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June 13, 2022

The number 1 thing you need to create compliant security tokens | Polymesh

If you want to create tokenized securities while remaining compliant, you’ll need to choose a blockchain security tokens can be issued on in a way that meets regulatory requirements.

There are lots of ways to create security token offerings (sometimes called tokenized securities or tokenized security token offerings), from using a tokenization platform such as Token Studio that hides the technicalities to actually programming the tokens yourself. 

Whichever method of token issuance you choose, the common denominator is that you’re utilizing blockchain. Needless to say, the underlying blockchain is incredibly important! 

But blockchain isn’t one-size-fits-all; there are numerous kinds for various uses, and every blockchain is nuanced in its design. Not all blockchains facilitate easy issuance of tokenized securities, just as not all blockchains will be compatible technology for an SEC-approved STO. 

For tokenized securities, you’ll want to choose a blockchain security tokens can be issued on in a way that facilitates regulatory compliance. 

Whether you’re planning to tokenize existing assets or planning a security token offering, your best bet is to use a blockchain such as Polymesh that’s built specifically for security tokens. 

Let’s find out why! 

What makes a blockchain security token-specific and why is it important?

Blockchains can be designed for one use-case in particular (e.g. security tokens, crypto), or they can be designed to be general-purpose (e.g. Ethereum, designed for both financial and non-financial protocols). 

General-purpose blockchains such as Ethereum might have large and versatile ecosystems, but they’re not the best fit for tokenized securities. That’s because tokenized securities are subject to complex regulations and need to conform to strict compliance requirements, just like their non-digital counterparts. 

From risk of hard forks (a legal and tax headache due to the duplication of assets) to the inability to guarantee verified identity (a requirement of capital markets that runs counter to blockchain’s original ethos), there are many reasons why a general-purpose blockchain wouldn’t sufficiently meet regulatory needs. It’s no wonder that security tokens are still in their infancy or that companies are reluctant to choose security token offerings or STOs instead of traditional IPOs. 

This isn’t to say that general-purpose blockchains are entirely unusable for tokenized securities. It’s been done! Even the team which engineered Polymesh began by building tokenization technology on Ethereum. 

The problem (as that team found out) is that general-purpose blockchains can’t provide the functionality needed to comply with evolving securities regulations without significant complexity in the end-to-end solution. As you’ll see below, this only makes the process inefficient, costly, and time-consuming– quite the opposite to the benefits blockchain promises to bring. 

The solution? Use a purpose-built blockchain such as Polymesh, which was built specifically for security tokens. 

With Polymesh– governance, identity, compliance, confidentiality, and settlement are built into the chain’s core. What does this mean? On this blockchain, security tokens and their operations don’t face the challenges traditionally associated with tokenizing regulated assets. 

But that’s not all! Not only does Polymesh’s purpose-built architecture streamline antiquated processes, but it also opens the door to further innovation and new products– whether in the form of security tokens, crypto (e.g. stablecoins), or even NFTs. More on that in our Roadmap.

Erasing the complexity of compliance 

On general-purpose blockchains, participants have to put in place increasingly complicated, often-proprietary systems to remain compliant. While these systems may add elements of automation to complex compliance rules, they still require manual intervention to deal with the convoluted process of complying with regulations in multiple jurisdictions. This ineffective automation affects all participants, making processes more time-consuming and costly. 

What’s more, these systems usually have to be implemented in the form of layer-2 solutions. Layer-2 solutions are solutions built on top of the chain that can implement complex frameworks, but the complexity required for implementing successive compliance rules can significantly slow down the system. Ultimately, layer-2 solutions push the chain to its computational limits as the number complexity of rules grows, resulting in higher computing costs and processing time. 

In the end, enforcing and keeping up with evolving compliance requirements is far from automated and instead just highly costly, time-consuming, and inefficient. 

But not for Polymesh!

Purpose-built for regulated assets, Polymesh gives issuers and investors the confidence they need to engage with tokenized securities by building compliance functionality into the core of the chain. 

With Polymesh’s on-chain compliance implementation, issuers no longer need to manually or semi-manually intervene to approve transfers. The process is simplified, faster, and cost-effective. It also expands the range of activities that can occur, ultimately increasing the investor pool and liquidity available to the issuer.

The most sophisticated compliance engine on the market

Through Polymesh’s sophisticated compliance engine, issuers have the flexibility to set complex rules around ownership and transfer requirements based on their specific needs and applicable regulations. Even very complex compliance requirements can be automated and enforced on-chain efficiently at scale. 

On Polymesh, compliance comes to life through attestations: on-chain evidence that an attribute of a user’s identity is verified true by a trusted third-party. Compliance rules and attestations work together to enable truly automated compliance, with compliance rules using smart extensions to automatically check that the correct attestations are in place to permit token transfer. 

Attestations can be based on the token without any action from the user (e.g. a lockup tied to when a token was issued) or they can be based on the unique identity of the user (e.g. jurisdiction of residence) and verified through a third-party KYC provider. What makes the latter possible is Polymesh’s Unique Identity System (PUIS). 

With PUIS, investors’ on-chain attestations are linked to on-chain identities tied to their real-world identities. Security token issuers no longer need to manage their permission lists for who can own and what can be done with their tokens, or capture and store information about investors centrally. 

Conclusion

Choosing the right blockchain for security tokens is important for anyone looking to create tokenized securities, but it’s especially important given the legal requirements securities are subject to. If you want to create an STO, you’ll need to ensure the technology will allow you to meet regulatory requirements– and ideally the blockchain can meet them without compromising on the technology’s benefits. 

Creating tokenized securities that can meet regulatory requirements doesn’t have to be a headache or limit the blockchain’s benefits if you choose a blockchain for security tokens such as Polymesh, which is built to accommodate the key regulatory needs– governance, identity, compliance, confidentiality, and settlement. For more on how Polymesh facilitates secure and compliant securities operations, see our key pillars overview

Want to dive deeper into how security tokens are created? Check out our blog post on the basics of creating security tokens, or read up on how to issue security tokens on Polymesh. 

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