Choosing the right blockchain platform for an STO and asset tokenization
The market today offers a huge variety of goods, so customers are often confused by a wide range of positions and flavors of a particular product when looking at the supermarkets’ shelves. This is analogous to the status quo in the asset tokenization market: dozens of firms offer tokenization platforms, all of which appear to be indistinguishable from one another. In this article, we’ll go through the requirements that an asset tokenization platform must meet so that you as a business owner or investor can pick the best one.
What is tokenization and its benefits?
Let’s briefly remind ourselves what tokenization is. Tokenization is a combination of technical and legal processes that transfers the ownership of an asset to the form of tokens on the blockchain. This asset may be corporate equity, debt, real estate, or a financial instrument. Tokenization provides several benefits. One of them is increased access when a single expensive asset, like a piece of real estate worth millions of dollars, can be broken down into thousands of tiny pieces. Also, it increases liquidity because tokens are easier to trade. Read our article to get a better grasp on the mechanism tokenization is implemented from a legal standpoint in the example of real estate – the asset tokenized the most – read our article “How does real estate asset tokenization really work?”.
What is necessary for successful asset tokenization from a technology perspective?
There are four things to be taken into account from a technological standpoint. First comes the underlying blockchain that is used for tokenization. Secondly, the token protocol, a specific form in which a token is stored on the blockchain. Thirdly, the platform for investor onboarding, token sale, and the management of investor relations. And, fourthly, you need to consider the form of secondary trading that the specific technology provider enables. Now, let’s take a look at the requirements for each of these pieces.
Requirements for the blockchain
Blockchain is the main underlying element of tokenization technology. It’s a piece of infrastructure similar to what roads are for automobile companies. Blockchain is a distributed database used to store information about your token’s ownership and process all the transactions. There are two main aspects you have to look at when choosing the blockchain.
Public or private blockchain?
The public blockchain is the one where anybody can join in supporting the network with its computing power, and anyone can use it. In a private blockchain, only the selected individuals or entities are allowed to interact with the network.
Private blockchains may be better for a certain number of cases, but generally, it is recommended to use the public one. There are two reasons for it. The first is that public blockchain is usually more resilient since many actors support its operations.
Secondly, public blockchains are more flexible and cheaper. The private blockchain, where regulated financial instruments are stored and transacted, can be operated only by their regulated financial institutions. These institutions are subject to several requirements that they pass on to you in the form of more cumbersome processes and higher costs to support the army of lawyers and accountants.
Adoption of blockchain
The second aspect to look at is adopting a given blockchain and how developed its infrastructure is. For more developed blockchains, there are a number of auxiliary technologies making them more convenient to use. For example, you need a wallet to hold tokens. For particular investors who are less familiar with the technology, installing a wallet may be problematic, which means you should focus on a blockchain where downloading a wallet is as easy and streamlined as possible.
The one blockchain that stands out given these requirements is the Ethereum network, the most widespread and popular blockchain globally. The particular benefit Ethereum has is that most technologies for decentralized trading have been developed specifically for it.
Requirements for a token
Token protocol is a specific complex of rules that define how a token is stored on the blockchain and how to conduct operations with it. Conventional token protocols do not correspond to all the legal requirements for regulated securities, so you should carefully examine the protocol proposed by the technology provider. It should contain at least the following features necessary for the tokenized securities.
The first crucial feature is whitelisting. It enables the issuer to manually choose wallets that are allowed to own a token. This is necessary so that only verified investors whose identity you have checked have the right to hold the token: if your security is owned anonymously, be prepared to still file reports about its holders with competent authorities.
Account blocking and token burn
Secondly, you need to be able to block a certain wallet and burn tokens on any wallet. This may be necessary if, for instance, you have a ruling from the court stating that a particular transaction is unlawful and should be reversed. Another even more trivial case is that an investor can forget their private keys to the blockchain wallet. The benefit of blockchain is that you get rid of intermediaries such as custodians holding securities on behalf of investors, but this also creates an additional risk because if access to the wallet is lost, it’s impossible to restore it. The functionality of token burn allows you to destroy the tokens on the wallet to which the access has been lost and issue them to the new wallet of the given investor.
