Transforming the Financial Landscape With Tokenization: A Closer Look at Polymesh
Background
Polymesh is an institutional-grade blockchain that is purpose-built for tokenizing real-world assets like stocks, bonds, and real estate. It simplifies the process of creating natively digital regulated assets and opens the door for financial institutions to integrate blockchain technology.
Polymesh was developed by the team that developed Polymath, an infrastructure for creating security tokens consisting of smart contracts on Ethereum with the native token POLY. The Polymath team led the creation of ERC-1400, which was widely accepted as the leading standard for security tokens on Ethereum. The ERC-1400 was tried and trusted by several institutions who utilized it, some examples including RedSwan CRE’s tokenization of $2.2B in commercial real estate, and BNP Paribas’ tokenization of a renewable energy bond.
Ultimately, the team at Polymath recognized the limitations with a general-purpose blockchain like Ethereum and concluded it would not suffice for a scalable tokenization solution suitable for institutional adoption. This prompted them to create Polymesh, a new layer-1 blockchain specifically designed for tokenizing real-world assets. The team also brought on Charles Hoskinson, co-founder of Ethereum and founder of Cardano, as the co-architect for Polymesh, further adding to its credibility. The Polymesh mainnet was launched in November of 2021 and was built using Substrate, the development kit used to make Polkadot, Kusama, and several other reputable blockchains.
Architecture
Polymesh was built with several features that make it compatible with security tokens at the base layer, as opposed to writing them in via smart contracts. After consulting with numerous institutions and hearing their concerns, they boiled it down to 5 key pillars that would be integral parts of the blockchain required for mass adoption. Polymesh was built with these 5 pillars in mind, which are:
- Settlement — utilizing the GRANDPA finality gadget, Polymesh provides deterministic finality to represent true ownership of assets. Polymesh also requires users to affirm settlement instructions, removing the risk of unwanted airdrops & transfers.
- Governance — a hard fork in a blockchain that holds regulated assets would present major legal and tax challenges. Polymesh builds governance into its core, allowing stakeholders to submit Polymesh Improvement Proposals to a Governance Council that can reach a consensus and find a path forward for the future development of the chain.
- Identity — Polymesh is a public-permissioned blockchain, meaning anyone can create a wallet but is required to onboard with an ID through one of Polymesh’s third-party KYC providers. Additionally, all node operators are required to be licensed financial entities.
- Compliance — Polymesh allows issuers to create flexible rules tailored to their asset type, jurisdiction, and regulatory regime. This flexibility is coded into the base layer, resulting in lower fees, faster processing, and greater scalability.
- Confidentiality — Polymesh uses a patent-pending protocol (MERCAT) to encrypt and hide users’ asset balances and transfers. Simultaneously, users can provide audit rights to trusted parties without compromising the privacy of their transactions or private keys.
These guardrails built-in to Polymesh, such as including KYC in the onboarding process for all chain users as well as requiring all node operators to be licensed financial entities, ensure that institutions can feel comfortable interacting with Polymesh without fear of regulatory backlash.
Tokenomics
The native utility token of Polymesh is POLYX, used for transactions, staking, and governance. When Polymesh was created, there were only two ways to increase the supply of POLYX on-chain: 1) a one-way bridge allowing users to transfer their POLY from Ethereum to POLYX on Polymesh at a 1:1 ratio, and 2) via block rewards, which are newly minted as blocks are created.
Polymesh uses a nominated proof-of-stake protocol, where stakeholders nominate their tokens to validators of their choice based on reputation and return. Block rewards are distributed each era amongst node operators as a percentage of POLYX staked per node. Additionally, all staked funds on Polymesh are subject to a 28-day unbonding period to further guarantee the chain’s security.
Block rewards are continuously minted and added to the supply up to a maximum annual inflation rate of 14%, which is reached only at the ideal staking ratio of 70%. Polymesh selected the ideal staking ratio of 70% because it balances chain security with adequate liquidity of POLYX. The block reward system incentivizes reaching this ratio, as rewards are higher before 70% is staked, but drop off significantly beyond 70% staked. Currently, the staking reward on Polymesh sits at a remarkable ~21.5% APY.
