Corporate governance is one of the hallmarks of publicly traded companies but is typically flexible(or even absent) in startups and small private companies. One of the interesting side-effects of security tokens is that they bring many of the corporate governance challenges of publicly traded or grow-stage companies to small private startups. Any company conducting a security token offering(STO) can end up with a number of investors large enough to make corporate governance nothing short of a nightmare. In the past, I’ve written extensively about security token governance presenting several theses about how to enable those capabilities in security token platforms. However, as more STOs have come to market, my thinking has shifted from the highly theoretical, blockchain governance protocols to more pragmatic governance challenges that need to addressed in the short term in order to ensure long-term viability of STOs. Among those governance challenges in security tokens, voting rights seem like the classic low hanging fruit.
Voting Rights
Traditional equities are a legal representation of ownership rights, cashflow and voting rights. The current generation of security tokens are mostly tokenized representations of ownership rights. However, as STOs become actively listed and traded, the need for voting and programmable corporate governance dynamics is likely to become increasingly relevant. Typically, voting rights will allow token holders to participate on important decisions related to the underlying asset of a crypto-security. Security tokens bring a unique flavor to voting rights as governance decisions are not only relevant to the lifecycle of the underlying asset but also to the crypto-asset itself. In that sense, voting rights in security tokens can be classified into two main groups: native-assets voting rights or crypto-asset voting rights.
Native-Asset Voting Rights
This type of voting right encompass corporate governance decisions that can impact the performance of the underlying asset of a security token. Some classic examples of native-asset voting rights include:
· New board seats awarded by a company.
· Sales or change of control of the underlying asset.
· Dividend payments.
· Raising institutional capital or taking on additional debt.
· Issue new shares.
· Director compensation.
· ….
Just as voting shareholders in publicly traded companies or preferred shareholders in ventured backend companies, security token holders should be able to participate in certain governance decisions related to their assets.
Crypto Voting Rights
Like everything in crypto, the picture is not complete until you go on-chain 😉 In the case of voting rights, there are specific decisions related to the crypto-security itself that should be subjected to governance processes. Here are some basic examples:
· Burn or mint new tokens.
· List on additional exchanges.
· Integrate with a specific crypto-protocol.
· Support decentralized exchanges.
· Undergo a crypto-security code audit.
· ….
Off-Chain vs. On-Chain Voting
In the current version of security tokens, governance decisions take place off-chain and there are no direct correlations to the lifecycle of the crypto-security. That model is unlikely to be sustainable in the long term as token holders will rightfully claim to participate in governance decisions related to their crypto-assets. From that perspective, I believe the evolution of voting rights in security tokens is going to have three main stages:
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Off-Chain Voting Rights: The current model, in which governance decisions take place off-chain and are completely disconnected from the related crypto-security.
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Off-Chain Voting with On-Chain Record: A simple evolution of the previous model, in which voting takes place off-chain but the results are recorded in a public blockchain.
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On-Chain Voting: An on-chain protocol that will allow certain type of token holder to participate in governance decisions that affect both the off-chain and on-chain performance of the crypto-security.
Having a transition model is nice. Unfortunately, security tokens are evolving fast enough that I am afraid we will to transition from state 1 to 3 in the next few months 😉
Extending Security Token Protocols with Voting Rights
Voting rights could be the next big iteration of security token protocols. In its simplest form, a security token platform can consider issuing two types of tokens for a specific asset: voting and non-voting. The smart contract of both types of tokens can be identical excepting the voting operations. The voting protocol will receive the information about specific resolutions and will wait for the input of the token holder. That input could be manual or automated.
While theoretically simple, programmable voting rights are not trivial to implement as they are subjected to all sorts of game theoretic attacks and token holder manipulations. To mitigate those challenges, there are two key security token mechanisms that need to build alongside or even before the first implementation of voting rights.
· Disclosures: Having access to verified information sets is essential to make intelligent voting decisions related to security tokens. Without a disclosures protocol, it’s hard to image any viable implementation of voting rights.
· Voting Incentives: Incentives play an important role to prevent bad behavior in voting decisions. The absence of a universal utility token for security token issuances make modeling incentives very specific to every STO.
Voting rights might be one of the first major innovations in security tokens that we will see this year. From the entire landscape of security token governance, extending security token protocols with voting rights seem like the easiest thing to fix. Certainly, incorporating voting rights into security tokens will go a long way towards implementing fairness across the entire ecosystem.