Security Tokens Will Make Compliance Easy – If We Put In The Hard Work

News, Opinion | April 12, 2019 By:

The dramatic rise of the cryptocurrency market in 2017 was partly fuelled by the so-called “ICO boom”. Initial Coin Offerings (ICOs) offered companies a quick route to raising capital by selling coins without the legal hurdles of traditional public offerings. This phenomenon quickly drew the attention of regulators, who sought to establish if the coins offered were securities. Issuing and trading securities is subject to strict regulation, designed to protect investors from fraud and market manipulation. Such protection is sorely missing from the cryptocurrency space. A recent study estimated that 80% of the ICOs conducted in 2017 were scams – although we should not overlook the fact that legitimate ICOs helped fund dozens, if not hundreds, of promising startups across the globe.

We consider digital securities the legally registered securities based upon the blockchain. They can benefit investors by bringing the protections of traditional finance into the cryptocurrency space. However, their true potential lies in how they can revolutionize the world of traditional securities trading.

Digital securities take traditional investment instruments and make them vastly more efficient by putting them on the blockchain. They let us automate processes that previously could take days. Even today, the settlement date for trading stocks is “T+2” – two days after the date of a transaction. If the transfer process upon a blockchain were legally pre-approved, this kind of inefficiency could be totally eliminated. Markets could function immediately, 24/7.

“Legally pre-approved”: this is the key benefit of digital securities. People talk, for example, about how digital securities will give businesses access to global capital, making it easier for investors to obtain assets abroad. This is true, but the point isn’t that this is impossible by traditional means. It’s just difficult. In that sense, digital securities are a kind of infrastructure project. They’re like building high-speed railroads where there used to be dirt tracks.

In the same way, the other major benefits of digital securities do not involve new laws or regulations, but providing digital infrastructure to make compliance with existing laws – or improved versions of them – simple. Fractional ownership, for example, is possible right now if you have the right pieces of paper (and the people to sign them!). But digital securities could simplify buying fractions of expensive objects, such as real estate or artworks, which in turn would increase liquidity and market depth.

The most significant issue is custody. We need to deploy innovations for providing strong and secure KYC/AML processes for blockchain-based bearer instruments.

Investors and businesses aren’t the only ones who stand to benefit from this increased efficiency. Digital securities also make life easier for regulators. If smart contracts encode securities, this drastically reduces costs involved in vetting for compliance – and the use of a transparent public blockchain could be required for certain transactions. The SEC’s budget of 1.6 billion USD could be applied to overseeing the market more effectively and better protecting investors, rather than dealing with so much complexity.

The fundamental value of security tokens comes from achieving greater efficiency by automating complex compliance issues. But this cannot be achieved just by writing code. It requires significant legal work. At present, there is no easily accessible platform for trading security tokens. Whoever wants to build such a platform must overcome the challenge of navigating both highly technical innovations and legal compliance in multiple jurisdictions. They must tame the real-world complexities of whatever they want to simplify digitally.

Whoever succeeds will benefit enormously. And they will create incredible value for the whole finance industry.