The flurry of change in our society – technological, political, economic – makes for a constant sense of unease. It’s a confusing time to be alive. There is always something to be wary about, whether it’s the machine-cold corporate race for human data and attention in technology, the soulless rigidity of legal and regulatory obstacles, or our engineered capital markets and financial industry and the consequent growing inequity. Something seems terribly wrong.
In this maelstrom, through a complex tangle of blockchain technology, securities law, and financial instruments, the security token industry has emerged as a step towards the promised future of a humane and equitable flow of capital. But, we contend, that the mindfulness (or lack thereof) by which we build the foundation of the coming global economy will dictate what ultimately manifests.
Being a fundamentally different class of change than that of Initial Coin Offerings (ICOs) and preceding traditional fintech innovation, security tokens possess the requisite features of blockchain technology capable of displacing (perhaps for the better) the existing power dynamics of centralized governance and its accompanying effects. But technology is morally neutral and, therefore, the outcomes of this technology remain unwritten.
We see the tension between a blockchain’s structural capacity to displace centralized power and the power of centralized entities to enforce rules meeting directly at the nexus of security tokens.
The Reg/Tech Tension
The blockchain revolution began after the 2007-2008 financial crisis when our largest banking institutions took voracious risks around the subprime mortgage markets to a point of collapse. When their actions were remediated by government bailouts, Bitcoin arose as a grassroots response of outrage, advocating for the belief that a decentralized ledger can more reliably mediate our money than a corrupted, centralized monetary system.
The growing functionality of blockchains, allowing for programmable governance, data retention, and control can now allow for a range of power dynamics, from complete anonymity and decentralization to complete authoritarian control.
But, unfortunately, as exemplified by the 2017-2018 ICO and cryptocurrency craze and consequent crash, many take advantage of others in a regulatory vacuum. They want money and people can be easily misled by their desires. Regulation arises as a response to identifying widespread abuses and aiming to protect the public.
From the 1933 Securities Act to Dodd-Frank, to State & Federal statutes, U.S. Securities laws function as a muddled web of regulations from over 50 different agencies. They are the complex, numerous, and overlapping output of our history, politics, and an earnest intention to protect the public from fraud. That is, to say, they are constructed tools.
In an earnest effort to comply with the law, security tokens aim to build the legal requirements of compliance with securities law across various jurisdictions into the programmable behavior of new tokens (digital objects holding value).
Some questions exist as to the logical possibility of reconciling this tension. As user @atoma1 writes in the GitHub discussion of ERC-1400 – Security Token Standard:
In reading the quality discussion above around various elements of the EIP, it strikes me that the creation of a “security token” standard requires that there first is consensus upon the definition of “security” as it is being used here.
The concept of a security relates to the treatment of objects of value and the permissioned identity types of legal persons defined as a function of some combination of variables including current wealth, nationality, age, past financial behavior, employer, and, in some cases, gender.
Broadly, the difference between a commodity, currency and a security is around the reference object that defines it’s assigned value. A commodity references a physical object, a currency, prior to bitcoin, has referenced a fungible, government-defined object of value, and a security references many types of government-defined objects of value with variable degrees of fungibility.
So is defining a security token standard that can successfully map an inconsistent, changing, and contradictory set of definitions of securities across various legal jurisdictions possible?
Perhaps there is something I don’t see, but, fundamentally, how can the concept of a security, which is itself not actually a coherent concept with a consistent logic that can be abstracted, then be coherently standardized as an ERC?
I suppose what I take away from this is that an approach of looking to existing securities laws across different jurisdictions as the framework for EIP1400 might not be optimal.
For example, the state of Minnesota has very onerous and restrictive laws that prohibit corporations, pension or investment fund, and most out-of-state natural citizens from acquiring any interest in their agricultural land (Minn. Stat. § 500.24). These kinds of peculiarities span the world, within multiple levels of regional and functional regulatory bodies.
New Chains, Same Shackles.
The contradictory nature of securities regulation across the globe and the goal of standardization of a protocol for security tokens bring to the surface the incompleteness and manufactured nature of government itself.
In replicating these jurisdictional rules of securities compliance, one must ask if the same power structures that many intended to replace are simply being transferred over to a new, and less efficient, method of data storage. How does the community of security token practitioners that wish to improve current economic models and their accompanying societal effects avoid simply rebuilding the past?
The opportunity for change exists in the exciting field of an unregulated space, situations in which blockchain allows for new possibilities that are neither prohibited nor accepted by regulatory oversight, but simply unprecedented.
Examples include revenue share tokens, equity + in-platform type tokens, tokenized VC funds and real estate with new liquidity features, and other hybrid structures previously unseen in securities to date. In these cases, an absence of rules allows for power to be grasped with near immediacy. The moral question of how we behave in an unregulated space is the crux of the matter. What do we aim to maximize in the absence of rules? Profit? Disruption? Balance?
One potential solution might come from economist and philosopher, Amartya Sen, who in his famed book, Development as Freedom, describes real freedoms that individuals can realize as a framework for moving towards positive growth in society. In unregulated spaces, perhaps we ought to aim to advance freedom of individuals. In a state of want and need, hunger, shelter, love, educations, etc., the human species cannot be truly free.
What does it look like to build unregulated space with Development as Freedom in mind? One example comes in the form of currency type tokens collateralized by security tokens. If, for example, a plot of real estate was held as a security token in ownership form, theoretically, that token and the known and stable value of the security token could be used as collateral for a currency-like secondary token that allowed for exchanges within an ecosystem, perhaps increasing returns for local workers while maintaining the growth and profits of the business as well.
Or, imagine a nation seeking international recognition in a struggle for independence. The lands being disputed represent reserves of oil and other known-value commodities. Could a currency be pre-sold for the country to fund its efforts to gain independence? What would the ethical approach to such a plan be? What regulation would speak to this? What protocol standard (aka rules, laws) would allow for such a token to emerge ethically in such a morally grey situation?
We are all are paving the streets and highways for whatever comes after late-stage capitalism. Those roads can lead to many directions. The developers and participants of the security token ecosystem are directing the way and the flow.
We are a brave, strange, and curious species of great apes. For the sake of knowledge, we launch ourselves into space and dive to the depths of the ocean. But people must also look internally. How do we remain mindful of what’s behind our drives and decisions while in the rush of innovating and competing for capital? How do we account for the fact that we are irrational and often self-delusional, often at great costs? How do we build wisdom into our next iteration of capital?
No one knows where this new system will lead, but surely, we are better off finding ways to get there together, sensibly, and with care. Our society, the environment, and international relations depend on it. We all have an epoch-sized opportunity to question and find ways to redefine our relationships – to money, to one another, and to our planet.
As leaders at the forefront, we should seek to continuously ask these hard questions and invite the community to join in on co-developing the answers. In the rush to build businesses and grab revenues, it’s all too easy, as we know in practice, to lose sight of the intentions that led us here in the first place. This is a task too big for one group or individual to tackle, which opens the invitation for all willing to embark on the journey with us.