Digital scarcity and Tokenisation of Securities – Security Tokens
There has recently been an explosion of blockchain solutions. At every possible conference and in the media there are so many statements that the careless listener could come to the conclusion that in a few years everything from laundering socks to registering vehicles will run on the blockchain. However, it only makes sense to use this shared accounting ledger in a few places. In addition to the currency itself, where does it make sense to utilize it?
It was not a coincidence that the first real application of blockchain only came with the creation of Bitcoin, even though the concept itself had been known at least since 1991. Bitcoin solved a specific need with a specific combination of technologies. The need was for the existence of non-governmental digital currency without a central single point of failure. The solution is a combination of asymmetric cryptography, hashing, proof-of-work, and blockchain. This combination of technologies ensured that over the long term a property, which is scarce and at the same time not administered by any particular administrator, could exist in the environment of the public internet.
Before the creation of Bitcoin digital scarcity was not possible. In the digital environment, things are not moved but are instead copied, whether this involves e-mails, articles or pirate copies of audio-visual works. Therefore, the only way to limit copying was the strict control of access by an administrator, whether by cutting off from the internet, hiding the works under a payment gateway or login details, or drastic measures such as DRM.
Since the creation of Bitcoin, it is finally possible to work with scarce properties even in the completely open digital environment of the internet. The application in the environment of the currency is evident. Bitcoin has been with us for almost a decade and reached market capitalization of over 100 billion dollars during the last year which it continues to successfully maintain.
However, can the technologies used in Bitcoin also be applied in other areas?
The Unbearable Lightness of Blockchain
Blockchain in and of itself is useless. Without the expenditures for its security (decentralized proof-of-work) and a tradeable token, it is simply not necessary and adds more concerns and expenses for the organization, which want to implement or utilize it. It is, therefore, necessary to use Blockchain in combination with the other above-mentioned technologies with the aid of which digital scarcity is created.
For this reason, the “application of blockchain” in the form of a private blockchain within the framework of a consortium of companies, which monitor the life cycle of goods, doesn’t make very much sense. Such a pseudoblockchain does not solve the problem of digital scarcity, but the mutual sharing of data (handled by professional database solutions, not blockchain).
Tokenisation of Securities (Security Tokens)
The concept of digital scarcity has great potential for utilization in the tokenization of securities – the creation of so-called security tokens. Securities are currently administered by national regulators, deposited in a securities depository and traded on exchanges, which are often established on an outdated back-end, which is moreover proprietary and globally incompatible. For this reason, instruments like bonds and stocks are accessible rather to larger companies since these can afford the high financial and time expenses connected with their issue and listing on an exchange.
Tokenisation of securities is based on the definition by the emitting company of obligations (or contractual relationships), which stem from the purchase and holding of their tokens. Tokens subsequently represent a right to performance. A tokenized security combines the characteristics of securities (clear underlying value, legal enforcement of obligations) with the characteristics of tokens (removal of intermediaries like depositories, 24/7 trading, P2P transferability, fractional purchases, immediate settlement of trades etc.).
Tokenised securities are of course not decentralized in any way – just like the firms themselves. Nevertheless, companies and their capitalization will be with us for a long time, and it is, therefore, fitting to examine whether new technological concepts such as digital scarcity can be utilized even in this area.
Centralized security tokens make much more sense from an investment standpoint, than decentralized utility tokens that often defy basic economic principles regarding the nature of currency, which should be as universal as possible, not serving for the purchase of one specific service (for example, access to an application). So large numbers of ICOs gradually fail because their tokens are useless and they would be better served by Bitcoin – much better if we take away the role of the token in fundraising. A far more fair and moral approach is the emission of security tokens instead of utility tokens. These represent actual obligations of the company and build upon tried methods from capital markets.
The Role of Intermediaries
There are of course obstacles to the rapid adoption security tokens. While it is already technically and contractually possible to emit such tokens today, the greatest problem will be the emission of tokens in accordance with various regulations and subsequently also the establishment of exchanges, which will have the proper licenses for trading them.
A critical aspect is of course also the legal enforcement of tokens as actual obligations of the emitting companies – for example, if a company emits a bond token, it must have a legally enforceable obligation to regularly send interest payments to (identified) holders. For this purpose, there will have to be intermediaries, which will guide firms through the process of emitting security tokens and ensure that the interests of companies and token holders are in accordance with and correspond to applicable regulations. And who knows, these intermediaries may in time grow to a size, where they will be able to lobby for the revocation of regulations that no longer serve their purpose in the 21st century.
During the past year, many projects, which seek to achieve a privileged position in the field of security token emission, have been created around the world. These include for example Polymath, Neufund, tZero, and Smart Valor, which however primarily focus on cryptocurrency projects. The nearest for Czech investors and firms is, however, the Czech company XIXOIO, which is currently building a crypto-banking ecosystem with a solution for company tokenization, the raising of investment capital through tokenization for standard firms. XIXOIO is preparing an international conference, which takes place on November 29th-30th, 2018 in Prague, on this topic.
Author: Josef Tětek
This article was published on www.btctip.cz
Disclaimer: The author collaborates with XIXOIO in the role of a consultant in the field of crypto-economics.