Dec 17, 2018
A Security Token — Revealed
An introduction and basic analysis of the key features needed for a security token. This is the first part of a series of articles where we will explore security tokens as a concept, their current state, and their future. We will stay within the Ethereum ecosystem as that currently has the most adoption.
Introduction
Security Tokens have been born of necessity and adversity in light of the collapsing Utility Token paradigm. The SEC and other regulatory bodies have raised issues with the fundraising model of a Token Sale in which millions of retail investors have been able to invest in blockchain projects. Their primary issue has been that the tokens being purchased are not usable as utility tokens in that the platform has not been built yet in most cases. The tokens are in fact speculative purchases in the hopes that their value will rise over time. The SEC attempts to protect retail investors by not allowing them to invest in products that it deems too risky — like the aforementioned Utility Tokens. Whether you agree with this premise or not, if you live in the US, you must abide by securities law — enter the Security Token. While there are many representations of the security token, they all need to fulfill the regulatory requirements of a US security.
Attributes
The items below are basic tasks that a security token on any platform should be able to support.
- Holding Period — A period of time determined by securities law that an investor must keep the asset after purchase before moving the asset via transfer or sale. ie. After purchasing 100 tokens of SECToken, the investor is required to hold the purchase for 9 months.
- Investor Accreditation — Since retail investors(aka you and me) can’t invest in a security or a token representing a security, a security token needs to be able to verify those purchasing it. An accredited investor is the term typically used to identify those allowed to purchase a US security. The SEC bases their accreditation on how much money the individual has but not on their understanding of anything related to investments or financial aptitude. The SEC says that this protects those who can’t afford to lose anything in bad investments, but in my opinion, it translates to the rich getting richer. Stepping down from my soap box now.
- Documentation — Just because we are tokenizing a security on a blockchain doesn’t mean that we don’t have to adhere to proper custodial protocol. A security still needs to have hard copies of disclosures, ownership, terms, etc. We should be able to provide electronic representations of these documents, digital signatures, or any other aspect of the security that can be audited.
Custodial Functions
- Issuance of assets — A security needs to be able to issue the purchased tokens to the investor and keep an accounting of the cap table of the asset’s distribution.
- Re-Issuance of Assets — A security will need to have the option to burn and reissue tokens in the case of the investor losing their private key. We will also need to be able to freeze/seize assets in the case of illegal activity or a court order.
- Dividend — Most securities would pay a dividend at certain intervals while holding the security token. We would need a way to generate the cap table in order to calculate dividend amounts based on total ownership of the security.
- Wind down — In the eventuality that a security’s lifecycle is ending and or being shutdown, we would need a way to shutdown the token and disburse the funds from the underlying asset after its sale. It is possible that one security token may want to switch to another chain or come off the blockchain altogether and we need to be prepared for such events.
These are just some of the features that are needed for a Security Token in the real world. Quite a few of these can be handled through standard token functions such as mint, transfer, burn, pause , custom smart-contract logic, oracles, and the like. The real hope here is for a common standard to emerge and become an efficient means of adoption.
Current State
Security tokens lend themselves to blockchain intrinsically, so most if not all blockchains could support a security token up to a point. Ethereum, Cardano, EOS, NEO, etc. — these are all capable and have some semblance of a security token on the platform. However, only Ethereum has any real traction in the space and products with real value invested. The biggest product offerings for Securitization as a Service are below:
Ethereum-based Security Token Platforms
- Polymath — The clear leader in the ERC based security token space. They have an
ST-20token standard that they have developed but several of their developers are also active contributors to the EIP(Ethereum Improvement Proposal) specs for an open security token standard. The latest evolution of this standard is ERC-1400. We will go over this spec in detail in the following article. - Securitize — This platform uses its own ERC token that works in conjunction with a proprietary protocol it has created.
- Harbor — Similar to the above platforms, Harbor uses its own token, the
R-Tokenalong with a regulator service that Harbor also maintains to approve and deny transactions.
Note: It is important to note that with the security token platforms there is no standardized token or shared interface other than the standard ERC20. As industry leaders, Polymath should be commended for their work towards a unified interface in the open standards of ERC-1400.
Summary
I hope that you enjoyed reading this article on my analysis of the security token market. We learned about the key attributes and functions needed for a security token, some current products, and gave a hint on our next article related to the ERC-1400 spec. Please give me a follow and I’ll let you know when the next article comes out — Thanks!
