Foreword: One of the biggest functions of the blockchain is the certification of assets. For example, the legalization of legal currency, gold, and real estate is being explored, but not all assets are suitable for generalization. Even assets that can be certified are faced with many difficulties. The first is how to achieve compliance, and the second is how to ensure the recourse and ownership of the certificate (when it involves physical assets).
The author Albert Ho thoroughly analyzes the advantages and disadvantages and feasibility of asset certification. This article was translated by the "Blue Fox Notes" community "Sima Qing Shirt". In 2017, the utility token and the first token public offering were widely publicized. In 2018, asset certification and securities tokens and corresponding platforms have developed. The emergence of platforms such as TrustToken, Harbour and Polymath is particularly evident in the United States. In Asia, this trend has also risen. For example, the Rate3 network has received investment from a number of well-known Asian venture capital firms such as Matrix Partners China and distributed capital.
Conceptually, it seems to be easy to achieve: issuing an ERC20 token (or issuing tokens on any other blockchain), giving the token legal rights and ownership, and then making it easy to trade. However, this needs to be sorted out clearly: how to distinguish between claims and ownership? What are the differences between the different types of assets? What are the obstacles to the adoption of universalization?
Comprehensive consideration of the need for understanding of blockchain and smart contracts, law, finance and economics. In this article, I want to give a comprehensive introduction to asset certification through the use of real estate as a prime example. Below we will discuss:
What is the generalization? (Isn't it just securitization?) What are the real benefits of pass-through? (Why are we so troublesome?) What are the more difficult issues to consider? (How do we ask the right questions?) What are the challenges of Citation? (What prevents it from being adopted?) What is the future prospect of CIS? (What are the elements?)
What is universalization? Isn't it just securitization?
For structured finance professionals, it seems that securitization is like securitization. In summary, securitization involves the following steps:
1. The sponsor (asset owner) collects the assets in the asset pool and transfers the pool of funds to a legal entity (usually a special purpose tool). Through this legal structure, assets are not exposed to counterparty risk or the bankruptcy risk of the sponsor's bank.
2. According to different risk levels and characteristics, SPV divides the assets in the asset pool into several parts. Securities are issued and supported by cash flows generated by related assets.
3. After issuing the securities, SPV sells the securities to the investors and transfers the proceeds to the promoters.
Securitization has many drawbacks: the typical securitization process is very expensive and takes a lot of time. The entire process can cost millions of dollars and can take up to a year. The securitization process needs to reach an agreement with the parties in the case of information asymmetry, as well as the heterogeneous structure of asset data.
In addition, the lack of complete transparency at all stages of securitization hinders the auditing and rating of related assets. In the subprime crisis, there was no transparency in the credit pool and audit procedures that led to the issuance of bonds.
Obviously, generalization does not mean securitization.
Pass-through, by its simplest definition, refers to the conversion of assets into digital tokens on a blockchain system. The biggest difference between pass and securitization is how to introduce programmability into the certified assets. In this way, business logic can be introduced to reduce the need for manual settlement. Smart contracts can have automated trading capabilities, formulas for calculating asset prices, and other specific functions.
What is the real benefit of universalization?
Many studies have discussed the various benefits of liberalization, but these benefits can be grouped into three core principles: (1) liquidity, (2) programmability, and (3) immutable proof of ownership.
Key Principle 1: Liquidity
The World Economic Forum predicts that in the next decade, 10% of the world's GDP will be stored in encrypted assets, totaling $10 trillion. This is mainly due to the increase in partial ownership and the release of the liquidity premium.
(Note: The so-called partial ownership means that there is a part of the equity of an asset. For example, a painting worth 5 million yuan, for tokenization, a total of 5 million tokens, if a person buys 50,000 Token, then, is equivalent to owning 1% of the painting, that is, part of the ownership)
Assuming that there are no legal and regulatory obstacles, pass-through allows for partial ownership. Most passes can be broken down into 18 decimal places, while French currency can only be broken down to $0.01. Part of the ownership has lowered the entry barrier for new investors. For example, I don't need to pay $1 million for a new apartment, but instead get a partial share of it by paying $50,000 in tokens. For investors, partial ownership and lower barriers help them increase the diversification of their portfolios and build a “more realistic” market portfolio.
