Derek Edward Schloss (TDW): Ben, great to have you on The Digital Wrapper. You’re the CEO of Hyperlink Technology and the lead architect of the SFT protocol. Before we jump in, let’s talk about your background.
Benjamin Hauser (Hyperlink): Sure. My background is as a developer — I found a VIC-20, the predecessor to a Commodore 64, in my parent’s basement at eight or nine. From there I taught myself BASIC¹. I was really big into the Internet back in 1996. Most of my 20s I was doing freelance work, web development, backend stuff. Then I randomly stumbled upon crypto in 2013 and was immediately like: “Ok, this is exciting.”
Derek Edward Schloss: I always enjoy talking with developers in the space — did you start working on projects right away?
Benjamin Hauser: So my first work within crypto was with brokering OTC² deals in Canada. From there, I started trying to develop trade bots. At some point I realized it was more work perfecting the algorithms than it would be to just trade manually, so I moved towards day-trading. Then 2017 happened — I did a few ICOs³ and thought it was an interesting concept. Then 2018 happened and I got to see firsthand what a fully unregulated market looks like.
Derek Edward Schloss: Yes, 2018 brought some major issues to light.
Benjamin Hauser: I finally started to understand that maybe regulations aren’t just there to hold us down — maybe there’s actually a reason why they make sense. Then as the industry began collectively talking about the idea of security tokens, I started looking at it more closely. As a developer I found it fascinating — in the ICO days all the smart contracts⁴ I worked on, they were critically important but ultimately not really doing anything that exciting. So I was immediately drawn to this idea of permissioning, transfer checks, and building a smart contract system that was more complex and with lots of moving parts. The more I read about security tokens, the further I went down the rabbit hole.
Derek Edward Schloss: What was your first impression of how regulated securities could interact with blockchain ledgers?
Benjamin Hauser: Immediately my first thought was — “this is going to be ICO 2.0.” I’ve since evolved a lot from that. In the early days, I just thought if we met these rules then we can continue what we were doing before. The more I learned about it, the more I saw that this was a fundamentally different thing from ICOs. Now, I’m far more excited about the impact we can have on traditional markets and the idea that we might be able to update legacy systems.
Derek Edward Schloss: Let’s dive a bit into these legacy systems — how do you see this technology helping solve existing problems?
Benjamin Hauser: With private markets, the big thing that gets talked about is improved liquidity⁵. That could eventually be a thing that we could help with — right now, I actually think improving liquidity is a bit mis-aligned because privately traded companies generally want to manage their investor base and their cap tables quite tightly. Any competently run privately held company isn’t going to like the idea that their equity just sells freely on a secondary market.
Derek Edward Schloss: From your perspective, what might be the stronger value-add for private markets?
Benjamin Hauser: I think the real benefit security tokens can offer private markets are things like reducing costs around compliance and lifecycle events — governance, voting, auditing. These things become cheaper with automation and transparency. When a company is small, they can enact smart contracts that help dictate the shape of the company. This will give early investors confidence that the terms are being followed throughout the lifecycle of the company. When it’s five fundraising rounds later, and the Board of Directors have been swapped out four times, there will still exist the same terms and guidelines for the company because they’re right there on-chain. We can completely transform the whole idea of “don’t be evil” into “can’t be evil”.
Derek Edward Schloss: That sounds like a great industry slogan. Given these benefits, do you think we’ll reach a point where investors won’t invest in deals that aren’t tokenized? And to remain competitive, issuers will essentially be disadvantaged by not tokenizing?
Benjamin Hauser: That is an interesting idea that investors end up demanding this. I hope we get there.
Derek Edward Schloss: So for example — investors might only choose to invest in places where governance, compliance, and transparency is improved as a result of tokenization. In addition, many investors may only seek out investments where, eventually, they may be able to better move in and out of positions.
