The SIX exchange in Switzerland lists 60,000 products including stocks, bonds, exchange traded funds, exchange traded products, and structured products. Source : SIX website. However, the number of unlisted securities registered with SIS, the central securities depository (CSD) in Switzerland has 800,000+ products. Source : BIS.

Unlisted securities are privately placed primary issues and secondary traded over the counter. Distribution is limited, price discovery scarce, and pricing spreads can be unreasonable. These are big challenges that issuers, asset managers and investors face. We have used a combination of open banking based payments and open finance based custodian integrations to address these challenges.

Asset managers can view holdings that their clients who are investors have with various banking custodians. All they need to do is select a supported custodian where the client has an account and connect to it.

They can then select any asset held and distribute them on the Verified Network that connects to asset and wealth managers in Switzerland and overseas. The screenshot below from the test application shows a publicly tradeable stock that is put up for sale.

Purchasing an asset involves selecting a bank by an investor and processing the payment to prefund its broker account that executes the buy side trade. The sell side order is initiated on the Verified Network application and routed to the custodian where the assets in account are held currently. If the investor is resident in Switzerland, the Verified Network application lets it select a Swiss bank for payments.

For offshore investors, payments are made to a Swiss broker dealer that executes the trade and keeps the asset in custody for the investor. Products distributed on this system comply with regulations related to the types of investors that can invest, and also the the types of products that can be publicly distributed or otherwise.

The system thereby enables the distribution of private and unlisted assets through verified channels, price discovery and settlement of trades with tigher spreads through trusted custodians and broker dealers that investors have accounts with.

This system is expected to launch this year.

For any information and inquiries, please write to interest@verified.network

Creating distribution and liquidity for unlisted securities in Switzerland was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Investment products such as shares, bonds, etc are entitlements to cash flows they produce to their holders. So, if you buy a bond that pays monthly interest, holding the bond entitles you to receiving that interest amount every month.

But as an investor, are you always aware of what you can expect to be paid off on your investments at any given point in time ? A fixed interest might be easier to calculate, but what about floating rate products. And it gets more challenging as the products become complex. Imagine a structured product with underlying bonds and options.

And it is not just about calculating pay offs from investments, investors also lose track of when important events occur in the lifecycle of products they have invested in. When is the next interest due ? What is the record date for a bonus that is announced on a stock ? When does a product become redeemable ? Has anything happened that breaches the terms of offer for a product ? And the list goes on.

So, does your regular securities brokerage account give you all the information ?

Or does the mere digitization (dematerialization) of investment products make them smart enough to provide you all the information investors need from them ?

The answer is ‘No’. Digital brokerages and Digitized securities are not enough.

This is where ‘smart contracts’ come in. A smart contract is software code that represents the terms that the investment product is offered at to investors. Examples of terms include coupon rates, redemption schedules, strike prices, calendar conventions for reset dates and distributions, etc. An ‘algorithmic smart contract’ is an advancement in the sense that it contains logic for calculating a time schedule for pay offs and the cash flows due to the holder of an investment product at any time on that pay off schedule.

Smart contracts live on a blockchain. The reason they are deployed on blockchains is to ensure that the contracts are immutable and that they can not be changed once terms are agreed to by the issuer and the investor of the investment product.

Now, where does Tokenization come into the picture ?

Fractionalizing a product and making it affordable for smaller investors and enabling distribution by making them accessible on digital platforms aside, what do security tokens do ?

A smart contract for an investment product represents the whole of the product or the whole of the cash flows produced or consumed by the product. An investment product is obviously brought by many investors. Each investor therefore is entitled to a share of (the cash flows of) the product. Each share of the product is a token which represents a proportionate share of cash flows the token holder is entitled to. A smart contract that represents an investment product therefore needs to be tokenized.

Do Tokenization software platforms out there today enable cash flow calculations and pay offs ?

The answer is again ‘No’. Security tokens complying with the ERC standards today are dumb and only allow transfers and querying balances of tokens held, but not of withdrawable cash flows.

While this article is short and I won’t go into the engineering details of the product contract implementation or its tokenization, we have implemented a real life case where an Active Managed Certificate (AMC) is implemented using a smart contract and is further tokenized. An AMC is an investment product that can have a number of underlying assets such as shares or bonds and may or may not pay an interest coupon. The asset manager for an AMC can actively rebalance the underlying assets to maximize performance on returns from the AMC.

