Category: Security Token Offerings (STO’s)

Security Token Offerings (STO's)

STO Processing Lifecycle ( Part 1)-An overview of STO lifecycle in Primary and Secondary markets

18 Jun 2019

Security Token Offering seems to be the next hype to utilize BlockChain concepts and transform the current security instruments (Equity, Debt, Derivatives etc) into digitized security. STOs have  gained popularity and momentum in recent times due to lack of regulations in the ICO world with a lot of outliers for most of the ICOs in 2018. There are many Startups that are building platforms by utilizing programmable blockchain platforms like Etereum. Recent developments in STO platforms seem to be moving in the direction of building an Ecosystem with defined standards as well. By seeing lots of traction on GitHub towards standards like ERC-1400, ERC-1410, ERC-1594, ERC-1643 and ERC-1644, it  has given us the opportunity to think about how can a technology company like us (Specialized in ensuring Quality standards for Blockchain based applications on Ethereum) can contribute to this. We started our journey in defining Complete STOs processing cycle in the context of real time usage (from functional perspective) with underlying Ethereum platforms (from a technology perspective).

It is highly important that we   list down all the major participants & their roles before actually defining the  STO lifecycle :

  1. Issuers – Legal entity who develops, registers & sells security for raising funds for their business expansion
  2. Investors – Entities who are ready to invest in securities to expect financial returns
  3. Legal & Compliance Delegates – Entities that ensure all participants & processes are complied within the defined rules & regulations by the jurisdiction
  4. KYC/AML service providers – Entity which provide KYC/AML for required participants
  5. Smart Contract Development communities like Developers, Smart Contract Auditors, QA Engineers

Most of the companies claiming to provide STO platforms are using Ethereum as the  underlying programmable blockchain platform with few exceptions. The rationale for using Ethereum as the first choice is – It is a Turing Complete platform to build complex decentralized applications by defining logics inside Smart contracts (Solidity is the most favourable programming language among developer communities). Pralallely, Ethereum is also getting matured, secured and  improved on performance with scalability by introducing lots of new features and improvements. There are very few who are utilizing other platforms apart from Ethereum to build their own STO processing platforms and  some of them are trying to build  a completely new blockchain platform dedicatedly designed for STOs. The last approach seems to be too optimistic as this might take years to build such a  system whereas the current momentum around STOs do not seem to wait that long.

Basis the above, we can now define the generic STO lifecycle from a functional standpoint into 2 phases as below:Primary Market

  1. To issue STO by Issuer
  2. To invest in STO
  3. Secondary Market to trade STO on either on Exchanges or Over The Counter

Primary Market

  1. To issue STO by Issuer –
  1. Registration of Issuer
  2. Creation of STO Token
  3. Approval from Legal & Compliance for STO
  4. Issuance of STO post Legal & Compliance approval  
  1. To invest in STO by Investor –
  1. Registration of Investor
  2. KYC/AML for Investors
  3. Whitelisting of Investors for STOs post KYC/AML
  4. Investment in STO for allowed STOs based on whitelisting of corresponding STO

Before we actually get into technical insight of underlying blockchain technology, we need to define the STO platform technical architecture from a  user perspective. Each STO platform that exists in any state in today’s world has –

  1. A Presentation layer (User Interface with any chosen front end technology, Integration with Wallets)
  2. A Business Layer (JS libraries to provide an interface to interact with Smart Contracts)
  3. A Data Layer (Ethereum data storage in blocks in the form of key-value storage)

Now  let’s define high level overview from a technical standpoint by assuming that the STO platform is using Ethereum as an underlying blockchain platform ( assuming that the Backend Layer has been setup already) –

  1. Creation of an external account for all participants to bring everyone on Ethereum blockchain
  2. Defining transactions for Off-Chain and On-Chain for all activities defined for Issuer and Investors
  3. Merger of Off-Chain data with On-Chain data
  4. Develop Smart Contracts
    1. Standard smart contract to be built for each STO depending upon Jurisdictions for generic processes among required participants
    2. STO specific Smart Contract to be built for implementing business/regulation rules
    3. Smart contracts with all business logic especially for transaction processing

Based on Expertise of our group, Magic finserv can contribute in a very big way in the development of Smart Contracts (Written in Solidity) along with Auditing of contracts.
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In next part, we will detail out all the above mentioned high level technical overview with high level functional overview followed by more insight on all these defined functional & technical flow.

Abhishek Jain

Sr Consultant - Magic BlockchainQA

Abhishek is a Blockchain enthusiast along with an explorer for all new tools & technologies along with researching on Security Token Offering and has been working with Magic for close to 3 years now.

