The hype of blockchain is real. The zealots view this infrastructure as a new Internet, enabling real-time, decentralized and trustless transfers of value. Banks be damned. Governments are moot. A brave new world is ahead.
Naivety abounds on the path toward this utopia. How value is onboarded from its current fragmented, centralized and opaque systems to this new nirvana is barely ever discussed. Few, if any efforts have been made by Bitcoin and blockchain pioneers to lubricate this transition beyond, “If you build it, they will come.” Enter the tokenized security.
SECURITIES RISE
Modern U.S. securities laws are anchored in the aftermath of the 1929 stock market crash. In fact, though, the concept of “securities” has been around for centuries. Founded on the need for governments to manage debt in turbulent medieval and early modern Europe, mechanisms were created to access funds that would otherwise sit idle. The need to transfer value separate but equal to the underlying asset is the cornerstone of economic development. Governments, banks and other central figures have been the foundation of this system since its genesis.
The exchange and settlement of modern securities today are built upon systems and technology born out of the Industrial Age. Public securities markets have done their best to iterate given the tools and resources of the Information Age, but keeping up has been a challenge. Exchange has been abstracted such that actual asset exchange happens upon settlement, often hours or even days after the transaction is consummated. Many of these exchanges occur in the same manner as existed in the Industrial Age — person to person, with little outside visibility into the market. The complexity of these abstractions upon abstractions has led to error, exposed parties to fraud, and otherwise added opaqueness to what is supposed to be a public, transparent and real-time process.
ENTER BLOCKCHAIN
Blockchain enables a total redesign of this centralized structure, but altering centuries of system, thought, politics and other facets of the modern economy will certainly not happen overnight. Some aspects of current blockchain technology, however, can be employed relatively quickly and easily to improve upon the current system. The exchange of cryptocurrencies and tokens is a global 24/7 endeavor. Once compliance is built into the system for any given jurisdiction, transfer between jurisdictions will be trivial — not only lubricating the exchange, but also breaking down the walls between the world’s markets.
For public securities, blockchain-based infrastructure, if viewed solely as a technology, will finally deliver on the promise of information technology — real-time settlement, reconciliation and trusted visibility into markets at a given point in time. Incremental from where we are today, yes, but the shift from days to seconds will no doubt provide for a better system, if only because of the efficiency gains and cost reduction.
For private markets, however, blockchain-based infrastructure provides for a revolutionary rather than an incremental change in how business gets done. Markets that have long been opaque become visible. Private markets bogged down by third-party rent seekers, intent on hoarding information for profit, become more visible and transparent. Markets that were unable to survive and thrive given prior inefficiencies and costs are able to emerge and grow.
To unleash the promise and potential of even the most incremental benefits of blockchain, securities need to be converted into tokens, the underlying asset of blockchains. In doing so, the underlying security token is then able to enjoy all the benefits of the blockchain, from real-time exchange to transparency.
TOKENS VS. CRYPTOCURRENCIES
The nomenclature for various blockchain-based digital assets can be confusing. Many are used interchangeably, though there are subtle differences among them. Cryptocurrency most often refers to the primary digital asset that underlies a blockchain, as it takes the form most akin to currency. Token refers to assets built atop a blockchain that are used to perform some function, such as a security. In this context, Ethereum is a cryptocurrency, for example. Tokens that are built on top of the Ethereum blockchain follow the protocol’s ERC-20 standard and include Kik Interactive’s Kin (KIN), Augur’s Reputation (REP) and Golem Factory’s Golem Network Token (GNT).
The current challenge is how to do this while ensuring compliance with current regulations and laws. Enter Coinbase, tZero (a subsidiary of Overstock.com), Harbor Platform, Polymath and others. Work is under way to develop blockchain infrastructure that is compliant with existing securities law. This is no doubt happening globally but, in particular, efforts in the United States are fervent. The vision for these entities is to work out the kinks of complying with current securities laws and regulations, negating the need for much, if any, change to allow for the onboarding of securities into this infrastructure at scale.
Already, several companies are going down the rabbit hole of tokenizing their securities. Anexio, a data center infrastructure company, recently announced it is converting equity shares into digital tokens using the Ethereum blockchain as the backbone. Coinbase, the early cryptocurrency service provider and exchange, announced in June it acquired broker-dealer Keystone Capital, equiping it with the licensure to offer tokenized securities.
As these attempts prove successful and as the compliant infrastructure under development comes to market, the process becomes simple:
- Focus on converting an existing good that effectively already functions in a tokenized manner.
- Leverage an existing blockchain protocol. A phrase pervades the space: “Don’t roll your own crypto.” In other words, don’t develop your own crypto system. Rather, leverage the work of others that specialize in the technology.
- Work under existing regulatory frameworks to deliver a result that functions just like its non-
tokenized counterpart.
No revolution to overthrow the government needed. No trampling of the modern banking system required.
Securities tokenization is coming. Are you ready?
Brandon Thomas (brandon@blockintel.co) is managing partner of Blockchain Intel.