In our proof of concept implementation, the AMC itself was created and managed using vestr which is a software service integrated to external trading venues, and the terms were imported to initialize the AMC product contract on the Ethereum blockchain. The AMC contract implements the ACTUS (Algorithmic Contract Types Unified Standards) protocol by the ACTUS Financial Research Foundation and is available in the form of a library deployed by Verified. The AMC product contract is then tokenized and serviced on the Verified Network which is a decentralized financial infrastructure platform for issuing, distributing and servicing tokenized investment products.

This is how it looks like — first, the issuer selects the AMC to tokenize. This imports the terms of the product, initializes the AMC contract on the blockchain with a security token created for the AMC which is used to create a liquidity pool for investors to subscribe to the AMC and trade it.

Second, the transfer agent can update the AMC as it progresses through it’s lifecycle. The transfer agent can also fund the AMC with stablecoins when pay offs from the AMC occur.

Third, investors can check funds when funds are withdrawable from the AMC and withdraw them from the security token contract linked to the AMC. Corporate actions can also be viewed and acted upon by investors using the security tokens they hold.

If you are interested in knowing more about issuing products such as AMCs, bonds, shares, funds that are native onchain using algorithmic smart contracts, please DM me. To keep yourself updated on our work, subscribe to our Substack and to ask questions on the ACTUS protocol implementation, please join our Discord. Your comments are welcome.

Tokenizing investment products using algorithmic smart contracts was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

So, what is the Verified Network ?

The Verified Network is a decentralized network of regulated financial services providers — transfer agents, custodians, asset managers, brokerages, payment institutions, compliance managers — that enable the issue, distribution, and servicing of tokenized securities aka Real World Assets (RWAs). Transfer agents are licensed in each country and are responsible for keeping a record of securities that are issued by issuers who are their clients. When securities such as shares and bonds are traded, transfer agents make a change in the records of their ownership. Custodians safe keep securities for issuers and investors. In the world of tokenized securities, custodians safe keep the private keys of security tokens. Custodians are again licensed and often offer insurance against theft or misuse of private keys. Asset managers manage capital and on the Verified Network, they can also underwrite issues of tokenized securities and provide liquidity for tokenized securities. Providing liquidity refers to the manager making bids and offers on a security so that anyone trading that security can get their orders filled without delay. Brokerages are licensed businesses that enable the issuers of tokenized securities to trade underlying assets. For example, if an issuer of a Credit Linked Note wants to create and manage a portfolio of underlying bonds, it would need a brokerage to buy and sell those bonds from exchanges. Payment institutions on the Verified Network accept fiat currencies (EUR, USD) and issue electronic money tokens aka cash tokens that can be used to pay for and settle trades of tokenized securities. Payment institutions are often licensed as e-money issuers. Compliance managers are licensed administrators that perform Know Your Customer (KYC) checks on new users and perform ongoing Anti-money laundering (AMLA) checks on users and wallets they use to trade securities and store cash tokens. A partial list of financial services providers on the Verified Network can be seen on its website.

What does an operator need to create a RWA market place ?

A RWA market place can be created by a company to offer its own shares to investors. It can also be created a platform operator to manage multiple issuers. An example of a RWA market place is here. An operator needs the following components to create a RWA market place

• transfer agents, paying agents, cash / securities / digital asset custodians, compliance managers. Here, the Verified Network has the service providers and the backend applications for servicing issuers and investors.
• blockchain smart contracts to create security tokens, liquidity pools for trading them, and portfolio management tools for investors to manage their investments. Here, the Verified Software Development Kit (SDK) and Verified Subgraphs are available for free so that software developers can focus on implementing the application front ends for web and mobile users. The Verified SDK is a set of Javascript interfaces to smart contracts that are already deployed on multiple blockchains including Ethereum and Base main nets. The Verified subgraphs provide GraphQL interfaces for software applications to query blockchain data generated by smart contracts on the Verified Network.

Compliance first, but how ?

KYC checks and AMLA monitoring is crucial when it comes to being regulation compliant on offerings of tokenized securities. Software applications that allow their users to use blockchain wallets to hold cash tokens and tokenized securities must first get the wallets whitelisted after licensed compliance managers on the Verified Network have performed KYC/AMLA checks on them.

For this to happen, anyone developing applications using the Verified SDK can use the KYC plugin code to expose the KYC workflow to their application users, and this workflow is serviced by licensed compliance managers on the Verified Network that can then view user KYC data and whitelist their wallets or request more information from users to process their KYC.

KYC workflows depend on whether the user is a retail investor, qualified investor, a financial institution or a business entity. AMLA processes allow for reporting of suspicious transactions, freezing wallets, sanctions monitoring and use sophisticated blockchain analytics tools.

