For the last 1.5 years, the team at Dusk has researched and built a blockchain network for the use case of issuing digital securities. We’ve taken many different approaches, eventually discovering the best ingredients that go into a palatable digital security.
The recipe can be found below, but first, let’s cover some ground on digital securities.
‘Digital Securities’ is a collective name for electronically registered and transferable equity, debt, and assets that are issued and/or traded using blockchain technology.
With a decrease in Initial Coin Offerings appetite and increasing demand for Offerings that provide actual equity or dividends, private companies are attracted to access the market and receive much needed liquidity. With these token offerings being classified as securities, companies need to adhere to KYC, AML and other compliance guidelines.
Lowering the barrier to entry, we leverage the benefits of our custom built decentralized consensus and blockchain technology, accommodating a full A-Z experience with the Dusk Network.
List of ingredients
We find that adhering to the following list of ingredients results in an ideal digital security situation:
1. Privacy compliance (GDPR, Data Compliance)
2. Automated Whitelisting (KYC/AML)
3. Management of Contractual Restrictions
4. Emergency recovery, retrieval and control standards
5. Explain Like I’m Five (ELI5), user friendly error messaging and support
Some ingredients are mandatory because they prevent failure down the line, and others are best practices that have benefits such as cost reduction.
Let’s go over them briefly from last to first.
5 Considering that transactions can fail for multiple reasons, user friendly error messages and ELI5 style text responses are a common sense suggestion. They take into account the fact that most users will not be tech savvy. In some cases, users who aren’t blockchain specialist may need to query the blockchain and determine whether a transaction will complete before they initiate it. User friendliness is key here.
4 Emergency recovery, retrieval and control standards allow the issuing party to control all digital securities wherever they may be and forcibly transfer them. Why is this even necessary you wonder?
The issuing party needs this degree of control because cases encountered through traditional securities offerings have set the precedent.
A few examples:
§ To recover digital securities if access to the wallet is lost.
§ To comply with court requests for forced transfers.
§ To exercise a drag-along right, which enables a majority shareholder to force a minority shareholder to join in certain decisions or the sale of a company.
§ To retrieve securities when the company goes public.
Ofcourse, since forced transactions are high-impact actions a system needs to prevent unjustified, impulsive or unauthorized actions.
Because of the need for strong corporate governance principles and contingency planning our very own smart contract standard — the Confidential Security Contract (XSC) — allows the issuing entity to appoint third-parties to co-sign before any important functionality is executed. The co-signing feature is made possible by threshold signatures.
3 Similarly, we’ve accounted for automated whitelisting and management of contractual restrictions in our design of the Confidential Security Contract (XSC).
Whitelisting allows for the issuer to ensure — through smart contract management — that only approved addresses can receive the tokenized asset. Token holders need to pass necessary KYC and AML screening in order to be listed on the Whitelist. In that way the issuers can create smart contracts which only allow for accredited or verified investors to possess their token.
2 With this development it is entirely possible to add other contractual restrictions to the contract as well.
Some examples of possible restrictions are:
§ You are issuing under an exemption, and to prevent additional legal requirements from kicking in the investor base need to be capped (SEC, 2000 investors; AFM, 150 investors).
§ Tokens need to be locked-up or vested (SEC, lock-up).
§ Shareholders should never own more than 20% of the total outstanding securities/voting rights.
Our Zero Knowledge Smart Contracts that run on the Dusk Network are designed to offer smart contract capabilities that can restrict trading to whitelisted individuals only. The management and adherence to the rights of the shareholder agreements, corporate statutes and legislation (such as directives or exemptions used to issue the digital securities) is entirely automated thus saving cost and time.
1 And lastly, the assurance of user privacy is fundamentally important if a digital security is going to meet compliance standards.
Compliance models worldwide require protection of customer data and adherence to privacy regulations. They serve to protect the players within the financial industry from leaking sensitive information or manipulating the market.
Primarily, privacy in the financial market is about creating a neutral level playing field and protecting market players, implying that all public transactional information should be anonymous. Consider a situation in which transactions are not anonymous. In this case, if an important market player is either buying or selling digital securities, it has instant market reaction as people would follow their lead, giving them manipulative power.
Europe’s GDPR guidelines require that companies grant natural persons the ‘right to be forgotten’ as well so it’s paramount that public information on a ledger is rendered anonymous. Likewise, the Financial Industry Regulatory Authority of the US oversees the enforcement of regulation S-P which requires broker-dealers to adopt written policies and procedures that address administrative, technical, and physical safeguards for the protection of customer records and information.
And so, it has been Dusk team’s intention to bridge the gap between trustless-ness and compliance, and our research and development over the last 1.5 years was built from the ground up with compliance and privacy in mind. Simply said, the Dusk Network offers the privacy of ZCash with the capabilities of Ethereum. We are creating a blockchain that will become the backbone of a fairer financial industry. By designing for privacy, we give investors the tools they need to safely enter the market for digital securities.
We are proud of our progress thus far.
Our ultimate goal is to create a scalable, privacy-oriented, compliant and self-sustaining network capable of removing any need for middlemen in the landscape of regulated financial markets as well as decentralized-apps. With this article we hope that you have received guidance on the key ingredients that we believe should be on every digital securities issuer- and investor’s checklist.
Stay tuned for our primary & secondary market series where we dive deeper into its relevance for the security token market, the interaction between tokenization and traditional infrastructure, and what potential benefits and limitations are.
Dusk — Technology for Securities
Dusk streamlines the issuance of digital securities and automates trading compliance with the world’s first programmable and confidential securities.
For more resources and our whitepaper please drop by our website.