Digital securities, when finance and blockchain meet

People a super bullish on Digital Securities and yet very few people understand how they are created and work. This represents a risk, as much for actors as it is for regulators.

Digital Securities are native instruments issued, traded and settled on a blockchain which reduce transactional friction. The governance or smart contracts include an Identity (KYC) associated to various regulatory rules that are encoded, from day 1, such as issuance, holding periods and cross border compliance aspects associated with the jurisdiction of the issuer, buyer and seller, respectively, the structuration of the underlying asset (Accredited/Qualified Investors, number of possible investors etc.) and international trade interdictions for example. (Note that, the more restrictive the whitelist, the fewer participants in the secondary market) Those are part of the “Automated Compliance” which on top of the near real time settlement or cleating system represents one of the major improvements of digital securities.

Talking about Settlement and clearing, let’s deep dive in this improvement.

Previously, when you thought you were holding an asset (because you had bought it), you actually had an entitlement to someone else that have an entitlement … to the asset. Not really efficient!

By the way, do you know why, historically, markets are not opened 24/7? It was to physically move the shares a depository to another.

With digital securities, you hold direct ownership to the underlying asset because you control the wallet. Therefore, when you sell your rights, you exchange value for value simultaneously. By transition, you eliminate the counterparty risk! Finally, the record keeping is more robust because the old way consists of multiple asynchronous ledgers whereas the blockchain has a single shared copy of the ledger. This avoids having an accounting system that creates more valid claims which can influence governance such as voting… (It happened).

Various rights can be embedded Digital securities:

  • Ownership rights as Equity which gives you full control of the asset.
  • Claim rights which gives you the possibility to claim the use of the asset or rights to the cash flow generated from the asset.
  • Governance rights which give you the possibility to vote for a specific decision

All those rights can be mixed together or not. Various combination are possible:

  • Claims without ownership can be Bonds, debt and leasing vehicles.
  • Ownership with governance can be equity.
  • Claims with ownership and governance can be the case in real estate if you’re talking about timeshares or maybe you want to control the pricing, hiring staff or anticipated sell of the underlying asset.

(Of course, this list is not exhaustive. Note that some combination can create misalignment between parties…)

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