Security tokens continue to gain steam going into 2019 as issuance platforms, exchanges, service providers, and developers push ahead in the offering of digitally wrapped financial securities.
The ecosystem is becoming more crowded by the minute, so it is worth evaluating some of the major roles in the ecosystem and well-known companies that are at the forefront of the transition towards regulatory-compliant security tokens. In particular, we can focus on security token exchanges, issuance platforms, and custodians.
Exchanges enable investors to buy and sell security tokens on primary and secondary markets. tZERO is one of the most prominent security token exchanges as it officially launched in January and comes from e-commerce giant Overstock.com, who has shifted significant focus to digital assets.
tZERO is an exchange for trading security tokens in a fully regulatory-compliant manner. They work with service providers such as broker-dealers, legal compliance, custodians, and regulatory authorities to provide a liquid market for security tokens. Companies can also issue security tokens on the platform, accessing capital investment from investors that may have previously been unavailable to them.
Currently, only accredited investors may use the platform and are onboarded through Dinosaur Financial Group LLC, the broker-dealer service provider. The platform uses an alternative trading system (ATS) for trading securities on the exchange and enables secondary liquidity for investments that have historically been illiquid — a primary benefit of security tokens.
Two of the leading issuance platforms are Harbor and Polymath. Issuance platforms provide the technical framework for issuers to create and launch security tokens. These platforms present developer tools for standardized token contracts, regulatory compliance, and integration with service providers.
Tokenized securities can include anything from commercial real estate to equity to debt. Harbor and Polymath are designed as platforms to guide issuers in launching their tokens for sale, providing the necessary tools to do so in a regulated manner. Importantly, these platforms design standardized security token contracts for coding specific legal parameters into tokens — such as trading restrictions.
Polymath has a proprietary ST-20 token standard for Ethereum and Harbor deploys its R-Token — also based off of ERC-20 similar to Polymath’s ST-20.
Issuance platforms also provide other services such as custody and KYC/AML verification.
Custody is a vital component of the broader digital asset sector and is an aspect that financial institutions seek when venturing into the young digital asset market. Major custodians in the security token ecosystem include BitGo — who is the custodian for Harbor.
BitGo provides custodial, compliance, and security services for multiple institutions and digital assets. They offer multiple layers of security and retain clients including service providers, exchanges, and investors. Custodians often process large amounts of transactions in digital currencies, and typically they include high-value transfers between institutions and exchanges.
Custodians also provide developer tools such as APIs for plugging into their infrastructure, mainly for client-facing interfaces with wallets and the underlying blockchains. The security standards of custodians are at the highest level available and include advanced transaction features such as P2SH and HD transactions for cryptocurrencies such as Bitcoin.
As the security token landscape continues to unfold, more market participants will begin to enter the ecosystem. Service providers such as legal compliance (i.e., KYC processing) and broker-dealers also play prominent roles, and many of them have expanded their services beyond traditional financial markets into digital assets. As security tokens gain traction, it will be interesting to watch which markets emerge first as the most popular method for leveraging blockchain-based tokens pegged to traditional financial assets.