Abhishek works  on building a Generic Automation Framework for all available blockchain platforms so it can be utilized to reduce the turnaround time not only for the development team but to benefit the end customer as well with no to minimum number of defects in production.

Security Token Offerings (STO's)

Why does it matter for a technology company like us to embrace global tech standards?

04 Jun 2019

When ERC-20 Standards came into existence, it eased down the ICO token interoperability across wallets & crypto exchanges for all ERC-20 compliant tokens. Having standards for any process not only helps to have bigger acceptance but also improves interoperability to build up an ecosystem. Being a technology obsessed firm, we’ve always encouraged standards to be in place. An acceptable standard not only helps developers (One of the strongest stakeholders in the ecosystem with  who has the responsibility to provide workable solutions by using available technology) to build  the ecosystem but also leads to minimal changes for implementing interoperability. In today’s world, there is no system in existence which does not raise any error /failure in real time usage ., Using global standards provides us another vital advantage of finding a resolution for such errors/failures as  these cases would have already been resolved by the tech fraternity earlier.

Today, it is of utmost importance to have standards that can not only integrate multiple systems (STO Platforms, Wallets and Exchanges) with minimal changes but also make security tokens easily interoperable across wallets and exchanges. Security Token Offerings can’t be an exception for not having standards when they seem to have the biggest and complicated technological advancement for transforming the existing world of security to Digitized security with automated processing over traditional blockchain technology.

  The recent traction on ERC-1400 (now moved to ERC-1411) has helped towards defining standard libraries for the complete STO life cycle especially for on-Chain/off-chain transactions This compilation of requirements has got the technology folks globally excited as this has the mettle to ease down the complete STO lifecycle.It completely makes sense that lots of individuals are very excited to see such a good compilation of requirements from various involved participants with probable interface that can ease down the complete STO lifecycle. Github, for instance has a lot of real time developers participating in discussions to share their experiences as well.

Ethereum Standards (ERC abbreviation of Ethereum Request for Comments) related to regulated tokens

The below standards are worth a read to understand in depth about the rationale behind targeting more regulated transactions based on Ethereum tokens –  

  1. ERC-1404 : Simple Restricted Token Standard
  2. ERC-1462 : Base Security Token
  3. ERC-884 : Delaware General Corporations Law (DGCL) compatible share token

ConsenSys claims to have implemented ERC-1400  on the Github repository & named the solution as Dauriel Network.  GitHub says, “Dauriel Network is an advanced institutional technology platform for issuing and exchanging tokenized financial assets, powered by the Ethereum blockchain.”  

ERC-1400 (Renamed to ERC-1411) Overview

Smart contracts  will eventually control all the activities like Security issuance process, trading lifecycle from an issuer & investor perspective as well as  event processing related to security token automatically. Let’s try to understand ERC-1400 standard libraries with respect to each activity for STO lifecycle :

  1. ERC-20: Token Standards
  2. ERC-777: A New Advanced Token Standards
  3. ERC 1410: Partially Fungible Token Standard
  4. ERC 1594: Core Security Token Standard
  5. ERC-1643: Document Management Standard
  6. ERC-1644: Controller Token Operation Standard
  7. ERC-1066: Standard way to design Ethereum Status Code (ESC)

All the defined methods inside each standard (Solidity Smart Contract Interfaces) at an activity level are (Pre Market, Primary Market, Secondary Market)  and can be represented pictorially as below:

It is of utmost importance  important to distinguish Off-Chain & On-Chain activities  with those that will be processed outside STO platform before defining the mapping between standard libraries methods and activities across all 3 stages.Off Chain activities can be done outside the main chain of underlying blockchain platform then merged. However, Integration will be needed for all activities performed outside an STO platform where several standards (e.g. ERC-725 & ERC-735 define for Identity management) play an  important role.

All activities related to Pre-Market is supposed to happen outside the  STO platform as those are completely related to documentation like structuring the offering, preparing the  required documentation with all internal and external stakeholders including the legal team to ensure regulation compliances . To bring reference of all pre market documentation to the  STO platform, Cryptographic representation of all documentation can be used effectively.

Similarly, KYC/AML process can happen off-chain with proper integration on the STO platforms with proper identity management (standards around Identity management like ERC-725 and ERC-735).

ERC-1400 (now a.k.a ERC-1411) covers all activities related to primary and secondary market with proper integration to all off chain data which brings all related documentation/identity to the underlying blockchain platform on which the STO is designed.