The next important feature is the ability to set transactional limits. There are two principal use cases related to this functionality. Firstly, it allows you to conduct additional due diligence on large transactions. It’s not necessary to verify every $1,000 investment, but when an investor wants to put in $50,000, you need to conduct additional verification of the source of funds to reduce the risk of money laundering. Accordingly, you may set the maximum limit for an investment that does not require proof and can be processed automatically, e.g., $10,000, and require an additional application from investors who want you to increase their investment limit. The second critical use case is to manage the risk of consolidation, i.e. the risk that somebody may have too large of a stake and therefore too much power over your business.
Lastly, the protocol should support the admin management functionality. Let’s imagine that during the offering, you attract several hundred investors each month. Naturally, as a business owner, you don’t have time to verify each investor, which leads you to additionally hiring a compliance officer for this purpose. To not give this person all the power over your tokens, you need the option to appoint it as an administrator with limited power only to whitelist wallets.
Requirements for the Dashboard
Requirements for the investment portal are the next check on the list. While the previous two aspects referred to decentralized technologies, the investment portal is a conventional web application.
White label access
The first need is that the platform is offered as a white label solution. The reason for such a requirement is twofold.
Firstly, it provides you with greater flexibility in the way the platform can be used. For example, if you are going to create your own crowdfunding platform focused on a specific sector, or have multiple investments to offer, or your brand is simply large enough, a white-label platform that you can set up for yourself works better than a centralized one that you share with dozens of other companies.
The second reason is that centralized platforms need a license of a financial intermediary, which increases the cost for you and creates additional limitations such as the limit on accepting investors from countries where this platform does not have a certification.
Stobox Digital Securities Dashboard is a white label solution to tokenize digital securities and conduct all operations with them in a convenient digital environment. Sell the shares, pay dividends, conduct corporate voting and corporate actions in a new, digital way. Raise capital and steamline investor relations.
Compliant investor onboarding. Know Your Client (KYC)
The next requirement is a compliant investor onboarding. Before investors can purchase your tokens, they have to be verified. This means that the platform should contain the so-called “know your client” (KYC) process as part of the investor onboarding. There are also additional requirements. For instance, for certain kinds of cross-border offerings involving the United States, you need to have a segregated onboarding for US investors and non-US investors. It is also advisable to check the investor’s wallet during the KYC process using the services that provide you with the money laundering risk score for a blockchain wallet.
Compliant investment flow
The investment process itself should also correspond to certain compliance requirements. One of the most important is that investors have to sign an investment agreement during the investment process so that they have legal rights protected not only on the technical level by the record in the blockchain but also by the actual legal document they can use in court or for income reporting purposes if there will be a need.
Personal data storage
Another crucial requirement refers to the storage and processing of personal data. This is especially relevant if you are working with EU residents who are protected by the GDPR. According to this regulation, you have to store data in a highly encrypted manner, as well as keep the records of each investor in its respective country of residence. Therefore, you have to be connected with at least 28 different servers to process personal data. This is one of the most sophisticated even though the almost invisible aspects of a tokenization platform.
Secondary trading is a crucial factor for your asset being attractive to investors. Even though some investors are holding an asset for a half dozen years, the overwhelming majority of investors are much more interested in assets like Tesla or Bitcoin that can be easily traded. Therefore, your tokenization technology provider should offer at least some options for liquidity. There are three ways you can enable trading for investors.
Over The Counter (OTC) transactions
To begin with, you can enable trading in the form of so-called over-the-counter transactions. These are private P2P transactions between two individuals negotiated only between the two of them outside the stock exchange or any other trading venue. Such trades are easy to enable, and they require almost no registration or regulatory disclosure. The drawback of such trading is that it can be hard to find a counterparty to sell securities to or buy from.
Another option is trading on a regulated stock exchange explicitly designed for tokenized securities. The benefit of listing on an exchange is a high level of liquidity and excellent access to investors. However, its drawback is a very high cost of the listing itself, as well as the additional regulatory burden of continuous disclosure, which requires a legion of lawyers and accountants.
The last check, a middle ground between exchange listing and OTC trading, is decentralized trading via the liquidity pool. In this case, you as an issuer serve as a market maker for your securities. If you want to learn more about liquidity pools and decentralized trading, check out the article “How asset tokenization brings liquidity to equity crowdfunding”.
If you want to simplify the choice of the tokenization platform for your business, take a look at Stobox that corresponds to all of the requirements above. We have developed a proprietary token protocol on top of the Ethereum network and Stobox Digital Securities Dashboard as a white label fundraising portal with legally compliant investor onboarding, investment flow, and personal data storage. The DS Dashboard supports the OTC transfer and is paired with a Digital Securities Swap technology that can be used to create a liquidity pool.