What We Need To Enable The Security Token Thesis
Security tokens are called to become one of the hottest trends in cryptocurrencies in the next few years. If you are working in the space, it feels like the early days of Bitcoin when the main components of the infrastructure for digital currencies were just being conceived and nobody seems to have all the right answers. In some sense, we are at that stage in the security tokens market. The elements of what will become the platforms for security tokens are just being imagined, the market theory for security tokens is being architected and the first generation of platforms and products is just being launched. From that perspective, there couldn’t be a more exciting time to join the security token ecosystem.
Recently, Professor Stephen McKeon from the University of Oregon wrote a brilliant essay titled The Security Token Thesis in which he explained some of the axiomatic principles that will guide the security tokens market. Professor McKeon listed eight main features that will be required in order to improve the widespread adoption of security tokens:
1) 24/7 markets
2) Fractional ownership
3) Rapid settlement
4) Reduction in direct costs
5) Increased liquidity and market depth
6) Automated compliance
7) Asset interoperability
8) Expansion of the design space for security contracts
In order to enable the aforementioned features, the security token ecosystem will need technological building blocks that interoperate with each other in order to build cohesive economic dynamics. While the initial wave of innovation in the space is just getting started, there are already a series of components that I consider foundational to the success of the security token ecosystem. Here are some of my favorites:
b) Tokenization Platforms
c) Security Token Standards
d) Liquidity Providers
e) Off-Chain Enforcers
g) Market Derivatives
The security token exchanges are coming! Security token exchanges are a vital element to enable the tradeability of tokenized assets under the right regulatory framework. While there are no lack of options for listing and trading utility tokens, the options for security tokens have been non existent thus far. Platforms such as OpenFinance and the famous tZero are addressing that challenge.
The road to security tokens starts by creating them 😊 Many times, security tokens will be generated by tokenizing existing financial assets in the real world. The process of producing tokenized representations of financial assets is the role of the first generation of tokenization platforms. Products such as Polymath or Securitize are filling that gap.
Security Token Standards
For security tokens to become mainstream, we are going to need standards that guide and regulate their behavior. If you think that every alternative asset in the world can have tokenized representation, then imagine what will happen if those representations follow different standards with no interoperability between then. Fortunately, initiatives like the Harbor R-Token and Polymath’s ST-20 are trying to address this challenge.
Like any nascent financial market, security tokens are going to behave highly inefficiently defying some of the principles of the Efficient Market Hypothesis outlined by Eugene Fama in 1965. The early stage of the security token exchanges and the relative small number of investor playing in the space raises some concerns in terms of the liquidity of security token products. To address that, security token platforms should build liquidity into their ecosystem by integrating with platforms like Bancor or BnkToTheFuture.
A lot of the lifecycle of security tokens takes place outside blockchains. Legally validating financial assets, auditing and certifying its value, validating accredited investors, distributing dividends, changing the ownership of an asset are all process that need to be executed in the real world. For that to happen, security token platforms should develop networks of off-chain partners such as law firms, trust companies, KYC-AML providers, auditors and many other parties that enforce the correct lifecycle of a security token.
A special type of off-chain enforcers are the regulatory arms of the different financial markets. For security tokens for become mainstream, the platforms powering the ecosystem should work with regulators such as the US SEC and CFTC in order to enforce compliance in the ecosystem.
Derivative products have not been particularly successful in the utility token space but are likely to play a prominent role in the security token ecosystem. Considering the link between security tokens and their underlying assets, its only logical that we will soon see derivative products that emulate financial marke vehicles such as Exchange-Traded-Funds(ETF), asset-backed securities, options, futures and several others. Although not playing yet in the security tokens market, the guys from Firmo.Network have some very interesting technologies in this area.