Welcome to the Year of the Security Token. Hopefully, It’ll Be Boring
01.04.2019

There’s a broad consensus that 2019 will see major advances in the use of blockchains and crypto-tokens to manage the trading and ownership of stocks, real estate, bonds, options, and other types of investments and property. One of the earliest iterations of this idea is now just days away from going live—though the specific implementation is a bit of a kludge, and highlights as many questions about “securities on the blockchain” as it answers.

As reported by CoinDesk and Bloomberg, an Estonia-based platform called DX.Exchange will sell its customers Ethereum-based ERC-20 tokens that represent shares in stocks including Apple, Amazon, Netflix, and Baidu. Actual stock trades will be executed by MPS Marketplace Securities LTD, a Cyprus-based brokerage. That firm will hold the shares on behalf of token buyers, sequestered from its normal operating assets. The service will reportedly launch on January 7.

Using blockchain to manage the ownership of assets—including not just stocks but everything from art to real estate—is a persistent locus of excitement in the blockchain world, even during the ongoing crypto bear market. Advocates including investor Anthony “Tokenize the World” Pompliano and Mattereum CEO Vinay Gupta argue that tokenization will have widespread, systematic benefits, including democratizing access to growth investments, and improving global capital efficiency by making it easier to invest in the developing world. In the case of tokenizing existing stocks, one benefit is the potential for 24-7 trading.

Security tokens can make investing more efficient and more global, but they’ll still rely on, and be constrained by, the complex global system of rules and restrictions on securities trading.

The DX.Exchange announcement, though, shows just how far we are from that universalist vision—and arguably, how far “tokenization” itself is from the founding values of cryptocurrency. Leaving traditional stocks in the functional custody of a third party, while trading digital tokens that merely point to those shares, may be fast and cheap. But it also requires a degree of trust in both private entities and governments—trust that DX.Exchange and its partners will honor its commitments to token holders, and, if it doesn’t, that legal regimes will enforce them.

That isn’t quite as neato as the idea of an investment that truly “lives” on the blockchain, independent of either trust or authority. Advocates for “utility tokens” thought blockchain assets would have value based solely on demand for systems that used them, an idea that partly fueled the 2017 mania. But the concept was overextended, and among other things, 2018 saw the slow realizations that a lot of “utility tokens” didn’t have any utility at all.

What emerges in 2019 will be less radical, but hopefully more real. Security tokens can make investing more efficient and more global, but they’ll still rely on, and be constrained by, the complex global system of rules and restrictions on securities trading. That includes, under most circumstances, careful monitoring of a holder’s identity and residence, and restrictions on access to certain investors, including U.S. rules limiting certain kinds of high-risk investment to wealthy people. At events bringing together security token advocates, how to build these rules into a blockchain is a recurrent theme—one that probably would have given Satoshi Nakamoto conniptions.

So there will be no borderless, unrestricted, pseudonymous trade in Apple stock on the blockchain. Especially not for Americans: Speaking to Bloomberg, DX.Exchange CEO Daniel Skowronski pointed out that DX doesn’t offer its services in the U.S., so doesn’t (according to him) need SEC approval for them. That points to a possible troubling future for security tokens, in which custodians like DX.Exchange provide tokens that nominally represent equity or other property, but only in jurisdictions with relatively lax securities laws or enforcement. Of course, those also tend to be places where the rule of law is shakier, raising the chances that a middleman would ignore buyers’ claims on the stock supposedly underlying their tokens (for a near-perfect parallel, see Tether and its nebulous cash reserves).

DX.Exchange’s location, fortunately, does not seem to raise those red flags. Estonia is part of the European Union, and has quite strong ratings on rule of law from the World Bank (extended occupations by both the Nazis and Soviets probably help make the Estonians bullish on justice and property). Though a historic money-laundering case tied to Russian gangsters unfolded there late last year, Estonian regulators were praised for their role in shutting it down. That should reassure prospective token-holders that their underlying stock claims are safe, and perhaps provide a real-life test of just how useful tokenizing the world will be.