Do We Need a Blockchain for Digital Securities ?

The idea of a blockchain for digital securities comes down to a very simple question: can we represent ownership effectively by using smart contracts? Ownership can be represented as a relationship between an owner and an asset. Simultaneously, ownership must have some basic properties: it has to be verifiable, transferable and accrue value based on market dynamics.

Ownership is the main principle of security tokens. And token issuance platforms are trying to model ownership dynamics on top of existing blockchain that were designed for asset transfers.

Any blockchain can be decomposed into three parts: a technological layer, an incentive mechanism and a node architecture. The technological layer is responsible for functions such as block issuance, transaction recording, consensus algorithm etc. The incentive mechanisms aggregate areas like consensus, token mining and several others. The node architecture describes the different types of roles a nodes can play in the network. For example, a blockchain like Ethereum was fundamentally designed for asset transfers and, therefore, have built the technological building blocks, node architecture and incentive mechanisms to support that model.

Building security tokens on top of Ethereum means adapting those mechanisms to support ownership dynamics. While the technological building blocks of a blockchain can work consistently for asset transfers and ownerships, this is not the case for the node architecture and incentive mechanisms. For example, the same miner that validates an Ethereum transaction is not equipped to do a capital-requirements validation on the same node. Similarly, also the incentives for mining an Ethereum transaction are not the same as those for validating the transfer of a start-up equity token between two parties. Security token transactions rely on identity as a core building block. However, blockchain like Ethereum are designed for pseudonymity and introducing identity violates some of its core principles.

The current security token platforms operate as centralized entities on a decentralized blockchain by introducing centralization functions such as compliance validators (KYC/AML), and off-chain processing. These features are not only necessary to overcome the technical limitations of Ethereum but also to simplify the issuance of security tokens. However, the introduction of too many centralization features might end up neglecting the value proposition of the blockchain in the first place.

Although a new blockchain may sounds like the better solution, the creation of a new blockchain for security tokens takes significant amounts of effort and time to be built out, meaning that it could take years before any applications are built out on it. In addition to that, a new blockchain requires the design of a new native cryptocurrency to incentivize network participants, in which the token economics will have to be well defined to ensure sustainability. Also, once deployed, the capability and security of the new blockchain will have to be tested over time. Furthermore, creating and growing a developer community from scratch as well as the necessary tools will take significant time.