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Derek Edward Schloss, Director of Strategy at the Security Token Academy and Host of “Security Token Stories,” the industry’s leading security token podcast, recently sat down with Thomas Borrel, Chief Product Officer and Adam Dossa, Head of Blockchain of Polymath, a security token platform that aims to make the creation, issuance, and management of security tokens simple. On the episode, Borrel and Dossa discussed the role Polymath has played facilitating new standards, including the ERC-1400 compliance standard, and building Polymesh, a blockchain that aims to bring regulatory compliance and institutional confidence to the security token industry.
Derek Edward Schloss: What led you both to start building technology at Polymath?
Thomas Borrel: I had been doing software and product development for a large portion of my career. At a previous company, we began to look towards blockchain to solve some of the software problems we had. After meeting the founders of Polymath at a conference, I thought to myself, “There’s a freight train coming to the industry — I can either hop on, or ignore that it’s coming.” So, I decided to hop on.
Adam Dossa: I spent the first decade of my career building trading risk management and regulatory reporting systems for the fixed income desk at Morgan Stanley. I started building AI and machine learning systems for venture capital in 2013 while taking a career break, and like many other developers, caught the blockchain bug after attending an Ethereum meetup in 2015. The rest is history.
DS: What were some of the challenges the industry faced using the ERC-20 standard to bring regulated assets to the blockchain?
TB & AD: As perhaps the single most heavily regulated industry in the world, financial services thrives in a world of protocols, standards and rules — compliance is at the forefront of securities. Though ERC-20 fulfilled the role of defining a common list of rules that all Ethereum tokens must adhere to, it’s permissionless. We found that our clients needed permissioned tokens so that the issuer of the asset could know exactly who was on their cap table.
The security token industry was full of friction because it lacked a singular standard that exchanges and custodians could adhere to and determine whether or not their infrastructure could support the storing and trading of a given asset. We found that ERC-20 wasn’t sufficient for regulated securities or for being able to enforce compliance driven by the asset type and jurisdiction, and it also fell short on identity requirements like KYC, regulatory reporting, disclosures, communication and auditing. Our clients needed a new regulatory framework to work in that would be easier and ensure compliance.
DS: What was the process like writing ERC-1400, a security token standard you’ve helped facilitate and shape?
TB & AD: When we set out to write ERC-1400, we wanted to answer the question, “How will the market respond to assets that are born digital, rather than made digital?” To do that, we brought together a group of 25 market participants, service providers and former regulators, to propose a new security token standard. Within ERC-1400, we built new modules to automate capital distribution, tax withholdings and govern trading volumes. Having the standard is what allows different smart contracts to be interoperable and represent ownership of a real world assets, which are regulated securities. We launched ERC-1400 in September 2018 after this collaborative effort. Several organizations have already embraced it as their tokenization standard. Our next step will be continuing to refine the standard for market fit.
DS: What brought you to start building Polymesh, a purpose-built blockchain for security tokens?
TB & AD: Ultimately, we wanted to make the creation and issuance of security tokens easier. Through our work with clients, we found that Ethereum wasn’t the best fit for a variety of reasons. Governance is a major challenge among most blockchains because they’re built to be inherently permissionless. That makes sense — because most blockchains are built for anonymity, but that’s the opposite of the environment that regulated securities require, as investors looking to acquire a security token need to go through the same steps as acquiring a traditional asset, including KYC/AML.
With those challenges in mind, we set out to build our own blockchain, now in development called Polymesh, that’s geared specifically towards security tokens — moving from a general purpose blockchain to a purpose-built blockchain.
DS: What are some of the design features that make the Polymesh blockchain unique?
TB & AD: Unlike public blockchains, identity is built into our ledger. Using Polymesh, investors undergo a series of suitability checks to ensure that their profiles align with the aspects of the security token that they’re attempting to purchase. Polymesh leverages “proof of stake,” meaning that it gives finality to a transaction so that banks and other large issuers don’t have to worry about a transaction being reversed mid-trade. Validators on our chain are reputable — they all undergo a KYC process to learn the nature of the commission structure on a given trade, what the stake is and what the token flow is between participants. The validators are real-life organizations who are permissioned to author nodes and vote on the corrections of blocks to be regulated entities across various jurisdictions. And nominators nominate the validator set. Our aim when building Polymesh is for regulatory certainty. Compliance, identity and privacy are at the core of Polymesh.
DS: How does our existing financial infrastructure make the jump to support this new era of blockchain-based financial services?
TB & AD: In order for the new era of financial services to thrive, we must bridge the gap between regulated securities and the new open world of finance. We can’t expect for open networks to thrive in a closed system. The industry must come together to innovate and marry open finance with traditional markets. We believe that security tokens will be the bridge, as they will democratize and bring greater liquidity to real world assets. But quality investors need quality assets. And if digital assets are going to appeal to quality investors — identification, privacy and compliance must be baked in at every step of the trading process.
DS: Looking out over the coming years, what does a tokenized future look like?
TB & AD: We believe that the future will bring a host of brand new asset classes, some of which are already beginning to emerge. New structured products will come about, which will lead to a more inclusive market. Broker-dealers and service providers like law firms will benefit as well, and new market participants and companies will appear around these new financial assets. The new era of financial services will bring with it increased transparency around financial products and greater efficiency routed in blockchain technology. We’re already seeing this transition taking hold between 2018 and 2019, when we saw digital-born assets emerging alongside equity tokens, fueled by the reduced cost of asset trading and the automation capabilities that exist today.
Image courtesy of the Security Token Academy.