How Blockchain Will Facilitate Security Token Life-Cycle

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Security token has been attracting a wealth of coverage in recent months. Traditional paper-backed assets such as a company’s shares or bonds suffer from poor liquidity, a lack of transparency, and are subject to a complex manual process when distributing profits or dividends.

[inlinetweet]It is expected that within 5 years, approximately $10 Trillion worth of assets will be tokenized.[/inlinetweet]

A security token powered by blockchain smart contracts will automate the management of all the elements involved in the security lifecycle. It will also lower issuance costs compared to traditional financing methods which are extremely high. For instance, IPO issuance usually costs up to 7% of the fundraising amount.

So how blockchain will facilitate security token issuance:

(1) Transparency and Ownership record: Using the blockchain, a database of investors holding a given token will be maintained. Let’s call this database a ‘White-List”. Each investor’s unique ID (wallet address) contains information such as:
– Country (for regulation purposes),
– KYC status, expiry date,
– Accreditation/qualification status.

(2) Compliant trading: Trading of security tokens or the exchange of ownership rights must adhere to strict compliance and regulatory requirements. For instance,
– Setting country restrictions e.g. preventing the exchange from the U.S. to non-U.S. investors,
– Enforce lock-up schedules or
– Limiting trade to only accredited investors.

This is achieved using smart contracts which validate that only authorized investors can trade post lock release and transfer or receive specific digital securities by checking the sender and receiver wallet address in the “White-List” database.

(3) Manage life-cycle: Smart contracts will also facilitate specific lifecycle events for digital security. For example, automatic distribution of dividends to token holders upon meeting predetermined conditions at a predetermined date.

Based on the specific logic of the contract, including the decision to use specific token or cryptocurrency for dividend distribution, the smart contract checks the “White-List” database and sends the corresponding dividend to the wallet where the investor holds their tokens.

Another example of a lifecycle event that can be managed via blockchain is the voting process for governance decisions. The smart contract accepts votes from wallets that are added in the White-List database or allows votes from wallets that hold tokens in a specific quantity during the defined period.

[inlinetweet]A decentralized ledger for securities will have a radical effect on the overall market of traded financial instruments.[/inlinetweet]

Some of the big names entering the space:

• London Stock Exchange and FCA (UK Financial Conduct Authority) are developing a fully compliant Ethereum-based security token issuance platform.

• SDX, a Swiss Exchange and one of the largest in Europe is developing an integrated transaction, settlement and custody infrastructure for the security token. The project will launch in phases with the first service opening by mid-2019.

• Gibraltar Stock Exchange announced its intention to develop a security token trading platform ‘Gibraltar Blockchain Exchange (GBX)’ at the Hong Kong Financial Summit in October 2017. GBX is currently seeking an online banking and trading license from the Gibraltar Financial Services Commission.

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