Requesting issue of security tokens

While businesses offering their own shares or bonds may not want this feature on their website since they are themselves the issuer, market place platforms may want to enable prospective issuers to request issues of their securities. Requests for issuances of security tokens can be for new capital raising (primary issues) or trading existing securities (secondary trading). Requests include submission of information such as the name and symbol for the security token, the cash token it is paired with which refers to what investors can pay for the security token with, type of investors (retail, qualified) that the issue is open to, country of issue and countries where the issue should be restricted to, besides submission of business and financial information on the issuer, and offering documents on the issued product itself.

Software developers can use the Verified SDK’s issuing functions to implement such functionality.

All requests made in the issue’s country of origin are processed by a licensed registrar and transfer agent that either approves or declines the issue request. Approved requests result in the minting of security tokens on the Verified Network. Such security tokens are based on the CMTA standard and allow for whitelisting, freezing, and snapshots of holders. Minted security tokens are credited initially to the issuer’s wallet from where it can offer them for sale on its website or use a liquidity pool to enable investors to trade them.

Offer for sale of Tokenized securities

Issuers and Market place operators can offer tokenized securities for sale to investors. Such offers for sale can be of two types — primary issues, where a new security is offered for subscription to raise capital for the issuer, or secondary issues, where an existing security is offered for trading to enable liquidity for investors. Primary issues have a different workflow that allows for closure of the issue on a specific date, subscriptions to the issue to a certain amount, allotment of securities in the case of over subscriptions and refunds to investors whose subscriptions have not been or are partially accepted. Secondary issues allow both market and limit orders that are entirely on chain and matched orders are settled by the transfer agent for the issue. Settled trades allow sellers to withdraw capital (that is, the paired cash token to the security that is traded) and allow buyers to transfer the security tokens from their wallet (that is, only after trade settlement, the buyer’s wallet is whitelisted for the security token).

Software developers can use the Verified SDK’s Liquidity pool contracts to execute trades of tokenized securities paired with cash tokens such as USDC.

Orders can be changed before they are filled or cancelled. Complete code for a walkthrough of a swap (that is, a Delivery versus Payment transaction) of a security token against a cash token, order cancellation and change order requests, and trade settlement can be seen here.

Managing Investment portfolios

Letting investors manage their portfolio of investments involve querying data from the Verified subgraphs and displaying them in the application. Application developers can show profits and losses, asset statements and balances.

Application developers can also display corporate actions published by registrars and transfer agents and enable investors to vote on resolutions in cases where they are allowed.

We will be publishing complete code for a mock application with the above features, but till then, anyone needing help can get in touch with us on Discord and use the complete developer documentation here.

How to create a regulation compliant marketplace for tokenized Real World Assets (RWAs) was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Traditionally, owning a stake in a prestigious investment fund or holding shares in a private business was available to only high net worth individuals (HNIs) or institutional investors. Now, through secure and efficient digital platforms like the Verified Network, you can also be a stakeholder in these investment products, thanks to digital asset tokenization.

So, what exactly is asset tokenization?

It involves turning securities representing assets into digital tokens living on a blockchain — a decentralized and secure digital ledger. This process allows traditionally illiquid assets, such as private funds, shares and bonds, to be represented as tokens that can be easily bought, sold, and exchanged.

Through tokenization, assets can be divided into millions or billions of tokens, allowing for trading between investors on a bilateral basis without the need for intermediaries. Asset tokenization has the potential to bring trillions of dollars of real-world value onto blockchain networks.

To buy a tokenized asset, all that investors need to do is create a wallet on a blockchain of choice such as Ethereum, and load their wallet with digital cash tokens such as US dollar stablecoins, that can be brought with any currency in a bank account. Once an asset token is brought, it is transferred from the issuer’s wallet to the investor’s wallet. When such tokens are traded, they are transferred from the seller’s wallet to the buyer’s wallet, in return for which cash tokens are transferred from the buyer’s wallet to the seller’s wallet.

Benefits of asset tokenization

• Accessibility

Asset tokenization allows individuals to fractionally own assets that were previously beyond reach, allowing them to diversify their portfolios without being restricted by geographical limitations or exorbitant capital requirements. Having the opportunity to purchase fractional stakes opens doors to unexplored investment opportunities.

• Liquidity

Traditionally, selling illiquid assets could take months or even years. But with digital asset tokenization, you can trade your tokens instantly on digital platforms, opening new avenues for liquidity and investment flexibility.

• Transparency

Now, you might be wondering about the security of these digital assets. Well, that’s where blockchain technology comes in. By leveraging blockchain’s cryptographic security and transparency, asset tokenization ensures that ownership records are tamper-proof, and transactions are immutable, providing trust and confidence to investors.