The increase in liquidity helps to unlock value for the market through liquidity premiums. When illiquid assets become more liquid, they will unlock about 20-30% liquidity premium. Real estate is an example: even if the sales price of these investments is slightly improved, it may bring trillions of dollars in new value to issuers and distributors .
Key principle 2: Programmability is built into the certificate
Programmability refers to the ability to introduce certain business logic into a smart contract, allowing automatic events to occur. Pass-based can also make it easier for investors to manage their assets and rights. Secondary transactions can be easily tracked by working with third-party exchanges, allowing investors to receive distributions and exercise other rights (such as voting) through the blockchain.
Programmability is especially useful for improving the speed of settlement. In traditional finance, settlement refers to the process of recording the transfer of ownership of assets before the actual transfer of ownership of the assets. If all participants have a digital identity that has undergone relevant compliance/KYC/AML checks, then compliance can be programmed into the pass.
Key Principle 3: Proof of proof of ownership that cannot be tampered with
The blockchain is not tamperable and it retains the public trail of each transaction and owner. The digital trace of such transactions not only proves the history of ownership, but also helps ensure less fraud. The non-tamperable structure makes it impossible for the holder of the pass to “double flower” its token – to receive the same certificate from two different sources. This helps to assure investors that no one can falsify a transaction after the transaction has taken place.
Let us know more about the certificate. Pass-through is the process of digitally storing the property rights of a value object (asset) on a blockchain or distributed ledger to transfer ownership through a blockchain protocol.
What are the challenges?
Question 1: What are the requirements for certification? There are 3 basic requirements:
1. The rights of assets can be stored digitally on the blockchain
Let us return to the real estate example. If I want to pass on my house, I must be able to record my ownership of the house with the pass. This means that for the regulatory authorities, the possession of the certificate represents the ownership or claim of the house itself.
2. These rights can be legally transferred through the blockchain
Although I can record my rights to the house in a legally recognized manner, I should be able to transfer these rights to anyone I want to transfer, and that person will have legal ownership of my house, provided that my pass has ownership .
3. The pass can be easily converted into value, which is to give the asset "value"
Finally, like any securities, I must be able to easily convert my real estate certificate into “value” so that I can give value to my assets.
Question 2: What other legal issues need to be considered?
In addition to these three requirements, it is more important to pay attention to the exact asset object you are in the context of the pass: Does the pass represent the recourse of the asset or the actual ownership of the asset itself? Investors and pass issuers must carefully consider what the pass represents.
The truth is: it depends on what you want to pass. Pass-through is a flexible process. Taking real estate as an example again, it can be the direct ownership of real estate (the owner of some equity), the right to lease income, and even the right to use the property (rental apartment).
(Note: The certification itself is very flexible, it can pass the ownership of the asset itself, and can also pass the income generated by the asset itself, or the right to use the asset itself. Therefore, it is necessary to pay attention to the specific evidence-based asset object)
Thus, a pass may represent the ownership of the underlying immovable property, the interest on the debt secured by the asset, the interest in the legal entity that owns the asset, or the right to cash in the asset.
There are three basic rights to understand . The rights conferred by a generalized securities (or securities pass) can be complex and difficult to understand. However, a certified security may include a recourse to an asset (usually including the resulting cash flow), direct ownership, governance, or a combination of all rights.
1. Recourse: Claims for specific uses (and recourses) of assets only 2. Ownership: equity ownership and control of assets 3. Governance: a system in which groups can make unified decisions
Let us explain this again with real estate and give examples of the rights of the holder of the pass:
1. Recourse, but no ownership: The holder of the certificate has the right to receive cash flow from the ongoing lease, but they do not have the “equity” and “ownership” of the underlying real estate.
2. Recourse + ownership: The holder of the certificate is the "owner" of the underlying real estate that seeks recourse to the cash flow. They can make decisions directly: how much rent to collect, investment in maintaining real estate, hiring employees, and taking into account the proceeds from selling real estate.
3. Ownership only: This example rarely appears, but it means that the holder of the certificate is now the “owner of equity” in real estate.
What are the challenges of these different rights? There may be a separation between recourse and ownership, which will result in inconsistent incentives between the parties.
