April 27, 2021

Here is how compliance can befriend a public blockchain


Blockchain technology allows creation of decentralised, distributed data entry systems. It allows representation of value with custom made units or tokens on a particular chain. It all started with crowdfunding as utility tokens on the Ethereum: pre-selling services or products using cryptocurrencies for a cryptographic token as a receipt. Recently, NFTs became a thing – so called, Non Fungible Tokens thriving within the DeFi – decentralised finance economy. These presume to have an ability to represent anything, but, mostly sentimental or collectible value. For example, a painting or a tweet, or the first ever trade on NASDAQ. A couple of years back, Security Tokens became a thing, allowing to represent regulated financial securities. But how can one have financial securities on a decentralised blockchain, which by definition cannot be decentralised and are a compliance-heavy asset class? Let’s figure it out.

Already in 2019, Fintelum Security Token Offering implementation envisaged creation of a viable, compliant way for token issuers and investors to maintain contractual obligations on the Ethereum blockchain. All of the possible compliance-related issues have been addressed. Assuming that everyone is familiar with ERC-20 (EIP-20) token protocol, security tokens are somewhat different. For one, although, securities are transferrable, they cannot be freely issued and then transferred as is the case for ERC-20 tokens. Security token issuance and transfer requires full AML/KYC in order to allow exchange and have ability to restore legitimate ownership, if need be. For instance, if owner of a security looses their tokens, the “your key – your wallet” principle does not apply. And such incidents can be rectified. This function is performed by a central counterparty that maintains the issuance and transferability of securities – the token transfer agent. 

Although differences may also arise across jurisdictions, the Fintelum Security Token implementation addresses typical securities law requirements for investor protection, ensuring investor rights. For one, lost tokens can be replaced, and old ones voided. In case of voting rights, the token can serve as a tool to cast a vote from anywhere. The right to income, in form of dividends for equity, or interest payment on a loan, it can be “airdropped” in cyptocurrency to Fintelum or designated wallet, or in fiat using payment institutions. The inheritance rights can also be also ensured and protected. And in the case of liquidation, token will cease to exist. Security tokens can be arrested and transferred upon a request from the court if there is conflict, litigation or to protect other legitimate interests. 

Finally, one of the most important aspects for using the token format for registering securities is – the secondary market. If by any way, the financial industry opts for settling trades on a public blockchain rater than currently employed proprietary databases, then the capital markets will become more transparent and available for analysis to anyone. If a token is a security, then it can only be traded on organised and regulated exchanges. With one exception allowed for crowdfunding service providers, such as Fintelum. With the recently adopted EU ECSP regulation, Fintelum is able to run a bulletin-board type of exchange for white-listed investors in a particular security.

To conclude, security tokens are a potentially a better way to represent lawful rights and enforce investor protection. Fintelum aims to show how assets may be tokenised and safely managed. One such attempt is demonstrated by Fintelum’s recent showcase of a project KEEPP. This is a real security token offering, based on a real physical business and a drawn up and publicly available shareholders’ agreement. It is estimating a 15% dividend payout annually.. Learn more on Fintelum.com/keepp. If you wish to read more about how security tokens work, you are welcome to browse through Fintelum’s whitepaper at fintelum.com/whitepaper. We encourage you to contact us directly on our Telegram channel and express your interest by becoming an investor with KEEPP STO.