How is Polymesh changing the future of securities?

Financial markets are constantly in flux as new technologies continue emerging. One of the most exciting innovations in recent years has been blockchain technology.  

Blockchains such as Polymesh have the potential to radically transform how financial securities markets operate and create new opportunities for both issuers and investors. 

In this blog post, we’ll explore how Polymesh is changing the future of financial securities and the specific challenges of implementing blockchain that it solves. 

Real-world examples of securities that can be tokenized on Polymesh 

Almost any asset can be tokenized on Polymesh with security tokens, making assets easier to exchange or trade and transforming the way we think about traditional securities. Here are a few examples of real-world assets and other traditional securities that can be tokenized on Polymesh. 

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Alternative assets such as real-estate and fine art 

Real-estate and fine art are two well-cited examples of alternative assets that will be revolutionized with tokenization. Blockchains such as Polymesh make fractionalization of these assets truly feasible, unlocking liquidity for what are traditionally illiquid assets and making new financial products possible. 

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Carbon credits

One less-cited use case for tokenization which Polymesh is highly poised to capture is carbon credits.

Carbon credits are a type of financial instrument that represent the right to emit a certain amount of carbon dioxide or other greenhouse gasses. Carbon credits are a useful instrument to incentivize businesses and organizations to reduce their carbon footprint and can be traded on various markets. 

Tokenizing carbon credits on Polymesh enables businesses and organizations to more easily track and manage their carbon credits as well as trade them more efficiently. This ultimately promotes wider adoption of sustainable practices and can contribute to the overall global effort to combat climate change. 

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Private equity 

Another example of a security that can be tokenized on Polymesh is private equity. Private equity investments are equity investments that are traded in private markets, such as ownership shares in a privately held company. These investments are typically complex and require a significant amount of due diligence and legal work, but tokenizing equity on Polymesh can make the process much simpler and more efficient. 

Investors can purchase tokens representing a portion of a privately held company’s equity and trade those tokens on Polymesh with embedded compliance rules, creating a more liquid market for private equity and making it easier for private companies to raise capital. 

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Bonds

Bonds are a common type of financial instrument used by businesses or government entities to raise capital. They typically involve the borrower issuing a bond to investors, who then receive regular interest payments over the life of the bond. At maturity, the investor receives the full principal amount of the bond back. 

As with other traditional securities, tokenizing bonds on Polymesh can make the process of issuing and trading securities much more efficient, cost-effective, and time-consuming by eliminating the need to rely so heavily on intermediaries such as underwriters and clearinghouses as well as manual, paper-based processes. Instead, tokenized bonds can be traded directly between investors and programmed to include certain features such as automatic interest payments and principal repayment.

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Challenges implementing blockchain in securities markets (and how Polymesh solves them)

While blockchain has the potential to transform securities markets by enhancing transparency, improving efficiency, and reducing costs, various challenges prevent participants from capturing its full potential. 

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Regulatory compliance

Currently, one of the most complex challenges is compliance. Securities markets are heavily regulated with many rules and regulations that participants must meet. These regulations play a key role in ensuring trades are conducted fairly and transparently, but compliance can be complex and time-consuming. 

Blockchain-based securities markets must be designed as Polymesh was with the intention of enabling regulatory compliance, which includes factoring in Know-Your-Customer (KYC) and Anti-Money Laundering (AML) regulations as well as securities law in various jurisdictions. 

On Polymesh, this is enabled by requiring participants to verify their identity with a third-party customer due diligence provider during onboarding, as well as adding attestations if needed. We’ll touch more on Polymesh’s unique identity system and compliance engine a bit further on.

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Chain interoperability 

Markets for tokenized assets can’t exist in a vacuum; they must be able to interact with the wider blockchain ecosystem as well as existing financial systems and infrastructures. This includes traditional trading platforms, clearinghouses, and settlement systems. 

Interoperability is improving capital markets by enabling these systems to interact with each other across various ecosystems, but it can be challenging developing the standards and protocols that allow for seamless communication, especially between blockchain-based systems and traditional ones. The task can only be completed with collaboration between the various stakeholders involved. 

For potential users of Polymesh, there’s comfort in knowing that Polymesh is Substrate-based. The Substrate family of blockchains is one of the largest blockchain ecosystems as the framework was designed specifically for easy chain interoperability. 

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Scalability for financial markets

On a daily basis traditional securities markets handle billions of transactions worth billions of dollars. To truly implement blockchain in securities markets, blockchain technology needs to be competent enough to handle similar volumes of transactions without compromising on performance and security. 

Achieving the level of scalability to fully implement blockchain in securities markets requires blockchain networks that have high transaction throughput, low latency, and minimal downtime. Designing blockchain-based systems that are up-to-par is a tricky task. Developers must pay careful attention to network architecture, consensus algorithms, and other technical considerations. 

For example, the engineers of Polymesh made it a key consideration to include financial primitives at the protocol layer. These layer-1 primitives provide full functionality for identity and tokenization, enabling innovative applications to be developed on top of the blockchain while ensuring operational costs remain low. 

