Securities on Blockchain: Revolutionizing Capital Markets – Interview with Alex Nascimento, UCLA

@Ishan PandeyIshan Pandey

Technology Lawyer working on code and everything law.
Founder : Blockchain Research

Welcome to our series, “Behind the Startup.” Tell us about your book on Security Token Offerings (‘STOs’) and your journey into the blockchain industry?

Therefore, in the journey of developing the curriculum for the course, I found that there were very few books available on the subject, and that was one of the reasons that motivated me to write the book. In addition, as we all know the Security Exchange Commission (SEC) of the United States deemed almost all ICOs as an unregulated securities offering, so not only as an investor but as a company and as an academic representing the UCLA blockchain effort, we focused this book on how to use blockchain for different business applications and how to raise funds via token offerings that are fully regulated and compliant not only within the United States but also in many other jurisdictions. Thus, the book provides information and guidance to jurisdictions that are also friendly to this kind of blockchain venture. The book’s name is  “The STO Financial Revolution – How Security Tokens Change Businesses Forever” and is available on Amazon. We are thrilled to be launching our 3rd edition of the book (updated) in conjunction with my FALL 2020 course at UCLA that start SEP 28. Our online UCLA Blockchain course is open to the general public and no technical expertise is required.

Can you explain what security tokens are and how does it work?

A Security Token is a file registered on a blockchain that represents a securities contract. Most variations of investment contracts are considered Securities in most of the main financial jurisdiction around the world, thus, need to be regulated. The idea is that regulators regulate investment contracts to protect investors from fraudulent investments that are not compliant to the laws in specific jurisdictions. For example, in the United States, the Security Exchange Commission (SEC) regulates and oversees all types of investment contracts. Whether you are exchanging money for a potential gain or an opportunity to gain in the future or generating value through the efforts of others. So, a security token offering is the representation and offering of that investment contract registered and
transacted on a blockchain. So because of the various advantages of security, transparency, and immutability offered by blockchain technology,  a Security Token Offering is an investment contract just like you would do get when buying stocks of a company like Microsoft, or Apple or any other. That digital representation of ownership of a company through a company share is nothing more than an investment contract between you
and the company now being stored and registered in a blockchain as a Security Token. Security Tokens can represent many different types of investment contracts, and that’s one of the reasons why it is going to revolutionize businesses forever as businesses will adopt STOs as a key financial tool representing different forms of investment opportunities!

Now, how do Security Tokens work? They work just like every other token on a blockchain. Just like company shares; STOs can represent a set of rights, clauses, and parameters defined by a smart contract, and this digital investment contract (STO) can be transacted between different investors via the blockchain.

Now, from a regulatory point of view, this STO trade should behave very much like a “pen and paper” contract, but now the contract is represented via a digital file stored in a blockchain and regulated by the competent organization of each jurisdiction in which that contract is being (or was) issued. In the case of the United States the regulator is the SEC.

Now we are having the evolution of the security token space, which are all these types of institutional-grade investment contracts being recorded and
transacted via blockchain. Then, one may ask, why are financial institutions
doing that? The answer is simple because the cost of managing a paper contract is exponentially higher than the cost of managing a digital version of that contract (which has a smart contract feature in the digital file that allows automatic execution and automation of many of the processes related to managing, transacting and settling that investment contract). So the cost reduction of automating that management of shareholders and investors on a paper-based is significantly reduced by the utilization of Security Tokens on a blockchain!

How are assets tokenized on the blockchain?

Like I mentioned in your previous question, what is being registered on a blockchain is the investment contract that represents an underlying asset as the main asset linked to the investment contract. If someone wants to tokenize an office-building complex, what we are actually doing is registering the shares (investment contract) of that building fractional ownership opportunity in a blockchain, just like it has been done for decades on a “pen and paper model” but now in a digital version. What we
are bringing as innovation is registering these investment contracts now being represented via a smart contract technology that self-execute many of the clauses on the contract, eliminating the middleman in the transaction. So what we are actually tokenizing is the investment contract to that specific underlying asset or, in this case, the office-building complex.

According to you, how will securitization of assets disrupt our economy?

The way tokenization of assets is going to positively impact the economy is that it will allow for a series of entrepreneur executives, companies, and asset owners to tokenize their assets, such as a share of their company or real estate property and to create financial products related to those assets. The first advantage of tokenization is gaining more liquidity, which helps if you are tokenizing, a traditionally illiquid asset such as a startup company share, for example. The second advantage is the democratization of the access to types of investment, which were traditionally only available to institutional or professional investors (like early share from Uber).  The third advantage is the automation of the management of that investment contract or shareholder agreement. This allows the fractional ownership to be sold at a very low entry cost because the cost of managing an additional investment is marginal (and very low when compared to traditional back-office costs).