Benjamin Hauser: I think that’s interesting. Freely tradable private securities are kind of the eventual hope here. Rule 12(g)⁵, the 2000 investor limit, somewhat throws a wrench into this today. If you allow something to trade freely, what’s to stop a competitor from essentially launching a Sybil⁷ attack on you and having 2,000 people acquire $10 in your company? I think we might need some regulation change before we see a point where private market stuff will truly trade freely.
Derek Edward Schloss: Switching over — what do you see as the major benefits for our public markets?
Benjamin Hauser: I actually think public markets are where security tokens are really attractive. In public markets we can achieve disintermediation. Some people find that word kind of scary — the whole system grew up out of a difficulty for these things to trade peer to peer, right? The stock market started as a bunch of traders meeting in cafes in Europe and literally just trading pieces of paper. As it grows bigger and bigger, it becomes really hard to move these things around. Suddenly we need a custodian to hold it all, and then we need a Central Securities Depository to hold all the stuff for the custodians. The infrastructure grew out of the complexity of how we physically trade these things back and forth. Now we have this technology, blockchain, where we can re-enable P2P trading. To me — the public market is the really exciting space. It’s also going to be the most challenging to enter due to powerful incumbents. But technologically speaking — everything happening between execution⁸ and settlement⁹ doesn’t really need to be there. That’s the thing that really excites me about this industry long-term.
Derek Edward Schloss: What specific problem is your team at Hyperlink solving for?
Benjamin Hauser: At Hyperlink, we’re starting off by building solutions for private equity. For example — Wyoming, through HB185, might be the first place in the world that allows direct issuance of certificated shares onto a blockchain. That’s exactly what we’re interested in doing. In the long run, the public market is really interesting — but we need to get a foot in the door, collectively as an industry. Private equity markets seem like the best place to enter. So to summarize, we’re building a technology solution that we think fits really well with privately held companies interested in issuing equity on the blockchain, with a focus on the regulatory structure within Wyoming.
Derek Edward Schloss: Private equity solutions seem like a strong go-to market. Let’s talk about Wyoming for a moment. Why do you see Wyoming as an attractive place for blockchain companies like Hyperlink to build their technology long-term?
Benjamin Hauser: Wyoming has a number of interesting laws in the pipeline that really take into account the benefits of blockchain — in particular HB185 that allows for blockchain based certificated securities. Prior to this it was only possible to do uncertificated issuances, to use a book-entry system. When you apply blockchain to a book-entry model, the blockchain essentially acts as your corporate shareholder registry. The problem with book-entry is that as soon as the transaction happens, since the blockchain itself is the shareholder registry, the corporate entity is implicitly approving that secondary transfer on the spot. That puts a huge amount of faith in the technology stack to do what it’s supposed to do, because if it fails the corporate issuer is liable. If somehow a trade gets through that shouldn’t have happened — and you manage to sell something in and around North Korea, for example — now the corporate entity has implicitly approved that trade. That is a huge amount of liability. I think legal and compliance teams inside companies are going to look at this and say, “No, we’re not doing that. That’s insane.”
Derek Edward Schloss: How does issuing certificated shares alleviate some of this liability?
Benjamin Hauser: With a certificated model we’re able to maintain a distinction between beneficial and record ownership. Here’s how it might work. Investor #1 owns a piece of paper stating that they own 1,000 shares. If Investor #1 wanted to sell those shares to Investor #2, they would swap the money for the shares. Investor #2 would then go to the corporate entity and say, “Hey, I did a deal and now own these shares.” Investor #2 would show the contract and certificate possession to the corporate entity. Then, the corporate entity would update their records to show that #2 is the registered owner of those 1,000 shares.
Derek Edward Schloss: So under Wyoming’s certificated model, liability wouldn’t extend to the corporate entity until they actually signed off on the trade.
Benjamin Hauser: Right — with book-entry, as soon as it’s confirmed on the blockchain, from a legal standpoint the share’s registered ownership has changed. Whereas with a certificated model I can transfer you my tokens and you are now the beneficial owner, but it doesn’t necessarily mean you’re immediately the registered owner. I think that this piece of Wyoming legislation — among others — is crucial for security token development.
