The Security Token 2.0 Stack

The Security Token 2.0 Stack

Last week I wrote some ideas about some blockchain protocols I believe could serve as inspiration to the next generation of security token platforms. Today, I would like to take the idea of security tokens 2.0 a step further and present a first iteration of a technology stack to power the next phase of security token platforms. My objective is neither to present an exhaustive list of technologies nor a constrained architecture guideline but rather to summarize some observations about the future of security token platforms that I’ve been sharing with some thought leaders in the space.

Security Tokens Today

The current generation of security tokens platforms is focused on two main areas:

  • Toke Issuance
  • Security Token Exchanges

Let’s keep things in perspective, the entire security token space is about one year old and, regardless of how fast its evolving, remains very immature technologically. Whereas some people seem to enjoy to continuously claim that security tokens are going to be the next Wall Street; most of those claims are not backed by any technological, economical or financial engineering rigor. The fact remains that, for security tokens to become a viable financial asset class, the platforms need to evolve and incorporate protocols/capabilities that are present in the newest wave of blockchain technologies.

Strategically speaking, the biggest issue that the security token movement needs to fix is to become attractive for sophisticated institutional investors. For that to happen, there are three major roadblocks that need to be removed:

  1. Liquidity: Access to large pools of capital by institutional investors.
  2. Custody/Insurance: Custody and insurance models for tokenized assets.
  3. Sophisticated Investor Products: Tokenized products that are match the financial sophistication of securitization offerings.

Security token 2.0 platforms will fundamentally focused on enabling the third item in that list, to ultimately enable the creation of sophisticated tokenized products. However, it turns out that point #3 is also a requirement for points 1–2. From that perspective, the evolution of the current generation of security token platforms into security token 2.0 stacks is vital for the

The Security Tokens 2.0 Technology Stack

Security Tokens 2.0 sounds like a bad marketing buzzword when we are just getting started in the first phase of this financial movement. The concept of security token 2.0 is to simply provide an umbrella under which we can group many of the relevant technology building blocks that are going to be relevant for the mainstream adoption of security tokens. I took a first pass to put together a diagram that groups many of the security token 2.0 technical components. Most likely, this diagram is incomplete and inaccurate in some areas but hopefully it can serve as a good first step towards conceptualizing the next phase of security token platforms.

Most of the components in the previous diagram are self-explanatory but I would like to highlight some interesting observations about some of the building blocks

  • Token Issuance Platforms: This group includes the current tokenization platforms such as Securitize, Polymath or Harbor.
  • Privacy Protocols: Today, the privacy of security token transactions is relying on basic Ethereum smart contracts. In the future, protocols such as zk_SNARKS or multi-ring signatures are going to be important to enable different levels of privacy in security tokens.
  • Identity: Consistent identity protocols for representing issuers, investors and entities its essential to model sophisticated security token workflows. Technologies like Civic bring some very interesting ideas in this area.
  • Consensus Protocols: Consensus protocols are key to enable voting and governance dynamics in security tokens. Delegated consensus models like DFINITY can be relevant in this area.
  • Legal Protocols: One of the challenges of security tokens is that many of the on-chain activities need to be translated into off-chain legal artifacts. For that, we need legal protocols such as OpenLaw to join the security token platforms
  • Voting/Governance Protocols: Security token 2.0 platforms should provide an easy way to model many of the voting/governance mechanisms that are present in corporations or securitized products.
  • Pricing Protocols: Not all security tokens can be priced equally. As part of security token 2.0 platforms, we need statistical pricing models that factor risk, dividend payment, market conditions and other elements unique to each token. I wrote about that topic here…
  • Collateralization Protocols: The issuance of security tokens needs to start considering different collateralization models can accurately model the financial behavior of a security token.
  • Token Models: Different financial instruments should be translated into different types of security tokens. At a bare minimum we should consider three types of security tokens
    1. Debt Tokens: Represent debt instruments such as real estate leases or cash loans. Dharma Protocol is a super interesting technology in this space.
    2. Equity Tokens: Tokens that represent shares in companies or special purpose vehicles.
    3. Hybrid Tokens: Tokens that can covert debt into equity and vice-versa.
  • Derivative Tokens: Security token derivatives are likely to become one of the most relevant trends in this space. I wrote about their importance here…Technologies like {Set}Protocol and dYdX are setting up a strong foundation in this area.
  • Oracle Registry: Today, tokenization platform are mostly focused on enabling KYC/AML compliance. However, there are hundreds of other regulatory models that need to be followed for security tokens to be tradeable on specific geographies or industries. To enable that, security token 2.0 platforms need to incorporate a rich catalog of Oracles for different data fees or compliance models that need to be followed by tokenized assets. Protocols like ChainLink or RLay are very interesting in this space.
  • Data Intelligence: For security tokens to become attractive to large institutional investors, they need to show a level of analytics and intelligence that is comparable with financial securities. If I invest in a tokenized pool of real estate leases, I would like to know how the performance of that asset compares to the market’s REITs or real estate ETFs. A solid data intelligence layer should be a key component of security token 2.0 platforms.
  • Liquidity Pools: Access to large pools of investors is one of the main challenges of security tokens today. Technologies such as BancorBnkToTheFuture or SwarmFund bring interesting ideas in this space.
  • Exchanges: Security token exchanges are evolving extremely fast and we should see the addition of more sophisticated financial products in the near future. Technologies like OpenFinance and tZero are leading the charge in this space.
  • Investor Products: Ultimately, security token 2.0 platforms should offer tokenized products that are appealing to large institutional investors. These products will mimic existing financial vehicles such as ETFs, index funds, mutual funds, etc.

I hope this is a good starting point to give you about the architecture of the next generation of security token platforms. I plan to deep dive into several of these areas in a future post.