How to Tokenize Securities

General StartEngine Stories November 24, 2018


How to Tokenize Securities

Throughout the StartEngine Summit, much of the day was given to the discussion of issuing security tokens and the impact tokenization will have on markets, but how do you actually tokenize an asset? On the “How to Tokenize Securities” panel, moderator Jor Law of Verify Investor walked through tokenization and smart contract design with some of the leading entrepreneurs working on tokenization: Jamie Finn (Securitize), Deven Soni (Polymath), Timo Lehes (Swarm Fund), and Allen Jebsen (StartEngine).

Can anyone tokenize their security?

Jor Law posed the question to the panel, and the answer is yes, but it doesn’t make economic sense. Early in the panel, Jamie Finn of Securitize explained it this way: “When you talk about compliance and securities, there are a lot of controls that have to be put in place. At the very high level, the most important thing here is transfer restriction and making sure that a digital security can’t be transferred between the wrong people. That’s the simplest way of looking at it. Then you get into nuances of funds vs real estate vs operating businesses, and there’s a whole variety of rules.”

Timo Lehes

Timo Lehes of Swarm Fund agreed with that message saying, “It’s like you want to do an ecommerce site, but I’m going to start building a web server. What’s my authentication and payment solution? All these components have been built. Why start over?…to solve compliance and governance and implementation of security tokens on a global scale is really hard. To do these things as a one-off activity is not economic.” He argues that entrepreneurs cannot match the economies of scale that tokenization platforms can achieve, so unless you have specific needs, it is better to use a security token standard.

If you take just the US as an example to illustrate the complexities of compliance, Allen Jebsen of StartEngine talked about ERC-1450, StartEngine’s security token standard, that was developed to support US crowdfunding regulations, including complying with Rule 144a, transfer restrictions, and communicating with a registered transfer agent. “These types of things have already been laid out for us from the 1934 Securities Act,” Jebsen said. “It’s up to StartEngine and each of the companies here to act accordingly.”

Picking the right blockchain

When discussing which blockchain is best fit for security tokens, Deven Soni of Polymath pointed to Stellar as a compelling option as an issuer puts simple trading tokens on the Stellar blockchain that refer to an off-chain ecosystem to determine the rules of trading and whether a transaction is approved to go through or not. Ethereum, Soni said, is a more robust tool than you really need (though it’s worth noting that Polymath is built on Ethereum). Soni also touched on R-Chain, which allows you to create shards of a blockchain in which you can create your own rules and governance. However, he noted that having all information on-chain poses its own problems. Who is verifying transactions, and how are they being compensated? It’s not as easy to be compliant in that type of structure.

A champion of Ethereum, Finn said, “at the end of the day, you have to think about who the customer is. Throughput isn’t the main issue here. It’s control and scale. What you want is something with wallets, exchanges, or marketplaces, where all of the infrastructure is there, and investors can use that infrastructure. I don’t see that with other chains yet.”

Pictured (L-R): Jor Law, Jamie Finn, Deven Soni, Timo Lehes, Allen Jebsen

On the other hand, Lehes, who is building on a cold fork of Stellar, has a more open mind on which chain is best suited for security tokens when he remarked, “this is a cross-chain phenomenon. At the end of the day, we will have security tokens on Ethereum…we will have Stellar security tokens, and EOS and whatever else. The endgame will be a cross-chain technology.”

With a proliferation of security token standards on the market, including one from each of the panelists, Law asked the panel why there were so many standards in development. Lehes, replied that “it’s competition.” He continued, “you back into these standards as they evolve. Once you see a winner emerge, you back into that.” The question of who solved the problem of tokenization best and is the winner is without an answer today. The market is still too young, the standards still being iterated upon.

What the panel concluded with on the subject was the idea of pooling liquidity and coopetition as the incentives to see more than one standard listed on trading platforms. In Jebsen’s words, “we want a buyer on one platform to be matched a seller on another…we think of it as growing all secondary markets together.”

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