Derek Edward Schloss: It’s great that you’re thinking about these issues. Gabriel Shapiro covered some of this in a piece he wrote called Tokenizing Corporate Capital Stock. If I remember correctly, Gabriel walks through these two ideas — book entry and certificated — and how these systems might fit within a new blockchain paradigm for transferring and settling corporate ownership.
Benjamin Hauser: Yes, actually Gabriel Shapiro has been a huge help in developing these ideas.
Derek Edward Schloss: Great. So your team is moving to Wyoming?
Benjamin Hauser: [Laughs] There’s a few locations we’re looking at right now, but Wyoming is on the short list of locations.
Derek Edward Schloss: Where is Hyperlink on its roadmap, and what are some of the products you’re launching this year?
Benjamin Hauser: We’ve been developing SFT, our open-source protocol, for about half a year now. At this point it’s done and currently undergoing an audit. Pretty soon we’ll start releasing information around the value-add features we’ve been working on — things like moving “right of first refusal” on to the blockchain, contracts to execute liquidity events.
Derek Edward Schloss: What would that look like?
Benjamin Hauser: For example, instead of an M&A event taking a year and a potentially million-dollar process, it can just be a contract where the funds enter, and the entire waterfall executes on chain. To this point, we’ve built a really granular on-chain cap table¹⁰ so that companies always know exactly who controls how much of their equity. We’ve built in options, companies can issue options to employees right on chain, and the terms for vesting will be verifiable right there — there’s no chance for any confusion or ambiguity. We’ve got really detailed governance built in, so for example if the company wants to do a capital increase, they have to run an on-chain vote to get approval. We’re going way beyond compliance and trying to make things that are very interesting where everything is happening right there on the blockchain — so that investors can see and verify what’s happening, and regulators can see and verify what’s happening. We’re minimizing opportunities for ambiguity, maliciousness, or negligence.
Derek Edward Schloss: Does this mean you consider Hyperlink to be more on the lifecycle management side of things as compared to capital formation?
Benjamin Hauser: Exactly. Our focus won’t be on helping with capital formation, but on lifecycle management. All the lifecycle events we can enable on chain and make them incredibly auditable for everyone. That’s really our focus — once you’ve raised money and now you have to actually run the company, how can we make it as transparent and as cost-efficient as possible?
Derek Edward Schloss: As it relates to Hyperlink’s focus areas, how do you envision the security token and digital securities industry evolving over the next few years? Maybe let’s take it in stages — stage one and stage two.
Benjamin Hauser: I think stage one starts when blockchain-based offerings are actually more attractive than the traditional route. Right now, if we’re just using blockchain to get to exactly where we can be without blockchain, that’s not really a good sell.
Derek Edward Schloss: I think that’s a fair point, and probably one of the better criticisms of our current space.
Benjamin Hauser: Right, that’s what I see as stage one — actually offering something more attractive, and as such, we start attracting great companies to tokenize. Companies that are actually interesting for sophisticated investors. Once the offerings are strong, we’ll start attracting capital from the places that we want to see capital coming in from. The industry finally sees some significant growth and we can stop tossing around words like “nascent”.
Derek Edward Schloss: What happens in stage two?
Benjamin Hauser: Then stage two — I think this is where we can start improving regulations. Once you don’t really need to explain to a regulator how blockchain works, once it’s more normalized — that’s where things get really exciting. That’s where you can start talking about setting up DAOs¹¹, building new hybrid instruments, and sitting down with regulators and saying, “Does this 90-year-old rule really still make sense? Is this really the way this law should look?”
Derek Edward Schloss: Do you have any regulations in mind?
Benjamin Hauser: For starters, I’d really like to change the requirements around KYC¹² — or at least the ability to offset the liability on KYC. Right now, it’s administratively inefficient for investors to get cleared ten separate times to invest in ten separate companies. From a technological standpoint this was one of the first things I was really excited about. There’s no question we can build these common whitelists¹³ and all the information is pulled from them, we’ve already done this. However — when you start thinking about the liability around something like this from a legal standpoint, it makes sense that nobody wants that kind of exposure. With that said — if we update the rules a little bit that would eliminate so much inefficiency.