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Reducing costs

Implementing blockchain can be expensive. The significant investment in technology, infrastructure, and talent that working with blockchain often requires can be a huge barrier to entry for participants, especially for smaller players in the securities market. 

To overcome this challenge and provide clear value proposition to market participants, blockchain needs to provably increase efficiency and transparency while reducing costs over the long-term. For both the creators and users of the technology, this means careful testing to ensure blockchain is delivering on this promise. 

On Polymesh, fees fuel the enabling economy by incentivizing ecosystem development while making it prohibitively expensive to perform an unintended or malicious transaction spam. At the same time, the amount of POLYX required for transactions is designed to be low enough to not materially impact legitimate users.

The Polymesh Association also offers grants programs to incentivize companies to build and take advantage of Polymesh’s low-cost infrastructure. 

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Awareness and adoption 

It may sound simple but one of the main challenges associated with increasing adoption of blockchain in securities markets is lack of awareness about blockchain technology. 

Blockchain is a novel technology that many market participants including issuers, investors, regulators, and other stakeholders are unfamiliar with. There’s both a lack of awareness about its potential benefits as well as a misunderstanding that blockchain equals Bitcoin or that all blockchain technology is the same.

This is changing as blockchain becomes more commonplace and recognizably viable for financial institutions. However, it’s still important for the industry to focus on education and outreach efforts that can help market participants implement blockchain more effectively. A good place to start is the Polymesh blog. 

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How Polymesh improves security and compliance of tokenized securities

In the above section we took a look at the challenges of implementing blockchain for securities markets and how Polymesh addresses them. Here we’ll take a look at 5 key ways in which Polymesh specifically improves security and compliance and how this can benefit issuers and investors. 

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1. Tamper-proof record of transactions

The secure immutable ledger provides a tamper-proof record of all transactions. Once a transaction is recorded on the blockchain, it cannot be altered or deleted, and all transactions require the consensus of Polymesh’s permissioned node operators before they are written to the blockchain.

This feature provides a high level of auditability and transparency and reduces risk of manipulation by malicious entities, as any attempt to alter the record will be immediately detected. Overall, the secure environment offered by Polymesh is critical for ensuring the integrity of financial securities. 

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2. Enhanced identity verification

Polymesh is a public permissioned blockchain. All participants must verify their real-world identity with a designated customer due diligence provider to be permissioned to access the network. Additional attestations can be added later as needed. 

Polymesh’s inclusion of identity verification during onboarding is critical for ensuring compliance with relevant regulations such as Know-Your-Customer (KYC) and Anti-Money-Laundering (AML) requirements. Participants in transactions can also leverage Polymesh’s unique identity system and sophisticated compliance engine to ensure that trades comply with compliance requirements in relevant jurisdictions and feel confident that they are interacting with verified parties. 

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3. A sophisticated compliance engine

Polymesh gives issuers of tokenized assets the ability to create and enforce automated compliance rules for their tokens, ensuring that certain transactions are automatically blocked should they violate specific rules. As a result, meeting specific regulatory requirements is much simpler. 

For example, if a transaction involves a party from a jurisdiction that is subject to sanctions, the transaction will automatically be prevented from succeeding. Ultimately, Polymesh’s sophisticated compliance engine helps ensure that all parties in a transaction are compliant with relevant regulations. 

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4. Customizable permissioning

Polymesh’s unique identity system allows participants to attach attestations to their on-chain identities as needed. Issuers of tokenized assets can leverage this functionality in conjunction with Polymesh’s compliance engine to control who can access and trade their securities.

For example, issuers can specify certain criteria that must be met for transactions to succeed, such as accredited investor status or geographic location. The result is a more secure and efficient environment for trading securities where issuers can ensure only qualified investors are able to access their securities and that access to investors who are not eligible to trade certain types of financial securities is properly restricted. 

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5. Reduced counterparty risk 

Polymesh reduces counterparty risk (the risk that one of the parties involved in a transaction might fail to fulfill its end of the trade) by making settlement on blockchain a reality. 

Most blockchains mitigate against counterparty risk with pre-funding, where transfer participants are required to part with assets in advance by pre-funding a transaction. The transfer is executed once counterparties agree on the terms (i.e. price and amount); however, this is far from fulfilling the possibility of instant settlement that blockchain supposedly allows. 

At the same time, counterparty risk is increased as users can agree to transfers without delivering the assets or agree to multiple transfers with the same set of assets. Layer-2 solutions can solve this problem but not without significant cost and reduced efficiency. 

Polymesh addresses these roadblocks to settlement with a unique, protocol-level asset transfer process that removes both the delivery failure problem and the need to pre-fund. As a result, counterparty risk can be mitigated with near-instant atomic settlement with the added benefit of eliminating the possibility of airdrops. 

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Each of the above features are essential to maintaining a stable and reliable environment for trading financial securities by improving security and compliance, as well as helping to reduce risk of fraud, financial crime, and other issues of regulatory concern. 

To learn more about compliance on Polymesh, visit polymesh.network/compliance.