encouragement of blockchain and cryptocurrencies, while other “blockchain unfriendly” countries have more regulations for companies and projects to pass through before reaching the public. For example, the United States has exemptions Reg D, Reg A+, Reg S, and Singapore MAS also has similar regulations that require specialized efforts to remain compliant. Companies in China that want to conduct STO may need to set up VIE architecture. Under Section 5 of the Securities Act of 1933, all offers and sales of securities must be registered with the U.S. Securities and Exchange Commission or qualify for an exemption: Regulation D, Regulation A+, Regulation S, and Regulation CF. In terms of legal services, 8 Decimal Capital is partnering with firms, such as Tackett Bartlett LLP, which is experienced in the cryptocurrency space. For example, Berkley Vice Mayor, , is an advisor to 8 Decimal Capital. He is also a strong supporter of the blockchain field and an advocate for the concept of Crypto Municipal Bonds. Ben Bartlett Ben Bartlett , Berkeley’s Vice Mayor and an Investment Partner at Octavia Capital, believes in the future of blockchain and the concept of Crypto Municipal Bonds. Ben Bartlett and Shane Tackett co-founded Tackett Bartlett LLP which consists of five service modules: Token Design, Global Taxation, Investment Fund , Corporate Structure, and Regulatory Compliance. For more information: http://www.tackettbartlett.com/ 2.) Investment in Securitize, Issuance Platform When it comes to Security Token issuance platforms, 8 Decimal is a strong supporter to Securitize. For more information: Medium: | LinkedIn: | Twitter: https://medium.com/@securitize https://www.linkedin.com/company/securitize/ https://twitter.com/securitize_io In the future, RegTech must be a combination of manual, legal, and technological standards. The Securitize platform will provide standardized templates and processes for creating Security Tokens for real assets. From a technical standpoint, ERC20 tokens are fungible. There are various securities in the traditional financial industry including partial stocks and ABS-type (Asset-Backed Security). Those securities are not fungible. There is a need to be a differentiation of characteristics between fungible tokens and non-fungible tokens. Examples include the ST20 standard for the Polymath platform, the SRC20 standard for Swarm, the R-token standard for Harbor, and the ERC-1400/ERC for the Ethereum community which are currently available, along with the 1410 standard and ERC-1404 standard. The existing insurance platforms include , , Securitize ( ) and , among others. 8 Decimal’s decision to invest in Securitize ( ) was largely based on its stunning track record of successfully issuing projects. Also, , , and 22x ( ) are all Digital Security Issuers that used the Securitize platform, all of which verify the success of Securitize. Polymath Harbor Securitize.io Swarm Securitize.io SPiCE VC Blockchain Capital 22xFund 3.) Trading Platforms: OpenFinance Exchanges that are prepared to enter the STO market can be divided into two categories: (1) cryptocurrency exchanges; and (2) traditional stock market exchanges. The above graph includes a portion of Coinbase’s current licenses. For more information and to see the full chart, check out: https://www.coinbase.com/legal/licenses?locale=en-US ( ) is one of the fastest growing crypto exchanges that dives into the ST market. Coinbase has successfully acquire a series of licensed financial institutions since last year, and now has multiple licenses such as BD, RIA and ATS. At the same time, tZERO and Templum ( ) are starting from scratch. Coinbase Coinbase Templum Blog On the other hand, traditional exchanges are also looking for ways to cut into the field of cryptocurrency, including the London Stock Exchange and Nasdaq, among other big players. However, 8 Decimal believes that some countries with strong policy flexibility, such as Malta and Gibraltar, may be more likely to issue compliance licenses to Security Token exchanges. The licenses required for the STO mainly include: ATS/ATLS (Alternative