Compliant Security Token Trading with MAP — Part One
A Primer for Token Issuers
This is the 1st post in Swarm’s series on Market Access Protocol, the compliance layer for security tokens. Read the entire series here.
This is the first in a series of blog posts, taking a closer look at each of the core participants in the security token landscape, the challenges they are facing, and how Swarm’s Market Access Protocol (MAP) can help resolve some of these. In this piece, we will be looking at the protocol from the perspective of Token Issuers. Follow-up pieces will consider Investors, Qualification Providers, Exchanges, Regulators and, finally, other Security Token Issuance platforms.
Defining the Players
A security, simply defined, is a contract entitling the holder to ownership of a thing that has monetary value and is expected to produce dividends. That is, an investment.
In this case, “Token Issuer” refers to someone using tokenization to represent an asset in the form of a digital token which can then be purchased for the purpose of investing in that asset. The underlying investment may be real (as in real estate, a startup offering an ICO, a developer requiring capital), or virtual (when investing into a crypto hedge fund, for example). It can also represent a range of different securities, from equity, to debt, to commercial contracts. Use cases include raising funds for an existing project, a new project, or divesting from an asset.
If you’ve spent any time in the security token ecosystem, you know that it can be incredibly complex, especially for token issuers. Let’s talk about some of the challenges faced by token issuers, and how MAP can help.
The Security Token Landscape
While the technology behind security tokens is new, the regulations to which token issuers are subject often pre-date the internet. Most regulations require token issuers to comply with KYC (Know-Your-Customer), AML (Anti-Money Laundering) laws, and often, even further qualification for “accredited” or “sophisticated” investor status in both the jurisdiction where they are issuing tokens, and from wherever they are taking investments. They then need to integrate these rules into smart contracts, and to be able to report on their compliance processes should they be audited. Token issuers bear ultimate accountability in ensuring compliance.
It’s easy to see how this process is not only quite tedious, but also introduces tremendous friction to a process that, ironically, blockchain otherwise stands to streamline. Investors want to participate in the security token marketplace with ease, yet the the qualification process can lead to low conversion rates. In addition, token issuers often bear the up-front cost of qualifying investors before any purchase, transfer, or trading can occur. If you put the numbers together, that can be quite a costly endeavor.
In the current environment, qualification is not transferable. This means that an investor, regardless of having been deemed qualified to invest in security token A, separately needs to gain qualification to invest in security token B, and so on. This is inefficient, costly, and time-consuming.
The New Paradigm
With MAP, Swarm introduces a protocol that tackles these challenges by allowing for an open and freely accessible marketplace and its participants. MAP enables token issuers to leverage pre-qualified investor pools effortlessly, and to connect their investor qualification process with exchanges. MAP takes care of compliance so that token issuers can focus on their core function of managing the assets and conveying their investment’s value proposition.
MAP repurposes the KYC/AML process investors must undergo to become qualified, so that qualification doesn’t have to be repeated for every additional security token in which they seek to invest. Token issuers can access potentially lucrative and large classes of new investors that are already qualified while retaining the ability to review the audit path and access the underlying qualification data for more detailed reporting. MAP also provides a queryable data ledger that can surface a compliance audit trail while still protecting each investor’s privacy.
Yet another challenge token issuers currently face is a lack of liquidity. Investors want their investments to be liquid, but transfer restrictions make this difficult. MAP tackles this within secondary trading by determining in near real-time whether a transaction is compliant. The recipient is qualified before the transaction is initiated, while transfer restrictions are checked in real time. If no impediments to the transfer are discovered, the transaction is approved and processed. This allows token issuers a leaner way to connect to exchanges and to create liquidity around their tokens.
MAP creates “embedded compliance” and gives the token issuer control to customize compliance as needed. Taking an even wider view, this feature supports processes around decentralized exchanges, making such transactions compliant. Using MAP, exchanges no longer need to go through the nightmare of redoing investor qualification custom for each security token. Instead, they simply plug in the MAP protocol and integrate it into their workflows.
While the security token landscape is still in its infancy, the challenges faced by token issuers are already something to contend with. Questions over compliance, auditing, and liquidity have already stymied growth in the market.
With MAP, Swarm has created a tangible and regulatory compliant marketplace that efficiently resolves many of the complexities of issuing and trading security tokens. In line with Swarm’s mission to democratize finance, MAP helps token issuers raise capital from a new set of investors, remove the barriers around regulatory compliance, and accelerate the adoption of blockchain in finance.