Magic and its approach for defining ERC-1411 mapping

Team Magic is working continuously to define  the mapping between all defined methods with all real time activities of primary and secondary markets. A key part of our strategy is  to collect all requirements from various stakeholders like Security lawyers, Exchange Operators, KYA providers, Custodians, Business Owners, Regulators, Legal Advisor. Once we have all requirements collected then our experienced business analyst teams (Experts from Pricing, Corporate Actions, and Risk Assessment) take over and reconcile the requirements with ERC-1400 standards to not only map the each requirement but also find out the gaps in the standards. Post this,our technology team  prepares the implementation strategy of all those standards by developing smart contracts in Solidity. Having an in-house develop smart contracts for any specific case study (Provided by our Business Analyst team) helps us define Auditing of ERC-1400 specific smart contracts and the testing strategy for each contract as well.

Abhishek Jain

Managing Consultant

Abhishek is a Blockchain enthusiast along with an explorer for all new tools & technologies along with researching on Security Token Offering and has been working with Magic for close to 3 years now.

Abhishek works  on building a Generic Automation Framework for all available blockchain platforms so it can be utilized to reduce the turnaround time not only for the development team but to benefit the end customer as well with no to minimum number of defects in production.

Security Token Offerings (STO's)

Security Token Offerings (STOs): Upping the Game

27 Feb 2019

We’ve come a long way since the Dutch issued the first initial public offerings (IPOs) in the seventeenth century. With the advent of crypto-currency, companies and corporations have new channels to access capital from markets and investors. Crowd-funding, for instance, is now a viable option for companies seeking capital across sectors.

Crypto-currency in itself has evolved and given birth to initial coin offerings (ICOs), a new spin on the legal concept of the IPO which is essentially a subset of investment contracts. As a digital version of investment contracts, ICOs enable the promoter/entrepreneur to offer a digital token of ownership for use in a future platform still in development. In return, the promoter/entrepreneur gets access to liquid finances to develop a platform where ICOs can be traded. It is for this reason that the investment community refers to ICOs as ‘token offerings’ powered by blockchain technology.

While ICOs have emerged out of the IPO concept, there remain notable differences between them. ICOs are thought to have function and utility embedded within the platforms and protocols an entrepreneur/promoter uses them to finance. They address two basic needs in capital markets—first, the need to circumvent restrictive policy controls and second, the need to disaggregate risks in financial markets by distributing the risks from capital investments among the masses. Unfortunately, however, ICOs have dismal survival rates due to the uncertainty built into the design of the offering. Murky trading practices and unregulated exchanges make it vulnerable to fraud and malpractice.

From ICOs to STOs: Getting Security Right

With the arrival of security token offerings (STOs), security is not nearly as much of an issue as before. This is partly because of the use of blockchain technology towards building and maintaining STO offerings and platforms. Blockchain social ledgers and distributed computing applications introduce resiliency and transparency to any form of social or business transactions by making them tamper-proof and available to all stakeholders in the space. The same principles apply for STOs, only that they are a more targeted application of blockchain and addresses security concerns that went hand in hand with ICOs.

Clearly, security token offerings (STOs) differ from preceding solutions in the crypto-currency investment domain for not only being a ‘programmable investment asset’ generated by blockchain technology but also for having significant compliance and oversight measures incorporated within it. This makes security token offerings (STOs) at par with stocks being traded on listed stock exchanges.

STOs do in fact need to be listed with the Securities and Exchanges Commission (SEC). Despite the use of blockchain technology, they have to be SEC compliant and have KYC features built into them and the exchanges where they are traded. The SEC regulates STOs across two different parameters—the eligibility of investors based on income and wealth ownership and restriction on the amount of finance an entity can raise from the market in a term. Ultimately, however, the beauty of security token offerings (STOs) is that they bridge companies and liquidity-seeking investors, forcing them to mature and deliver stability and consistency to the digital capital offerings market.

The Path Forward: Weighing Out the Options

At the end of the day, both ICO and STO instruments have their share of pros and cons. ICOs offer variability of use, quick liquidity and massive gains in value over short stretches of time, whereas security token offerings (STOs) provide stability and a reasonable level of protection for the investor. While there are low barriers of entry for ICOs in capital markets, the same is not true for STOs. The latter requires specific skills and processes for SEC compliance and legal management in trading and transfer. Thus, STOs might not be as easy to implement for small firms and startups and can lock out outliers from capital markets.

MagicBlockchainQA can bring unique value to entrepreneurs and promoters in the STO space by leveraging its extensive blockchain experience. MagicBlockchainQA endeavors to strengthen the STO ecosystem making it easier for companies to launch their security token offerings (STOs) by aggressively partnering with major STO platform organizations. MagicBlockchainQA can provide development, blockchain testing, security auditing, legal and advisory services.

Anuraj Soni

As a President of MagicBlockchainQA, Anuraj is building Financial Services business grounds-up based on new-age technologies like AI & Blockchain.

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