Trading System License), RIA (Registered Investment Advisor Licence), BD (Broker-Dealer Licence), RAE (Clearing and Transaction Execution Licence). Overall, the existing cryptocurrency exchanges are more familiar with crypto trading, but they often do not have the necessary licenses in place, while the traditional exchanges are the opposite. Private equity trading in secondary markets has already existed. Platforms such as Equidate, , and the SecondMarket, LP interest trading platform are making equity trading more flexible and smooth. The main pain points they are addressing are the liquidity of private company equity and other Alternative Assets. They are working to provide a more transparent, wide-spreading online trading and hosting platform for such alternative assets. EquityZen In terms of trading platforms, well-known projects to look at, to name a few, include , , , ( ) OpenFinance tZERO Templum Gibraltar Blockchain Exchange GBX We chose to invest in . OpenFinance OpenFinance was founded in 2014 to provide trading and clearing and settlement services. OpenFinance CEO, , holds a Computer Science degree from Northwestern University and an MBA from the Kellogg School of Business, and has many years of experience in financial exchanges. OpenFinance already has multiple STOs in the pipeline, such as SPiCE VC (SPiCE). It is available for Regulation D, S, A+ or CF exemptions, and can also be traded on ATS (Alternative Trading System). In addition, OpenFinance and Firecoin have also reached a deep strategic cooperation. Juan M. Hernandez For more information: Medium: https://medium.com/@openfinance | Twitter: https://twitter.com/OpenFinanceIO | Website: https://openfinance.io/ 4.) Investment in the Ecosystem In terms of information platforms, 8 Decimal invested in DappRadar and is incubating STO.review. For more information: Medium: https://medium.com/dappradar-com | Twitter: https://twitter.com/dappradar | Website: https://dappradar.com/app/676/fomo3d In terms of liquidity providers, 8 Decimal invested in ( ). AirSwap Ltd AirSwap Team For More Information: Medium: https://medium.com/@airswap | Twitter: https://twitter.com/airswap | Website: https://www.airswap.io/ Into the Future: In the past, people bought stocks and signed contracts based on paper documents and signed them manually. Now with ’s electronic signature tools, electronic signatures in the US are beginning to have legal precedence. The future trend is to further develop and digitize the process of information matching, contracting and transaction. DocuSign For example, allowing multiple witnesses (changing the notary’s model), on-chain data non-tempertable, and compliance standards (such as KYC/AML/qualified investor certification standards) to be turned into contract layers. To do this requires online and offline collaboration and the integration of regulations and technology. Code is Law. 8 Decimal also believes that in the future, the financial agents and regulatory agents will still exist. But the funds in the industry will provide more than just capital, there are more roles for them to fill. 8 Decimal Capital: Shape the Blockchain Future | | | | Medium LinkedIn Twitter Facebook Website Email: contact@8dcapital.com if you have any more questions about this topic. 8 DECIMAL CAPITAL is a multi-strategy investment firm focusing on token and equity investments. 8 Decimal currently has more than 40 portfolio companies with an AUM of 60M USD. The investment team consists of more than 10 venture capital veterans, researchers, and trading professionals. The advisory board comprises Fan Zhang (Former Founding Partner of Sequoia Capital China), Karen Chen (Former CEO of UBS China) and Ben Bartlett (Vice Mayor of Berkeley). Based on the professional fund index ranking agency Token Metrics , 8 Decimal was ranked second out of the 51 active crypto funds. 8 Decimal is also well-received in China, named one of the top 10 funds in the blockchain industry by both 36氪（36Kr.com） , Chain Capture , and Odaily , as well as named one of the top 20 funds by Tsinghua X-Lab and Youth Education Chain League.