What if the … holder of the certificate has ownership? How do 1000 holders collectively make the best asset decisions? Do you need to delegate a vote or make a decision? What if the … pass is only to recourse to the holder of the certificate? The pass issuer (owner) can reduce the profit and cash flow of the pass holder by reinvesting. This will harm the interests of the holders of the certificate who originally focused on future cash flows.
Smart contract geeks may ask: Can't you automate all of this logic in smart contracts? No, smart contracts can't solve all of these problems.
Contracts and smart contracts are incomplete:
1. The contract can only be executed if the event and behavior can be verified by a third party.
This is a long-term problem of the "prophecy machine" in the pass. Some events can be implemented in code, but it is almost impossible for any arbitrator to determine if they have actually happened.
For example, I issued a real estate certificate to the holder so that they can get a portion of the rental income. However, I may not have recorded all the lease agreements, so the holder of the certificate does not know what the actual rental income is. If this is not done effectively, there is no reason for the parties to comply with the smart contract.
2. It is almost impossible to write a contract that includes all possible conditions and events to achieve “integrity”.
The problem with the contract is not in the contract, but in the contract. Writing down every condition and event is very time consuming and laborious, and it is also a challenge in operation. In addition, events and conditions in real life will change, and contracts must adapt to these real-life changes.
Given the incomplete limitations of smart contracts themselves, certain asset types should not be certified.
What should not be certified?
1. When the blockchain cannot fully capture changes in asset ownership
There are some assets in the market where people can sell physical assets directly outside the agreement, even though it has been certified. For example, I can pass the real estate certificate and pass the pass to you, but I can legally sell the same property to others.
In other cases, I can trade the pass, but I can't make sure I can verify the authenticity of the underlying asset. In terms of real estate, it is easier to verify, but there are other examples, such as gold bars. If a large amount of cost and resources are needed to verify its authenticity, it may not be a viable solution.
2. When the use of price prevents the agreement from achieving its objectives
In some cases, we don't want to decide who can get what by price. Sometimes, prices cannot capture the social benefits and costs of spillovers, and may not be the most equitable way to allocate resources. For example, social goods. (Note: Social goods refer to public goods.)
3. When we just don't want to pass certain "assets" and rights
For example, the rights to birth certificates or educational records should not be universalized because they represent a unique right. We will not, and should not, pass these "assets".
Obviously, given the limitations of real life, some asset classes should not be certified.
How to truly pass the certification?
We have already discussed the content and reasons of the pass, and now let's talk about the way of pass. Several types of assets have been certified:
Legal currency: The legalization of legal currency has led to an increase in the use of stable currency. Tether is the first example, it created the USDT. However, Tether also has inherent challenges.
Gold: Digix is an example of a gold pass.
Each DGX is a 1:1 gold support, and one pass represents 1 gram of gold in 99.99% purity. It comes from the London Gold and Silver Market Association certified refinery and gold is stored in the insurance vault. Buying 1 DGX Pass is equal to buying the actual gold itself.
Real estate: Considering the analogy between real estate investment trusts and universal real estate, my main interest is real estate. How Manhattan real estate is certified, or how part of St.Regis Aspen is certified, and these recent examples are very interesting.
For St. Regis Aspen, each Aspen Pass represents an indirect ownership interest in the t. Regis Aspen REIT common stock. According to high returns, “REIT provides a tax efficient structure, while blockchain provides peer-to-peer investment and cross-border transactions, which is easier for investors.”
Obviously, there are many challenges in the certification process.
1. Lack of standardized standards and legal infrastructure
Pass-up is not just about creating a pass – any developer can do it. Instead, it is about the design of the entire system, including understanding the various rights and issues we discussed earlier. How to deal with these issues by the standardization of the standard:
· Incentives (recourse, ownership, governance) · User and system administrator privileges (who operate the license contract) · Asset lifecycle management (issuing, payment, extraction) · Security management · Integration of different jurisdictions KYC / AML requirements for the district · Integration with the exchange · Interoperability between different public chains
In the case of cross-chain interoperability, we did see a public chain with different initial characteristics. For example, Ethereum has scalability issues, but provides a more sophisticated Turing-complete smart contract. So what about other public chain networks?
