What is “tokenization”?
The process of creating digital representation of a real world asset using blockchain technology.
What is a blockchain?
In simple terms, a blockchain is a method of accounting, which replaces the clearinghouse in financial transactions.
In more technical terms, a blockchain is a data structure consisting of blocks of data that are “chained” together using cryptography and can be used as a distributed public ledger to create an immutable record of transactions in a trustless manner.
What is Ethereum?
Ethereum is a blockchain that provides infrastructure enabling smart contracts.
What is a smart contract?
Smart contracts are protocols that enable trustless transactions without the need for a central third party.
What is a token?
A digital unit of value stored on a blockchain.
What is a “tokenized” security?
A security that is represented as a blockchain token (rather than paper form).
Why tokenize securities?
Tokenization has the potential to significantly impact financial markets by lowering transaction costs, introducing programmable compliance, reducing settlement time and increasing potential liquidity.
What is programmable compliance?
Programmable compliance allows for certain logic checks to be embedded into smart contracts, ensuring that tokens will only trade in a manner consistent with any regulatory and/or contractual transfer restrictions that may be in place. The types of information encoded into the smart contract can include “know your customer” (KYC) and anti-money laundering (AML) checks, accredited investor verification, total number of holders, and any additional information that is required to comply with any regulatory and/or contractual transfer restrictions in place.
How is programmable compliance enforced?
Programmable compliance is enforced by embedding these logic checks into the smart contract representing the token. When a token transfer occurs, the smart contract will check an on-chain whitelist (i.e. list of approved wallet addresses) to verify whether the receiving party is a suitable counterparty based on the relevant regulatory and/or contractual transfer restrictions the particular asset is subject to. The on-chain whitelist is backed by off-chain due diligence on the party (e.g. accredited investor verification). If the results of the logic checks show the party is appropriately verified, the transfer function will execute and the token swap will occur. If the results of the logic checks do not show the party to be appropriately verified, the transfer function will fail and the token swap will not occur.
Who is the administrator of the whitelist?
As a technical matter, any party can be designated as the administrator, however in practice the issuer of an asset will often act as the administrator (as it controls the initial distribution) or may designate a third-party to act as the administrator. A smart contract embeds the administrator information.
What asset is suitable to tokenize?
Any “long tail” asset is most suitable to be tokenized. Private real estate assets are one example. These types of assets will benefit from tokenization because their current markets are plagued with inefficiencies in the transaction processes, limited accessibility, and poor liquidity. As a result, there is friction in an investor’s ability to enter, exit, and trade in the market.
How do you store tokens?
Private keys to tokens are stored in wallets.
What is a wallet?
Your wallet is your access to the blockchain. It’s like a digital lockbox - it can only be unlocked with your key. You can use it to store all of your digital assets and to interact with decentralized applications.
Why peer to peer?
With a non-custodial, no order book model, AirSwap technology is far better positioned for the private securities market than alternatives that take custody, use order book matching engines, and wrongly assume that private securities will trade with the same frequency as publicly traded securities or cryptocurrencies.
Are tokens representing securities the same as cryptocurrencies like Bitcoin and Ether?
No. Cryptocurrencies like Bitcoin and Ether are natively digital and do not represent a tangible asset in the real world. While tokenized securities may be powered by the same underlying blockchain (e.g. ERC20-compliant tokens on Ethereum), these tokens represent ownership of real assets.
Are tokenized securities regulated?
Yes, “tokenized” securities are still securities and are regulated in the same manner as traditional securities. In the United States, securities are regulated by the Securities and Exchange Commission (SEC).
Where does Fluidity fit in the tokenization process?
Fluidity offers technology services to FINRA-registered broker-dealers and issuers to help them incorporate “smart contracts” and blockchain technology into their SEC-compliant offerings.