From Research to Use-Case: How 8 Decimal Capital Strategically Constructs Its Security Token…

ICO’s Have All But Completely Exited Stage Left. Enter The Security Token? As the great cryptocurrency winter of 2018 extends its grip by yet another month, at various blockchain conferences worldwide has been rife that a is on the cusp of forming. This new breed of digital assets is one that seeks to comply with existing regulators, rather than to subvert. Security tokens are are programmatically designed to be compliant with relevant regulations. In the words of influential crypto podcaster and fund manager : anecdotal evidence security token wave Anthony Pompliano If cryptocurrencies like Bitcoin are considered “programmable money” then you can consider Security Tokens a version of “programmable ownership.” With recent examples of assets being tokenized ranging from the , to a , to a Picasso painting (facilitated by a certain ), to private shares of startups from and , momentum is clearly favouring this nascent development. Whisper it, but we may even be witnessing the first shoots of a transition from the wild west that was ICO-mania making way for a ‘Security Token Offering (STO) spring’. St. Regis Aspen Resort New York real estate fund John McAfee Germany Brazil Setting The Scene Before I proceed any deeper — and without suggesting that STOs will necessarily step in to fuel yet another market-wide bull run (out of scope for this piece), I would highly recommend that you revisit this great introductory piece on tokenization: _Not everything will be tokenized, but those that can be will be._hackernoon.com How does tokenization work, anyway? Followed by this other persuasive piece which lays out the full transformative potential for the security token space: _Last summer I wrote Traditional Asset Tokenization, in which I hypothesized that a broad array of assets will move to…_hackernoon.com The Security Token Thesis In short, there are a whole host of benefits driving the security token thesis for mainstream adoption, including 24/7 markets, fractional ownership, rapid settlement, automated compliance and asset interoperability. The purpose of this article is to provide the reader with an understanding of what we define as the — think of it as a series of production line steps which are necessary to create and trade a security token — and an overview on how the ecosystem is shaping up around these layers, especially in markets with more developed regulatory frameworks relevant to STOs such as the United States. security token value chain The Security Token Value Chain (aka Yet Another Stack) The following provides a layered structure of how we’ve classified the various security token ecosystem players today (from bottom to top): hamburger Deal Flow Origination Issuance Platforms Services Secondary Market Trading Defining The Security Token ‘Ecosystem Stack’ Today While the above provides some form of general structure around the process, do note that some of the activities (e.g. auxiliary services) may overlap across multiple other layers, and/or differ entirely in various other flavours as designed by the platform stakeholders. Deal-flow Origination We begin with the very bottom of the security token hamburger stack. Simply put, deal-flow origination refers to the process of matching the demand and supply of capital for investments. The degree of customer accessibility to these investments vary along a spectrum. On one end there are more open platforms such as Kickstarter where the average retail investor Joe may participate in funding the development of cool product ideas; while on the other end there are platforms such as where only accredited investors are able to join in on equity investments in Silicon Valley-based technology startups. AngeList As a rule of thumb, the general requirements for an aspiring investor to partake becomes more onerous as factors such as deal exclusivity, target capital raise, average cheque size and financing complexity increases. Said requirements usually entail attaining investor accreditation status, more disclosure requirements and sometimes higher fees. Current notable deal-flow origination platforms involved in the STO space include , and . Indiegogo — most notable among the examples for having been in the traditional crowdfunding space for about a decade — lent its credible reputation to back the ambitious by being the platform through which investors could participate in the initial STO. Most platforms have side-stepped requirements to file for traditional securities offerings by allowing only accredited investors to participate, while some such as Republic allows for regular retail participation via relying on an alphabet soup of ( ). Republic Crypto SeriesOne Indiegogo St. Regis Aspen Resort tokenization project SEC regulatory exemptions more on that later Fancy purchasing a fraction of a fancy ski resort? Issuance Platforms and Core & Auxiliary Services Moving along to the meat within the security token stack, we come to the issuance platforms. These players specialize in providing the technical smart contract know-how necessary for the primary issuance of programmable security tokens. They provide solutions that handle for things like investor accreditation, KYC/AML requirements, capital raising taxation, as well as the myriad of other more specific shareholder provisions (e.g. first rights to refusal, residency requirements, shareholder ownership concentration rules, etc.). They aim to address as far as possible the common needs of the majority of asset issuers. The goal for these solutions would be to automate compliance while maintaining immutability and process transparency. Implemented well, such solutions will ensure that situations such as the — whereby human error during various ledger reconciliation processes resulted in duplicate shares of Dole Foods being issued on various ledgers — does not wastefully occur. Dole Foods case Most issuance platforms come bundled with services aimed at meeting the common requirements of potential STO issuers in a bid to make up a full-service solution. This would include dashboards for token issuers, and functionalities to allow for them to easily conduct corporate actions such as shareholder voting, rights issue, dividends, interest payments, revenue share distribution and ESOPs, with the aid of document signature tools for token-holders. Examples include , which enabled the tokenization of the Aspen project on Indiegogo, as well as Coinbase-backed startup , which had facilitated the tokenization of two blockchain investment funds, and . Templum Securitize Blockchain Capital SPiCE VC Rounding off the