Adoption
Since its inception, Polymesh has shown a definite trend of increasing adoption. Being that we are only within 2 years of mainnet launch, the occasional news demonstrating adoption is sparse, but meaningful. As of August 2023, 31 assets have been created on Polymesh with an additional 52 tickers registered. As evidenced by the chart below, both are in a clear and consistent uptrend since the launch of mainnet.
Account activity has shown an increase since early 2022, with now 3,800 unique holders on Polymesh. The number of operator nodes has also reached 41 to date, more than double the amount at mainnet launch as more and more companies like Greentrail, Binance, and Huobi have joined the list.
The total supply of POLYX on-chain has steadily increased over time, in part from both block rewards as well as POLY tokens bridged by users and the Polymesh Association. The supply has almost reached 1,000,000,000 tokens, which was the total amount of POLY in the original Polymath smart contracts on Ethereum, indicating that Polymath users have been actively bridging their tokens over to Polymesh. The bridge is set to close at the end of January 2024.
For many months following the inception of Polymesh, the one-way bridge was the only way to acquire POLYX and there was no way of selling it anywhere. Bridging POLY tokens to POLYX in early 2022 meant taking a leap of faith. However, the brand-new coin has since been listed on several of the largest exchanges in the world including Binance, Crypto.com, and Huobi, among many others. Further adding to its validity, both Binance and Huobi have committed to becoming node operators for Polymesh, with Binance even offering POLYX staking to its users.
Below is a list of other notable partnerships and developments on Polymesh since the launch of its mainnet, in no particular order:
- Polymath Capital is unveiled, an institutional-grade dashboard for digitizing real-world assets on Polymesh
- Smart contract and NFT functionality is added to Polymesh
- TaroFi, an investment platform, commits to building a decentralized exchange on Polymesh and receives a grant from Polymesh’s Ecosystem Development Fund
- Nova Wallet, a multi-chain mobile wallet provider, adds support for POLYX on its iOS/Android application
- Stably issues USDS on Polymesh, a regulatory-compliant US dollar-backed stablecoin
- NayaOne integrates Polymesh into its platform, allowing institutions to experiment with tokenization, fraud, compliance, DeFi, deploying nodes, and more on Polymesh
- Korea Digital Asset Custody Co. (KDAC) joins Polymesh as a node operator, expanding the blockchain into South Korea as the country prepares to become a security token hub. KDAC is backed by Shinhan Bank, the 2nd largest bank in South Korea
- Korean digital asset custodian BDACS signs a Memorandum of Understanding in collaboration with Polymesh to launch an innovative security token project focused on K-culture
Challenges
There are two broad scenarios in which Polymesh will flop:
- Tokenization of real-world assets never catches on. This particular use case for blockchain is never adopted by the masses, let alone any major financial institutions. As a result, Polymesh and all other comparable tokenization solutions suffer the ill fate of becoming ghost chains. As interest in tokenization technology has been on the rise, I am optimistic that we can soon cross this scenario off the list. The terms “tokenization” and “RWAs” (real-world assets) have been increasingly being thrown around as more and more institutions have been testing the waters with this new promising technology. Some familiar names might include Goldman Sachs, JP Morgan, and HSBC, all of which have created their own private tokenization platforms.
- Tokenization goes mainstream, but alternative solutions take the lead and capture the greater market share, leaving Polymesh behind. This scenario will always remain a possibility, but here’s why it seems unlikely:
- Several other tokenization alternatives exist as layer-2 infrastructure instead of a layer-1 blockchain built for security tokens, like Polymesh. Like Polymath, which was built on Ethereum, tokenization alternatives like Aave, Ravencoin, and Tezos come with all the issues associated with hosting regulated assets on a general-purpose blockchain; Namely, the 5 pillars of Polymesh (scroll up to the Architecture section). As a result, while these necessary functions can be built in via smart contracts, the computational cost becomes too high for a practical and scalable solution.
