“Due to the precision of software and mathematics, cryptocurrencies are some of the most fungible assets in the world.” – World Crypto Index

A dollar is a dollar is a dollar
In today’s world of digital currencies, attention has been heavily placed on security tokens because they are subject to regulation and typically tied to assets with real-life value (real estate, companies etc.). These tokens appeal to investors because real-life assets provide a means to measure the actual value of the tokens, making their value more tangible and potentially more akin to fiat currencies. Ironically, fiat money was once itself backed by gold  – the gold standard meant that banks accepted these notes for gold; however, in 1971 this was terminated and money was no longer backed by anything of real value. When you consider this reality – there may actually be some merit in applying value to tokens over fiat currencies.  

Security Token Offerings
Interest in security tokens has grown significantly, and governments such as the Gibraltar government, are seeking an extension to its license so that it may provide a security token exchange on its servers – which would be centralized. While this initially sounds like progress – this walled garden approach is founded on flawed thinking. The appeal of the crypto market for many is that it is decentralized and is based on peer-to-peer (P2P) networks without intermediaries. Reliance on the Gibralter government or any other government undermines this philosophy.

P2P networks maintain the fungibility of cryptocurrencies because and there is no threat to the value of these assets being reduced arbitrarily in an open, decentralized market. Conversely, centralized exchanges have been known to selectively reduce the value of particular tokens at their discretion,  for example – when a token is of unknown origin the exchange may elect to reduce its value. In the world of fiat currencies, a dollar is a dollar is a dollar…and, currency values should not be reduced – but rather, compliance procedures should be actively implemented.

Centralization Doesn’t Equal Security
Centralization typically means points of weakness regarding security, stability, and a fair market. Most banks operate using a centralized database. It only takes one qualified hacker to code their way through the system and access the information needed to rob people of their life-savings. We also don’t know how “fit” the individual verifying values and transactions really is. The combination of cryptography and “sharing the burden” with a P2P network allows decentralized mediums like blockchain to enforce a secure value transfer.

Programmatic Compliance
There are many ways to enable compliant secondary trading without centralization. A viable alternative to the walled garden approach is embedding compliance into a token during token issuance. By using an accredited issuance platform, regulatory requirements are applied at the token level and this approach does not limit trading to one or few centralized exchanges but instead propagates trading across many decentralized exchanges.

Decentralization Protects More Than Just the Value of Your Tokens
In the early days of the world-wide-web desktop computers communicated directly to servers and other desktop computers. However, with the proliferation of digital giants like Facebook, personal information has become increasingly stored in centralized data banks by third-parties which have resulted in major data breaches such as the Cambridge Analytica scandal, in which Facebook profiles were harvested for the purpose of steering the 2016 political election. Decentralization means that these breaches can be more easily avoided.

Increased security and the ability to trade in larger and more liquid environments all make decentralization increasingly appealing. By removing third-parties the blockchain becomes a trusted ledger where all assets are equal – and wasn’t this the point?

Challenges of Decentralization
From a legal and financial perspective, aspects of decentralization do not come without challenges. For instance, global peer to peer indexing allows anyone to post a buy or sell order, against market rates, using a smart contract to fulfill the order, rather than an exchange. Compliance practices such as KYC and AML, as well as due diligence checks, are necessary to ensure the integrity of the blockchain ledger as a trusted record of trades – especially when the token is determined to be a security.

If compliance is embedded at the token level and value is assigned correctly to each token then trade in-between tokens and value systems offer fungibility in its optimal form. Security tokens and decentralization bring improvements to traditional financial products by removing the middleman from investment transactions. This removal has a ripple effect leading to lower fees, faster deal execution, free market exposure, a larger potential investor base, automated service functions and so on.

A New Source of Truth
The world is changing, decentralization and tokenization are no longer foreign concepts. The traditional and decentralized economies are becoming more integrated, and the preservation of asset-fungibility on peer-to-peer networks is successfully occurring without intermediaries.