list of services necessary are trust companies and custodians — a category of companies that are absolutely integral to making tokenization tick, especially in the case of most assets that are not (i.e. today’s “ ” assets such as stocks, real estate and art). Their jobs as custodians are to ensure that these assets — be it the stock certificate, property title deed, physical painting — are being held in a secure location, with token-holder ownership rights being clearly defined and legally upheld, and that the tokens in issue that represent them are always counter-balanced in a 1:1 ratio by the underlying asset. Key players to have established this niche for themselves are and . natively-digital real-world PrimeTrust BitGo Secondary Market Trading Finally at the very top, secondary market trading is the layer which provides security tokens with their much-heralded benefits of liquidity and 24/7 trading & settlement. An intuitive, easy-to-use trading interface constitutes table stakes for any form of digital asset exchange product these days. For any STO exchange to materially value-add to the user experience, they will have to be cognisant of the rules of the legal jurisdiction that they operate in, as well as that of its customer clientele. For instance, they may automatically facilitate reporting on capital gains taxes applicable for American users who have profited through trading on the secondary market, but not for Singaporean users (where capital gains taxes do not apply for retail investments). Other differentiating factors relate to the user experience journey. Exchanges can be set up such that they give users the option of self-custody of their own digital assets, or — for those who are less savvy technically with managing private keys — provide them with just a simple, user account plus password system. Exchanges can also help reduce the time taken for trade settlements on their platforms through the use of . Stablecoins will allow for such trades to happen atomically, which implies that I receive my sales proceeds the moment that my sell order gets paired with an interested buyer, with my security token going the other way in one single, simultaneous action. This is an exponential improvement over the settlement speed for securities trading in existence today, where T+2 represents the gold standard (cross-border stock trading settlement sometimes require T+5 days even!). stablecoins A couple of juggernauts have already made their mark. has raced ahead on the partnerships front, forming a to list the tokens issued by an assortment of niche issuance platforms. , a blockchain subsidiary of NASDAQ-listed company Overstock, has built up a sizeable war chest after the conclusion of its own US$134M in August. Purchasers of their tokens are promised regular dividend payouts tied to the profits generated by their exchange business. OpenFinance Network whole slew of collaborations tZERO STO round The Land Grab Race Is On Calling the space fragmented would be an understatement at this point in time; slide not an exhaustive representation of all notable players The current landscape remains largely fragmented with players finding their niches and gradually establishing partnerships. While there are unique cases of projects such as that are seeking to provide a complete end-to-end solution for potential STO issuers — or rather ETO (equity token offering) issuers, as they have chosen to term it, most are specializing within a certain layer within the stack , before partnering with other projects that complement them. For example, — a tokenized fund specializing in investing in blockchain startups (deal-flow) has partnered with Securitize for the issuance of their tokens, and also with OpenFinance Network to enable the of their tokens. Neufund SPiCE VC future subsequent trading Another observation to make would be that the structure of most of these blockchain startups are rather akin to that of a “traditional” tech startup, operating on a service revenue-based business model. Exceptions include those which have made use of STOs to coordinate platform incentives and/or raise capital (e.g. Neufund, SPiCE and tZero) from investors in exchange for the promise of future dividends, along with several others which have done ICOs (e.g. Polymath, Rate3 and TrustToken) or have distributed their tokens via mining incentives (e.g. Ravencoin). Finally, it is also noteworthy to mention that the large majority of these players are based in the United States, highlighting the immaturity — as well as the consequent potential — of the asset tokenization space in other markets. Still Early Days On The Regulatory Front While acknowledging that there have been several forward-thinking, tokenization projects that have made news headlines recently, one cannot stress enough on the infancy of the entire security token space as a whole. Most of the marquee, flag-bearing tokenization proof-of-concept projects so far are just that — PoCs that are being sold to a small, of investors only, in order to stay on the right side of regulators. Mass retail adoption are still some significant way off. ‘real-world’ select group accredited Having said that, it is apparent — and heartening — that the clarity of regulatory exemptions available within the United States has resulted in many security token ecosystem projects and partnerships flourishing there. Ken Nguyen, founder and CEO of Republic was recently interviewed in a great podcast, in the process demystifying the various US regulatory exemptions which STO projects could seek: It does not appear long before other Asian ‘pro-crypto’ jurisdictions such as Singapore and Japan start embracing STO innovations on their shores as well, allowing for the retail investor masses — — portfolio exposure to security tokens serving as proxies for investments which they may never have got the access to otherwise. not just accredited investors This is a thought which truly excites me; imagine the multi-fold returns of having been able to invest in one of the early rounds of equity fundraising for startups such as Grab or Gojek. Think of the whole new design space which issuers could work with to increase customer engagement and loyalty, such as, for example, allowing for priority booking for token-holders. With jurisdictions like the United States laying the groundwork for others to observe and adapt, what was once solely the domain of the rich and connected may soon become within touching distance of the masses within the near future. Disclosure: I work at Rate3 Network , a protocol that handles asset-tokenization and identity management across both Ethereum and Stellar blockchains.