- Other layer-1 chains that offer tokenization, such as Realio or Provenance, fail to meet other requirements for institutions beyond having identity, settlement, and flexible compliance rules built in. For instance, Provenance, although a permissioned blockchain, does not require node operators to be licensed financial entities. As a result, this leaves the possibility of a node operator being some untrusted entity such as the North Korean government, for example. This would present a major problem for large financial institutions that want to interact with the blockchain.
- With a current market cap of ~$75,000,000, Polymesh has the first-mover advantage and stands far ahead of the competition. For being a blockchain of its kind incorporating identity, settlement, governance, compliance, and confidentiality at the base layer, Polymesh is the only one so far. Polymesh is also the only tokenization platform to be co-architected by Ethereum co-founder Charles Hoskinson, who is also the founder of the very successful Cardano.
- Other tokenization platforms like JPMorgan’s Onyx, Goldman Sachs’ GS DAP, and HSBC’s Orion may have features that appeal to large financial institutions, but they are private blockchains whereas Polymesh is public. We don’t know yet whether private or public solutions will capture the majority of the tokenization sector. Looking back to the Protocol Wars in the 1980’s however, we saw the internet beat out protocols like IBM’s SNA and DEC’s DECNET. As decentralized projects like Bitcoin pick up steam and the world wakes up to the potential of blockchain, I’m willing to bet that the public solutions will win again.
Conclusion
The Polymath team that developed ERC-1400, the former leading security token standard on Ethereum, has collaborated with Charles Hoskinson to create the world’s first purpose-built blockchain for security tokens. Both parties have a history with successful blockchain projects and it’s likely that Polymesh will be their next one.
Polymesh, a public-permissioned blockchain that incorporates identity, settlement, compliance, confidentiality, and governance all at the base layer, featuring guardrails to stay within the bounds of regulation, is the ultimate tokenization solution for financial institutions.
Tokenization is an obvious use case for blockchain and could transform our current financial system, making everything cheaper, faster, and more efficient. Trillions of dollars in financial securities may be tokenized in the coming decades and Polymesh, a leader in the space, is well-situated to capture some of it.
References
“BNP Paribas and EDF ENR Partner on First Renewable Project Bond as a Digital Asset.” BNP Paribas, 13 July 2023, group.bnpparibas/en/press-release/bnp-paribas-and-edf-enr-partner-on-first-renewable-project-bond-as-a-digital-asset.
De, Nikhilesh. “Polymath, Charles Hoskinson Team up on Security Token Blockchain.” CoinDesk Latest Headlines RSS, CoinDesk, 13 Sept. 2021, www.coindesk.com/markets/2019/05/13/polymath-charles-hoskinson-team-up-on-security-token-blockchain/.
Polymath, 2020, Tokenizing Commercial Real Estate How RedSwan CRE Marketplace Is Using Polymath Technology to Create the Largest Online Marketplace of Digital Asset-Backed CRE Securities, https://info.polymath.network/hubfs/Landing%20Page%20Images/Case%20Study%20Red%20Swan/Red-Swan-CRE-Case-Study-Polymath-Inc.pdf?hsCtaTracking=0add11f0-4eab-49ce-b95a-9eff5145e537%7C87ad26ef-9ce0-48c0-9ba9-b75b81df1dae. Accessed 10 Sept. 2023.
“Polymesh: A Blockchain for Security Tokens.” Polymesh Official Website, Polymesh Association, 2023, polymesh.network/.
Polymesh Association, 2023, Polymesh Whitepaper v1.2, https://assets.polymesh.network/Whitepaper.pdf. Accessed 10 Sept. 2023.
“Polymesh Blog: Explore Polymesh and the Industry.” Polymesh Official Website, Polymesh Association, 2023, polymesh.network/blog.