Derek Edward Schloss: So for you, stage two is about starting to optimize the laws and regulations around the traditional securities industry — working with our legislators and regulators on new laws that better take into account the power behind a fully blockchain-based securities ecosystem.
Benjamin Hauser: Absolutely. I feel like you can’t expect the regulators to do two things at once. First, we need to prove to issuers and investors that this technology is better than existing systems, and simultaneously get regulators to understand the technology. Then, in stage two, we can talk to regulators about amending the rules. We can’t just walk in and drop something on the table and say, “This is superior. Change the rules.” I think it’s just too much, too fast.
Derek Edward Schloss: As a developer, where do you stand on the permissioned chain versus permissionless chain argument as it relates to security tokens?
Benjamin Hauser: My personal stance is towards a permissionless chain with fully on chain governance. I can see the benefits of a permissioned chain — they are easier to control. They are going to scale a lot faster. But when you think about the underlying technology here, and what it’s used for, permissioned chains are not disruptive and innovative. With a permissioned chain — you’re essentially taking all the existing pipes and infrastructure — custodians, clearinghouses, and CSDs — and turning them into authority nodes and trusted signers. In that way, permissioned ledgers are not actually advancing the industry — you’re just making it more efficient for the people that are already there. In addition, with a permissioned chain, you’re arguably giving up more trust than you are in the current system as it exists. Imagine a shareholder activist looking to acquire a significant interest in a company. He doesn’t have a legal obligation to declare himself until he owns 5% of the company’s shares, and as an OBO only his broker knows his identity prior to this. But in a permissioned chain setup, all of the authorities on the chain are aware of his identifier. As soon as he starts doing anything, everyone can see it. It’s no longer just like you’re trusting your broker-dealer or you’re trusting the one entity that’s entering in this system. You’re now putting trust in everyone who is an authority within this permissioned set up.
Derek Edward Schloss: I always come back to why blockchains are fundamentally game-changing for securities. For me, the more third-party trust that exists in a system, the fewer benefits this industry will be able to collectively generate over the long term.
Benjamin Hauser: I would definitely agree with you. I think the public chain ends up being better for blockchain-based securities because we can build a system where no one has that authority to just step in or sit in the middle of a transaction. This is why I’m also so drawn to having everything on chain where possible. If my transaction fails, I as a coder want to be able to go in and see exactly why it failed. There’s never the chance that my attempt to vote on chain was just blocked because an authority node got paid off by some guy who wanted the vote to go in the other direction. The more logic handled on chain, the more transparent and auditable the processes, the better.
Derek Edward Schloss: To your point about putting more information on chain — often times corporate entities don’t necessarily want their on-chain transactions, voting, or general market moves broadcasted to all of their competitors. Isn’t there a strong argument that some of this information might be better placed off chain?
Benjamin Hauser: That’s definitely something to keep in mind. To that end, we’re really excited about a project we’ve been working with called AZTEC. They’ve built a protocol using zero-knowledge proofs¹⁴ to allow confidential transfers on Ethereum. Individuals can still retain privacy — and make private transactions — while on a public chain. AZTEC is one of those things I’m most excited about with regards to security tokens. Because you’re absolutely right — how are you ever going to sell this thing to a pension fund or giant hedge fund when they know that every time they try to move their position it’s potentially going to move the market? So utilizing AZTEC is a critical piece of the puzzle if you’re going to build a viable system on a public chain.
Derek Edward Schloss: How do you envision AZTEC’s protocol working with stablecoins¹⁵? In addition to privacy, I’d imagine price stability is another important requirement for those transacting in and out of investments.
Benjamin Hauser: Definitely — The first public AZTEC transaction was actually using Maker Dai. There are some stablecoin projects, such as Carbon, who’ve announced an intention to fully integrate it. We plan to work with them so that our clients can leverage a fully zero-knowledge stable coin. Clients will get the benefit of privacy and stable distributions. We’ll be talking more publicly about this soon.