How do you implement interoperability of certified assets (in the form of a pass) on these different chains?
2. Digital identity recognized by law worldwide
From a regulatory perspective, issuing and transferring assets between citizens in different jurisdictions is a regulatory nightmare.
Suppose I am an EU resident seeking to pass on my own real estate, which has only recourse (note: simply understood as income rights). How do I transfer this pass to the Americans, considering their identity, KYC/AML issues, US regulations, taxes, and all other issues?
How can I reasonably and easily trade in a legally compliant manner with our verified and certified US citizens in our two national jurisdictions?
3. Pass-through does not mean immediate liquidity
Liquidity is the biggest challenge in the field of securities clearance, and it does not happen organically. History has provided us with examples of various financial markets and financial instruments that have not yet reached significant levels of liquidity. By allowing institutional investors or recognized retail investors to adopt hosted solutions will be key to promoting liquidity creation. Of course, the underlying asset must be useful.
How do we introduce long-term, sustainable solutions to large institutional investors (market makers) to create and sustain liquidity?
What is the future of universalization?
In general, I am optimistic about the future of certification: a fairer, more equitable world, with lower entry thresholds and lower capital requirements for individuals or businesses.
By capturing value in certified assets, we can reshape the complexity of the existing financial and operational world, reducing operational costs and complexity. When combined with the complex business logic entrusted by smart contracts, we can faithfully and more effectively express complex business interactions.
Interoperability through standardization
Take the ERC 20 certification standard as an example
If the ecosystem of global assets is interoperable, this means that we can hold back on the same platform for ownership of assets such as commercial buildings, early equity, corporate bonds, T-bill, and single-family homes.
Different assets can be referenced to each other by contract and interact in an automated manner. This means increased liquidity across all asset classes.
ERC 725 for identity authentication
Fabian Vogelstellar (the creator of the ERC 20 standard) is providing a unique decentralized identity for "humans, organizations, objects and machines." Directly quoted from ERC 725 Github: "This identity can have a key to sign the action (transaction, document, login, access, etc.) and recourse, these keys are certified by a third party (issuer) and self-verified (# ERC735), and the proxy function that acts directly on the blockchain."
There are some well-known projects that have been working on implementing the ERC 725 identity contract. For example: Origin protocol and Rate3 network.
The future of universalization has not yet arrived, but it will be faster than we think.
We are optimistic about the future of the certification of securities and securities. The generalization we have observed today has many elements in the future:
1. The government is increasingly working with private companies to create infrastructure solutions
One example is the cooperation between NASDAQ, the Monetary Authority of Singapore (Singapore Central Bank) and the Singapore Exchange (Malaysia's major stock exchanges) to develop delivery and payment functions for use on different blockchain platforms. Clearing certified assets to improve operational efficiency and reduce settlement risk.
2. The project has recognized the need for compliance and is creating solutions for automation compliance and AML/KYC
It has now touched on the need to integrate real-world legal requirements into the blockchain space. There are many projects around the world that do these things:
Harbor: A compliance platform and agreement to ensure that the issuance and trading of the Securities across the globe is in compliance with current securities laws. Rate3 Network: A protocol for handling asset authentication and identity management on the Ethereum and Stellar blockchains. Polymath: A secure pass-through platform on which to establish regulatory compliance.
I did notice that more blockchain projects are building a Citation solution for different asset classes. For example, by issuing debt and equity passes to simulate different ways of structured financing. More importantly, these solutions know that working directly with regulators, working with central banks and other projects will help improve the entire ecosystem. Ensuring the legal design of the entire system is key.
3. “The path of least resistance” will help everyone connect existing instances to the upcoming Citation project.
Real estate has always been an example of a generalization project. This is due to the structure of real estate investment trusts (REITs), which can be more easily linked to the generalized structure.
Generalized real estate is not a real estate investment trust, but we can use various principles to help us better understand, connect and think: for example, property rights, the economics of real estate investment trusts. Not everything can be clarified, but those that can be certified will be clarified.
Risk Warning: All articles in Blue Fox Notes do not constitute investment recommendations. Investment is risky. Investment should consider individual risk tolerance. It is recommended to conduct in-depth inspections of the project and carefully make your own investment decisions.