Why You Need To Know The Security Token Value Chain (aka Yet Another Stack)

Capital Formation — the killer app for blockchain?

Liquidity is one of the golden promises of security tokens as a new asset class. Unfortunately, until now, the security tokens have shown an almost concerning lack of liquidity. Most people tend to see liquidity as a factor related to the maturity of the market and assume that it will develop organically in the security token space. The truth is a bit more complex. Liquidity is in fact a sign of maturity in financial asset classes but only those with the right infrastructure. Many mature financial asset classes remain highly illiquid as they don’t possess the correct building blocks for nurturing organic liquidity. Similarly, other asset classes with the right liquidity framework take years fail to achieve relevant levels of liquidity in its early days. Today, I would like to explore some of the key building blocks that need to in place to enable liquidity in security tokens both from the technical and financial standpoint. If there is a single principle I want you to take away from this article it would be this: In the context of security tokens, the market could remain highly illiquid unless we establish the right infrastructure for the different participants to engage in trade dynamics. “In financial markets, liquidity is something you build for not something that happens”. From the perspective of traditional financial markets, liquidity manifests in two main dimensions: funding and market. Funding liquidity is typically associated with the availability of credit or funding mechanisms that allow institutions to borrow money or take on leverage. Complementary, market liquidity refers to the ability of market participants to transact or of the overall market to absorb large purchases or sales without affecting the overall prices. Both market and funding liquidity are closely related and mutually reinforcing dynamics. When funding liquidity is abundant, traders have the resources with which to finance trading positions that smooth price shocks and make markets liquid. In order to build funding and market liquidity, security tokens need to establish the basic protocols for the funding and trading of assets. Differently from other financial asset classes, security token liquidity is an infrastructure building exercise rather than a financial engineering process. Liquidity pools for security tokens are relatively available as they are a combination of traditional security investors and crypto advocates. However, the bridges for those liquidity pools to participate in the security token market are not available. Without those bridges, liquidity in security tokens will remain an elusive goal that can impact the evolution of the entire space. The Exchange Liquidity Myth Arguably, one of the biggest fallacies in the security token space is associating liquidity with the availability of the new generation of security token exchanges. By exchanges, I am specifically referring to centralized marketplaces such as tZero, OpenFinance or Malta’s Security Token Exchange which will enable the listing and trading of crypto-securities. Exchanges are certainly an important component to achieve liquidity in security tokens but they are far from being an enabler of that market dynamic. Without infrastructure artifacts such as disclosures, custody or liquidity protocols and without high quality projects, security token exchanges will be just a centralized marketplace for highly illiquid, digital assets. There is also the question of whether security tokens will be actively traded in centralized marketplaces or in a peer-to-peer fashion( I will cover this in a future article) which is not exactly trivial to answer. Considering all those factors, centralized exchanges should almost be seen as one of the latest manifestations, rather than an enabler, of a liquid security token market. The Building Blocks of Liquidity If centralized exchanges are not the answer to liquidity then what is it? In my opinion, liquidity will be the result of building not one but a series of infrastructure building blocks and protocols. The following figure attempts to provide an evolutionary view of liquidity in security token