This is the second part of an essay exploring some controversial technological and economical ideas related to the security tokens market. The first part outlined 10 points that reflect perspectives about the security token market that deviates from the status quo:
1. Tokenization Platforms Are Likely to Get Commoditized
2. There Will Be a Handful of Winners in the Tokenization Space
3. Ethereum Might Not Be the Platform of Choice for Security Tokens in the Long Term
4. Smart Contracts Are a Horrible Way to Implement Security Tokens
5. Without a Killer Product, Security Tokens Might Stay Irrelevant for Years
6. The Killer Application for Security Tokens Might not be Obvious, Yet
7. The Killer Application for Security Tokens Will Not Happen Without the Right Infrastructure
8. End to End Tokenization Solutions are the Way to Win Today, Best of Breed Stacks Will Emerge Soon
9. Liquidity is Something you Build, Not Something that Happens
10.Security Tokens are a Recentralization Vector of the Crypto Space
Let’s explore the next set of ideas:
11-There are Only Two Features of Security Tokens that are New
Programmability and interoperability are the two biggest contributions of crypto-securities as a new asset class. Programmability will allow us to compose and decompose crypto-securities into new crypto-assets that respond to specific market conditions. Programmability is also relevant to aspects like governance and compliance. Interoperability is the benefit of using crypto-securities across different exchanges and marketplaces without the need of any specific infrastructure. Most of the other benefits associated with security tokens have existed in the market in some different form or fashion and never became particularly popular.
12-The Biggest Win in Security Tokens Might Not Be to Create New Securities But To Expand Existing Ones
Today, we are obsessed with using security tokens to create new types of assets such as real estate crypto tokens or tokenized private shares. However, there is another use case for security tokens that remains largely ignored and that can result of the biggest financial upside in the short term: tokenizing exotic securities. By exotic I am referring to securities like bonds, exchanged traded funds(ETFs), real estate investment trusts(REITs), index funds or other securities that are not broadly available to global retail investors. A security token collateralized by an existing ETF will expand access to the underlying derivative to a segment of the global investor base that doesn’t have access to it today. Additionally, most of the headaches with structuring a security token such as pricing, risk management etc are already factored in existing securities.
13-These Three Crypto-Financial Primitive Protocols are the Most Important Feature Missing in the Security Token Space
Is not regulation, not KYC/AML, not even liquidity. Security token desperately three basic protocols: equity, debt and derivatives. Security tokens behave like one of the following asset classes: stocks, bonds, commodities, currencies or derivatives. Those basic patterns need to be abstracted in the form of crypto protocols to enable developers to create sophisticated crypto-securities. At the moment, all security tokens are a basic digital representation of a share which leaves 90% of the interesting cases out of the market.
14-Bond-Based Stablecoins Are Going to Be Relevant
Most stablecoins in the market are either collatelarized by a fiat currency or in some-form of on-chain reserve. Security tokens opens the door to creating tokenized representations of robust bonds such as US Treasury which can effectively become an interesting form of stablecoin. A bond-based stablecoin can have the obvious benefits of price stability while also providing dividends to token holders.
15-Security Tokens Need New Consensus Models
None of the existing consensus mechanisms like proof-of-work, proof-of-stake or even new forms like proof-of-authority that have become relevant in the blockchain world are well equipped to support the dynamics security tokens. A crypto-security consensus is about two things: proving who you are and asserting a set of rights such as voting, cash-flow or ownership. I believe those dynamics are the basic for a new form of consensus optimized for security tokens.
16-Debt is a Killer Use Case, But We Need the Protocols
Tokenized debt is one of the most attractive use cases in this stage of the security token market. Every week, I talk to 2–3 companies that are thinking about issuing debt-based security tokens and my question is always the same: how? Currently, the security token platforms are missing a protocol for modeling debt dynamics like risk of default, dividend distribution, restructuring etc. Dharma is a phenomenal protocol for modeling debt dynamics but needs to be adapted to security tokens. Without such a protocol, tokenized debt will continue being a nice idea.
17-Security Tokens Might Help Us to Redefine Securities
Conceptually, financial securities are a combination of two main aspects: some form cash-flow ownership( equity or dividends) and some ownership-voting rights. The programmability of security tokens enables the composition and decomposition of those concepts into new forms of securities. For instance, we can envision a security token that represents just the cash-flow component of a bond-product or the voting rights of a stock. Similarly, we can have a security token that only activates voting rights after a specific cash-flow position has been achieved. Professor Stephen McKeon has some very interesting ideas in this area.
18-Crypto Exchanges Might Become an Important Acquirer-Investor in Security Token Exchanges
Think about it, you are a big crypto exchange like Binance or CoinBase and you would like to get into security tokens but you want to avoid regulators disrupting your current infrastructure based on utility tokens, what do you do? You either take an equity position or flat out acquire a security token exchange. I believe large crypto exchanges are going to become one of the most active investors in the security token marketplace/exchanges space. It’s happening already.
19-Security-Utility Hybrid Tokens Might Be the Ultimate Crypto-Security
Very often, I struggle modeling aspects such as voting rights or governance mechanisms in security tokens. While you can represent voting rights in a security token smart contract, balancing the financial nature of a security token with the governance mechanics can get very complicated very quickly. Utility tokens are a great mechanism for programming governance and voting mechanisms. In that sense, I believe security token platform are going to include a form of utility token to represent aspects governance and compliance behaviors in issued tokens.
20-We Need More Code and Less Talking
Evangelizing new technologies is an incredibly important aspect in the development of a new tech market. However, I believe that, in very early markets, too much evangelization can cause confusion and set the wrong expectations. Think about the decades that it took the artificial intelligence(AI) market to become mainstream.
When comes to security tokens, I believe there is a wide and growing gap between the claims expressed by many industry leaders and the technological realities of the space. If there is something clear about security tokens is that we don’t know how this space is going to evolve. Statistically speaking, there is a good chance that most of those predictions we hear today might turn out to be wrong and that new opportunities might reveal themselves as the market evolves. At the time in which the core infrastructure of security tokens is just being imagined, I believe it is time to invest in technological and financial rigor instead of marketing.
I know many people are going not going to agree with me but, hey, I never said they would 😉.