4.1. Why tokenization: security tokens and stablecoins
Tokenizing securities means representing an ownership right (such as shares in a company or a credit) through a token. This right is usually guaranteed by the token issuer, who is contractually bound to recognize the token as a bearer security. These kinds of tokens are often referred to as “stock tokens”. The token may also grant administrative rights corresponding to company shares, where the token holder exercises his rights cryptographically and pseudonymously by demonstrating ownership of the security using his private key.
The token can also represent an asset in the issuer’s custody, for example, stablecoins, which have fiat money (such as the US dollar) as their underlying asset. Theoretically, stablecoins can be included within the broader definition of security tokens, although in some jurisdictions, the classification may be different for legal reasons.
While cryptocurrencies like Bitcoin are issued in a decentralized way, the issuance of securities is always centralized, meaning the issuing entity is also prosecutable by authorities or other entities. Despite this, the advantage of a blockchain for securities is evident: the blockchain is the first technology capable of transferring bearer securities in digital form without relying on a centralized system. In other words, whereas the issuance may always be centralized, there is great value in disintermediating the custody of securities, as well as the clearing and settlement of securities trading, i.e., allowing securities to be bought and sold for other cryptocurrencies (e.g., Bitcoin), directly through a DEX, without requiring agents, brokers, exchanges or other intermediaries.
Sequentia’s architecture offers the Access-Control-List (ACL) tool for developing decentralized finance with particular regard for securities. It is possible to picture a future in which companies or self-employed people freely issue shares or bonds on a blockchain and then transfer them without friction. Private arbitrators elected by the parties could then be responsible for handling fraud cases against the token issuer and enforcing rules through ACL. Examples of fraud cases might be:
- The business profits are not redistributed as scheduled based on the distribution of the assigned tokens;
- The administrative rights associated with the token are denied;
- Modifications to the supply (inflation) of the token do not meet the expected schedule, or tokens are burned/locked by the issuer against the terms of the public offering.
Some of these schemes might be prevented if the RAS token representing the security is issued without the possibility for the token issuer to intervene in factors such as the generation of new tokens (inflation control). However, often such rigidity might not be well-suited for regulated securities, and a free market is better capable of providing correct incentives; when serious disputes arise, the token’s digital nature and the total absence of frictions in exchanges would immediately lead to a fall in its value, undermining the issuer’s credibility.