What regulations and compliances do we need in place to support the development of STOs?

The regulation necessary for STO depends exclusively on the jurisdiction that the token is being issued at. In United States, we already have the JOBS Act, which stands for Jumpstart Our Business Startups Act, created under the Obama Administration. That regulatory framework is fully approved by the SEC, and in July 2019, the SEC approved not only one but two public token offerings, in which Security Tokens were sold to
the general public regardless of them being accredited investors. STO regulation around the world has become much friendlier, including jurisdictions like Cayman Islands, Singapore, and Bahamas, being among the most friendly and the ones we advise our clients to work with.

The safety of funds remains a significant concern for investors and users. How is the security of tokenized assets protected?

The protection of funds for investors is a crucial pillar for the adoption of Security Tokens across different industries and across the globe. Thus, it is important to understand how Security Tokens can protect the funds of investors. An STO, by definition, is a fully compliant and regulated investment contract, so like any other investment contract in United Stated,  a US-based STO is fully regulated by the SEC. By default, an STO always needs to comply with all the necessary rules, regulations, and requirements and is under the oversight of the respective local governing regulatory securities agency.

What trends and challenges do you see ahead for the Security token (STO) industry?

The Security Token industry has the mission of democratizing investments across the Internet. For that to happen, a jurisdiction approach that’s more encompassing of a globalized environment interconnected world is necessary. Another challenge that the industry is facing is the consensus over a specific protocol of blockchain technology that should be used to develop most of the security tokens. A third challenge that I believe that the security token industry faces is mass adoption. Currently is easier to create an account on a regular cryptocurrency exchange than in an STO exchange.

The reason is that STO exchanges require much more documentation from investors to be fully compliant with all the procedures of KYC and AML necessary to transact regulated investments. Nevertheless, I’m very confident that we will overcome all these challenges with more friendly STO regulatory frameworks, a working technology protocol consensus among key issuers like Polymath, as well as much better user experience for investors and issuers.

What has been the impact of Coronavirus pandemic on Security tokens? Has the pandemic accelerated the growth of STOs?

I haven’t seen any data that creates a correlation with the pandemic. From my personal standpoint, as the managing director of 7CC Blockchain Investments, which is a firm that invests and provides advisory in the blockchain industry, we’ve been seeing a lot of demand from clients and exchanges to tokenize assets and products. Thus, we’ve experienced significant growth in our business due to the higher demand for our services, such as tokenization of European bonds, prime real estate, and startup companies.

Therefore, I believe that the industry has been growing as it’s clear the
rising number of STOs being offered in exchanges around the world, including tZERO in the United States, and iSTOX in Asia, so I’m definitely very excited about the future of the industry.

According to you, what is going to be the effect of coronavirus pandemic on technology and corporate behavior?

I believe that we are adapting to work more remotely in general, and obviously, tech is one of the industries that most benefits from this trend. So, I believe that we will see a greater expansion of the tech industry, as we become a society that is every day more technologically interconnected. Obviously, there is still a lot of intrinsic value gained through personal interactions in business, so I personally believe that remote work will increase, but personal meetings and office interaction will still remain very valuable.

What are your views on the global economy right now? Further, according to you, what challenges lie ahead?

We are living in an era where we are extremely connected via the web and the different technologies that we consume as a society today. As that interconnection between people keeps on growing and becoming more important, we also see political and economic tensions growing among
the key players of the geopolitical arena.

I believe we are in a race for geopolitical and monetary power, as well as technology leadership. Tokenization of assets and digital currencies are going to play a major role in driving people’s adoption of blockchain technology because we are so interdependent, and our need to transact using a preferred and commonly accepted form of currency will result in the increasing use of specific technologies, like blockchain. I believe this is all intertwined in a socioeconomic fashion. We see Countries like China really charging ahead to promote their political agenda, developing and distributing their technology at a global level, as well as innovating with a central bank digital currency and a supply chain network built on the blockchain like the belt and road initiative. Those efforts together are promoting China as the next superpower.

This is something that we, as an investment firm, base our projections on. The growth of China will be immense, and we all are going to see a major adoption of Bitcoin and other digital assets in the very near future.