In recent years, security tokens have gone from being a promising concept to being a hot topic. PWC revealed that 380 token offerings raised a total of €4.1 billion in the first ten months of 2019 and that between 2017-2019, established financial institutions raised more than €4.2 billion in security token offerings issued directly by the companies. Despite factors like identity, governance, and compliance presenting hurdles to overcome, investors, institutions, and regulators are starting to take notice. This allows blockchain digital securities to move forward to shake up both the traditional financial markets and the blockchain landscape. For example, the Sustainable Digital Finance Alliance (SDFA) and the HSBC Center of Sustainable Finance recently joined forces to highlight how security tokens for green bonds can reduce management costs and increase operational efficiency by up to tenfold. times. And in early 2020, the RedSwan CRE Marketplace symbolized €2.2 billion in commercial real estate, making it one of the largest tokenizations we've seen so far and illustrating how digital assets can move. traditionally illiquid markets. About the Author Thomas Borrel is Director of Product at Polymath With backing from financial institutions like HSBC, backing from regulators, and more evidence to illustrate their benefits, security tokens are poised to take the blockchain, securities by storm. and the financial industries.
The definition of security tokens
Security tokens (or digital securities as they are sometimes called) are digital representations of an asset such as stocks, fixed income securities, real estate, mutual fund shares, commodities, and structured products that are traded and held in a chain of blocks (a distributed ledger). What makes these assets "securities" is that they are regulated, and governing bodies around the world dictate how they can be issued, managed, and traded. By leveraging blockchain technology, security tokens automate many traditionally cumbersome and highly manual processes and provide a golden source of truth that all parties can trust. In short, security tokens combine the speed and ease of blockchain with the strong legal protection of traditional securities.
What are the advantages of security tokens?
Security tokens offer a number of advantages over traditional securities, including: Efficiency: The automation, speed, and transparency of the blockchain make creating, issuing, and transferring securities faster and cheaper. By automating traditionally labor-intensive processes, security tokens accelerate efficiency while lowering costs and reducing the risk of manual errors. Liquidity – Through fractional ownership and secondary markets, security tokens make traditionally illiquid assets like real estate and fine art more liquid for asset owners. Dividing ownership into small fractions, rather than being owned by a single person or entity, democratizes access to wealth creation for small investors. Transparency: The status of a security token transaction can be monitored throughout the entire process, from inception to settlement, and all parties involved have access to an up-to-date on-chain source of truth gold. With an up-to-date record, you reduce conflicts around record keeping and the need for parties to come to an agreement. Reduced risk: Security tokens are used to schedule rules and compliance checks. By automatically discovering problems before the transaction begins, the risk of irregularities decreases.
How are security tokens created?
Creating a security token involves reserving and naming your token token, creating a token that can programmatically enforce regulatory compliance, and creating and distributing the token to investors. This can be done in two ways: Asset Tokenization – When a traditional financial asset that exists off-chain is represented on-chain, making it a tokenized security. A good example would be tokenizing an existing shared certificate. Asset Creation: When the financial asset is defined and only exists on the blockchain. These assets are often described as "native digital assets." Asset origination offers a great way to create financial products that cannot be created with traditional means.
What issues are delaying the adoption of security tokens?
Security tokens are off to a good start by revolutionizing traditional asset ownership. But there are several challenges that act as obstacles to their acceptance and adoption by institutions, regulators and issuers, including: Identity: Regulations stipulate that titles must be associated with an identity. However, general purpose blockchains were built to resist censorship and pseudo-anonymity. On public blockchains, token holders can circumvent the rules by holding assets under multiple digital identities and lead sybil attacks, where a person attempts to seize control of a network by creating numerous pseudonymous digital identities. For trading to be supported, it must be determined by known, trusted, and regulated entities, a difficult feat on public blockchains.
Compliance: Security tokens are subject to a variety of complex regulations, and we expect them to increase in number and complexity. Many players have implemented proprietary systems, but they require manual intervention and have yet to provide the end-to-end automation necessary for automated compliance. Additionally, general-purpose blockchains make it difficult to implement a complex compliance framework. Built at the top of the chain, these Layer 2 applications can automate key steps. However, as users begin to apply successive rules for compliance, the number and complexity of those rules can push the chain to its computational limits, increasing costs and processing time. In turn, this can limit the ability to innovate and automate.
Confidentiality: Financial institutions value confidentiality. Banks want to keep their business patterns under the radar because that's how they differentiate themselves. On general-purpose and public blockchains, this can be exposed. Layer 2 solutions offer confidential transactions and balances, but come with an infeasible trade-off: To add privacy to transactions, they must sacrifice the ability to configure compliance rules or enable key reporting features, such as ownership.
Governance – Due to its decentralized nature, a blockchain can be split into two separate chains, called forks, which can expose significant legal and tax challenges for real asset-backed tokens. If an investor owns 1 ounce of tokenized gold, they will not get a second ounce of gold when the blockchain forks and the asset is duplicated, because the additional gold does not exist in the real world. It may also not be practical to split it into two tokens worth half an ounce each. This is why it is essential that a blockchain for securities have a governance process capable of mitigating contentious ranges.
The security token landscape is taking steps in the right direction to overcome these obstacles. New and traditional market players are collaborating more frequently, and institutions around the world are realizing the opportunities offered by security tokens. From the widely used ERC 1400 security token standard, launched in early 2019, which reduces the need for technical due diligence, to blockchain technology designed specifically for security tokens on the horizon, the case is strong and growing.