Digital Asset Securities and Blockchain

Why is Blockchain Beneficial to Us?

In order to understand why Blockchain is beneficial; we must understand the basics of Blockchain. A Blockchain is a digital ledger of transactions which are distributed across an entire network of computers (or nodes). These distributed ledgers use multiple independent nodes to record, share, and synchronize transactions instead of keeping them on one centralized server. A blockchain uses various technologies including digital signatures, distributed networks, and encryption/decryption methods in addition to “distributed ledger technology” (DLT) to enable blockchain applications.

Blockchain is one type of DLT in which transactions are recorded with an unchangeable cryptographic signature called a hash. This is why Blockchain provides a completely transparent and immutable chain-of-custody for transactions and asset ownership.

The Ethereum Blockchain invented the concept of “Smart Contracts.” “Smart Contracts” have opened the door to a myriad of innovations, including the use of blockchain technology for the securitization of corporate stocks and bonds that would automatically comply with all the SEC regulations.

In relation to regulated securities Blockchain technology enables the streamlining of processes, lower costs, increased transaction speeds, enhanced transparency, and fortified security. This would impact all securitization participants—from originators, sponsors, and servicers to ratings agencies, trustees, investors, and regulators.

The combined impact of Blockchain’s benefits is the lowering of risks within the securitization markets, which leads to greater investor interest. This, in turn, will improve prices, volume, and spreads. In addition, with better and more transparent information, regulatory compliance could also be simplified, and market failures would become less likely.

When we first started to research the possibility of applying blockchain technology four years ago as a means to facilitate raising capital, it was a very exciting time. It was like1998 and the invention of the Internet again. All of a sudden it felt like “all things were possible.”

 

So What is the Problem?

Many traditional real estate investors do not understand crypto currencies like Bitcoin, NFTs and other blockchain assets, and prefer to stick with what they know, such as “brick and mortar” real estate and Wall Street. Currently when an investor is told that a real estate investment is digitized, or that the investment interests will be recorded on a “blockchain” very often they immediately react with their negative perceptions of cryptocurrencies.

 

There are two very clear differences between Cryptocurrencies and Digital Securities

 

Cryptocurrencies are by their nature “bearer instruments” with anonymous ownership. They can be exchanged for value, in the same way cash or a dollar bill is a bearer instrument that can be spent. Also like a dollar bill, if you lose it, it is gone. Possession is ownership.

Digital Securities can only exist in a complex regulatory environment. Ownership must be known by the issuer at all times. Digital stocks and bonds must be held in the custody of organizations licensed by the SEC to custody digital securities. If lost, they can be re-issued.

The Evolving Nomenclature of the Digital Securities Industry

The negative perceptions of investors and investment advisors are made worse by Cryptocurrency news regarding,” Lost Crypto Keys,” “hacks” and “bankruptcies,” etc… In addition, Words, phrases, and acronyms that are used by the media to describe various “Digital Security “innovations have changed multiple times over the last few years, creating confusion and perpetuating the negative perceptions.

Industry participants are aware of this terminology-confusion issue and continue to try to produce descriptive phraseology that will clearly segregate the two asset classes, in the public’s perceptions. We are on the 4th iteration for Digital Securities:

1st: “Initial Coin Offering” or “ICO” – These terms are still being used, appropriately, for new non-regulated, cryptocurrency projects. Originally people were trying to structure coin offerings to raise capital and avoid being classified as regulated securities. It soon became obvious that there was no way, a for-profit business could raise capital and avoid the classification of a “security” by the SEC. Next.

2nd:  The term “Security Token Offering” or “STO” was created to differentiate from “Initial Coin Offerings” or currencies. Post offering the “STO” would be called a “Security Token.” However, the use of the word “Token” which is still being used in many other non-regulated contexts, continued to cause confusion with regulated “securities.” Next.

3rd:  The “Digital Security Offering” or “DSO” was created to avoid using the “token” word. Post offering the “DSO” would be called a “Digital Security.” While the term “Digital Security,” is still being used, the word “security” many times causes people to think “Cyber Security,” for the security of a digital network. Next.

4th:  The official term as adopted by The Securities and Exchange Commission (SEC) is – “Digital Asset Security” with no acronym. Where:

    • A “Digital Asset” could mean Bitcoin, cryptocurrency, or a Non-Fungible Token (NFT), or any other asset that is represented on a blockchain and does not meet the definition of a “Security” under the federal securities laws.
    • A “Digital Asset Security” refers to an asset that is issued and/or transferred using distributed ledger or blockchain technology and meets the definition of a “Security” under the federal securities laws.

Here is an official Statement from the SEC on Digital Asset Securities Issuance and Trading – Nov 2018:

https://www.sec.gov/news/public-statement/digital-asset-securites-issuuance-and-trading