markets considering some of the fundamental building blocks that will act as enablers of this market dynamic. Disclosures If you have no information about a crypto-asset how could you possibly engage in any level of fair trade? Disclosures are the most basic block that needs to be in place to fight information asymmetry and illiquidity in the security token space. A security token disclosures protocol should be associated with any crypto security and integrated into exchanges and marketplaces. Protocols like incorporate some interesting ideas about disclosures that can be relevant to the security token space. TruSet Liquidity Protocols Programmability is the biggest advantage of security tokens compared to traditional securities. As a result, many of the market dynamics in security tokens can be express as programmable protocols and liquidity is not the exception. Protocols that facilitate liquid trade dynamics must become a key building block of the security token space. Efforts like or are very relevant in this area. Fuidity’s Two-Token-Waterfall Bancor P2P-Swap Trading Protocols I believe that a significant percentage of security token trading won’t take place in centralized exchanges but in peer-to-peer decentralized models. For that to happen, p2p or swap protocols should incorporate aspects of crypto-securities like compliance or regulation. Protocols like or are incredibly well positioned to lead this effort. AirSwap Kyber Network Debt Tokens Nothing increases liquidity in an illiquid market like cash flow and, for that, debt vehicles are ideal. Compared to equity tokens, tokenized debt represents a lower barrier of entry for most investors into the security token space and one that can offer higher level of short term liquidity. I believe debt tokens are going to become one of the most prominent forms of liquid crypto-securities in the short term. Protocols like provide a foundation for debt protocols that can be applied to the security token space. Dharma Decentralized Marketplaces If many security tokens are going to be traded in a decentralized model, then we are going to need some marketplaces to enable that. Decentralized marketplaces are likely to become relevant for some forms of crypto securities. is a good effort in this space. AirSwap’s Spaces Custody Custody is one of the aspects that helps to legitimize any financial market and increase its liquidity. Security token custodian products have the potential to unlock new forms of liquidity that are just not viable in the current market. Established financial players such as , , and are well positioned to lead this segment of the market. Fidelity Digital Assets Northern Trust Goldman Sachs Intercontinental Exchange Centralized Exchanges As mentioned before, centralized security token exchanges are certainly an important component for achieving liquidity in the security token market. Protocols in areas such as disclosures or custody should be incorporated into centralized exchanges. Efforts like tZero, OpenFinance and the Malta’s Security Token Exchange are leading the charge in this area. Futures Futures is a vehicle often used to increase and hedge liquidity in a financial market. As security tokens evolve, we are likely to see futures as the first form of derivative that can increase the levels of liquidity in the space. Other Derivatives In financial markets, liquidity foments the creation of new products that, in turn, help to increase liquidity. Derivatives is one of the most prominent financial models that can unlock new forms of liquidity not available to traditional asset-backed products. Options, exchange traded funds(ETFs), composed products like collateralized debt obligations(CDOs) are some of the products that are likely to achieve relevance in this space. These are some of the building blocks that are necessary to build and unlock liquidity in security tokens. As the security token market evolves, programmability might unlock new forms of liquidity that are not available in other forms of securities.

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openfin.co

-- employees

Since n.d.

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OPENFIN

EVERGREEN INDEX #8059

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