Once an asset is tokenized using blockchain it can trade much more efficiently, but this does not eliminate the need for compliance. This means a shift in the status quo and regulations for both traditional and decentralized finance.

About Prefacto
Prefacto is a token compliance tool offering free audited smart contracts, global best-in-class KYC/AML for over 160 countries, source of funds reports to help issuers open bank accounts after completing a crowdsale, and programmatic secondary trade management. Register now: https://platform.prefacto.net/Account/Register

About iComply Investor Services Inc.
iComply Investor Services Inc. (iComply) is an award-winning software company focused on reducing regulatory friction in the capital markets. With powerful data, verification, tokenization solutions, iComply helps companies overcome the cost and complexity of multi-jurisdictional compliance to effectively access new markets. Learn more: iComplyIS.com

So you’ve issued a token, and things seem to have gone off without a hitch; however, that doesn’t mean that your compliance days are over – you’re still responsible for that token and the source of wealth for the person who holds it.

Unchecked secondary trading of tokenized asset opens the door to sanctions violations, facilitation of money-laundering and the ability for bad actors to use your token to fund the next terrorist attack.  

The use of blockchain in finance continues to grow exponentially – from central bank adoption to micropayments – with more successful use cases moving from pilots to production implementations. Perhaps no area has grown as much as the use of smart contracts to create “tokens”, fractional ownership units for private equity, debt, real estate, and funds. 

Awareness and usage of cryptocurrency have proliferated in recent years, with 2017 bringing an estimated $680 million of investment into blockchain assets. However, this dramatic growth was met with an equally dramatic number of scams and security breaches, with $23 million being lost daily due to malicious actors, gaps in compliance or sheer negligence.

This rapid growth comes as no surprise for those that have endured the inefficiencies, redundancies, and even human error or manipulation in the finance industry. These are some of the issues that have pre-empted the dramatic growth of the crypto and digital finance space at large.

Decentralization of financial services meant freedom from bureaucracy, gouging fees and piles of paperwork. Clearly, this was attractive. Financial services haven’t truly been disrupted at this level since the introduction of the banks themselves, which provided a trusted intermediary for transactions.

With Great Freedom Comes Great Responsibility
Despite its benefits, decentralization has also meant little protection for those choosing to engage in the early, wild west days of cryptocurrency. But this all changed forever in June of 2017 when the SEC announced that ICOs could be subject to securities laws.

As an issuer – from the moment you issue a token, you are responsible for that token for the rest of its existence. If an ineligible purchaser or a bad actor takes ownership of the token, perhaps via from one of the many crypto exchanges operating in grey markets or with meager KYC/AML requirements – the issuer is put at risk.

Multi-Jurisdictional Compliance
Running to Malta or the Bahamas also doesn’t change this requirement. One of the biggest knowledge gaps in this market is awareness of the fact that compliance isn’t actually about where the issuer is – but where the investor is. And each new locale – be it national or at the local level (various states in the U.S. have different rules around securities). Even if KYC/AML screening is adequate in one state, the requirements will likely vary and may even take on a different meaning in a different jurisdiction. Politically Exposed Persons Screening (PEP) varies significantly across different nations.  

Hair of the Dog – Programmatic Compliance
Interestingly, it is the same decentralized and public blockchain ledgers that opened the minds of the world to the benefits of decentralization (and gave us the wild-west of cryptocurrency) that also have the ability to technologically surpass the highest standards of compliance, integrity, and transparency of any multinational bank or financial institution.

iComply makes it possible for token issuers and investors to rely on Prefacto™ compliance, which means that the tokens have been developed to commit only those transactions which adhere to the rules that have been programmed into them. These rules could be securities laws for security tokens or other rules required for a particular utility token (eg. Sale restrictions).

See how iComply addresses these issues with a personalized demo.

About iComply Investor Services Inc.
iComply Investor Services Inc. (iComply) is an award-winning software company focused on reducing regulatory friction in the capital markets. With powerful data, verification, tokenization solutions, iComply helps companies overcome the cost and complexity of multi-jurisdictional compliance to effectively access new markets. Learn more: iComplyIS.com