Derek Edward Schloss: Before we wrap up, your development work on a project called Brownie has actually been making the rounds on social media. Congratulations! What can you tell me about Brownie? What pain points does it solve for developers like you working on Ethereum?
Derek Edward Schloss: For us non-developers, why is that?
Derek Edward Schloss: But for things like back-end development?
Derek Edward Schloss: How does this relate to Ethereum?
Derek Edward Schloss: That’s a testament to your skills as a developer in the Ethereum community. Closing up — what does 2019 look like for Hyperlink and the security token industry as a whole?
Benjamin Hauser: For Hyperlink — once SFT comes back from the audit and everything looks strong, we’re going to start talking more publicly about what we’ve built. Our technology is attractive not because it’s compliance oriented, which it is, but because it’s deal oriented. We’re aiming for a much higher end of the market, and we think we’ll be successful there. As far as the security token industry, I think that we’re going to start seeing more interesting offerings as infrastructure gets built and things continue to progress. I will say, I’m excited to be building in this space right now.
Derek Edward Schloss: I’m looking forward to following along. Benjamin, on behalf of The Digital Wrapper, thanks for your time.
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¹ BASIC is an abbreviation for Beginner’s All-Purpose Symbolic Instruction Code, a family of general purpose programming languages whose design philosophy emphasizes ease of use.
² OTC is an abbreviation for “Over The Counter”, a type of market trade used as an alternative to trading over exchanges. In the US, securities that trade OTC are matched via a broker-dealer network.
³ ICO is an abbreviation for Initial Coin Offering, a fundraising mechanism where individuals purchase digital tokens to help bootstrap new token-based networks. In the US, the SEC has released ICO comments to help provide guidance around compliant token-based offerings.
⁴ Smart contracts are a pieces of computer software designed as automated self-enforcing contracts, which means it triggers certain actions after predetermined conditions are met. For example, smart contracts can be used as digital agreements that intermediate the exchange of digital assets between two parties.
⁵ Liquidity is the ability to find someone on the other side of the market, at a reasonable price, for the size that you’re looking for. It’s both the size of the “bid-ask” spread, which is the difference between what people are willing to sell and buy for, and also how deep those markets are.
⁶ Rule 12(g) of the Securities Exchange Act of 1934 states that an issuer is required to register as a publicly reporting company with the SEC if and when specific conditions are met — subjecting the company to specific reporting requirements.
⁷ Sybil attacks are a kind of security threat of an online system where one person tries to take over the network by creating multiple accounts, nodes or computers.
⁸ Execution is the completion of a buy or sell order for a security, and occurs when the order gets filled (not when the order is placed).
⁹ Settlement is the process by which securities are delivered, usually in simultaneous exchange for payment of money. In the US, the settlement date for marketable stocks is usually two business days after the trade is executed. For listed options and government securities, it is usually one day after the execution.
¹⁰ Cap tables are a spreadsheet or table that shows the equity capitalization for a given company.
¹¹ DAO is an abbreviation for Decentralized Autonomous Organization, a system of hard coded rules that define which actions an organization will take.
¹² KYC is an abbreviation for Know Your Customer, and is used to describe the legally-required process by which a business identifies and verifies the identity of a client.
¹³ Whitelists are a method by which to restrict transfers of security tokens. Pre-approved individuals are put on a list that is held by parties like issuers, broker-dealers, technology platforms, and trading venues. When a token attempts to get transferred, the smart contract logic in the security token pings the whitelist to verify whether the receiving party is a suitable counterparty based on regulations. If the counterparty is not suitable, the system will throw an error message back, and prevent the transfer from occurring.
¹⁴ Zero-knowledge proofs allow one individual to prove to another that a statement is true, without disclosing any information beyond the validity of the statement.
¹⁵ Stablecoins are cryptocurrency that demonstrate price stable characteristics.
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