But like any investment opportunity, there are risks involved. Regulatory challenges, technological hurdles, and market volatility are factors to consider when venturing into digital asset tokenization. However, with proper due diligence and risk management, the potential benefits far outweigh the risks.

Conclusion

To conclude, digital asset tokenization revolutionizes our investment, offering unprecedented access, liquidity, and security. Whether you’re a seasoned investor or just dipping your toes into the world of finance, exploring the opportunities presented by asset tokenization could be the key to unlocking your financial goals.

However, reliable and secure platforms are necessary to realize the potential of tokenization to generate value, and such platforms have to be fully decentralized to limit the risks of centralized intermediaries.

Discover Verified Network, a global, decentralized network of licensed financial institutions that issue, distribute and service tokenized investment products.

What is Asset Tokenization? was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Single currency pegged stable coins such as USDT, USDC and others as well as Central Bank Digital Currencies (CBDCs) currently in discussion or pilots in China, France, Switzerland and other countries have yet to answer the question on how transactions for payments and settlement of trades in two currencies can be executed.

Stable coins have been used mostly to hold value in digital form on blockchains when investors in crypto assets switch between holding crypto assets and cash, as the cost of switching from crypto to cash in bank is quite expensive. However, there is no practical way of settling a payment in, lets say, the Philippine peso in Philippines by sending a US dollar pegged stable coin like USDC unless the beneficiary in Philippines wants to hold the USDC. Top crypto exchanges like Coinbase, Kraken and even Binance do not settle in many currencies and even when they do, volumes and spreads may not be attractive. Besides that many currencies like the Philippine peso may not have a stable coin yet to which a potential exchange from another currency pegged stable coin may take place.

CBDCs are no better than stable coins in at least one respect that their issuers may not share a common standard or infrastructure for issuing and transferring payment tokens. While most stable coins currently are ERC20 standard compatible, they may still be pegged, algorithmic or hybrid when it comes to pricing them. CBDCs may be more standard on how they are priced, but the discussion on technology standards for issuing and transferring them across borders have not probably reached the discussion stage.

Global remittances and settlements of securities and investments therefore need a standard framework for issuing digital cash tokens denominated in multiple fiat currencies, and standard technology infrastructure for transferring and holding them. The large market opportunity in global remittances and capital flows justifies an attempt at working on it.

In our work on issuing and trading of digital securities on the Verified Network described in another article, we needed digital cash tokens in multiple currencies to enable settlement of trades. The Verified Network is a Layer 2 Ethereum network of financial service providers that enable tokenization of private financial assets, investments in and trading of tokenized assets, and their settlement in multiple currencies. Our work based on digital cash tokens is based in this context, but the current solution can work for the global remittances use case as well.

The Layer 2 network does most of the transaction processing and heavy lifting without incurring Ethereum gas fees and validators on the L2 network stake their share of fee from transactions on the network. L2 validators may be country specific payment acquirers such as money transfer agents or payment processors, payment settlement companies such as authorized dealers of foreign currencies and payment banks. Balances of digital cash tokens and fiat currency in custody against which they are issued are rolled up to the Layer 1 Ethereum main net which reinforces security and the ability to interface with individual users on the main net, in addition to users who interface with digital cash issuing, exchange, transfer and settlement related smart contracts directly through L2 using Decentralized applications (Dapps) with built in ERC20 compliant wallets.

Individual or Business users wishing to remit payments or settle financial or non financial trades can purchase or borrow or request for a new issue of digital cash tokens by paying in fiat currencies that are held in custody of banks in those jurisdictions. Digital cash tokens issued against fiat currency deposits can be transferred on the Verified Network to recipients directly or through regulated payment service providers that settle receipts in favor of recipients in fiat currency of the receiving jurisdiction. However, if the receiving country does not originate payment and settlement transactions in the same order of volume, the recipient or settling payment service provider in the receiving jurisdiction carries the risk of being stuck with a glut of illiquid digital cash tokens. This has been referred to as the Opportunity cost of Cryptocurrencies in an earlier article published here.

So, how do we address these concerns? We need to first offset the opportunity costs that the settlement company incurs by holding received digital cash tokens Rx corresponding to the received fiat currency R. That is only possible if Rx holders earn from their holdings which in turn requires demand for Rx. We have earlier discussed that remitters can either buy or borrow Rx which creates demand for it. However, whether a remitter buys or borrows Rx depends on whether it is more profitable for the remitter to buy or borrow Rx. To keep the exchange rate of the Rx stable against the underlying fiat currency R, the cost of holding the Rx needs to be equal to the returns its holders get by holding the Rx digital cash tokens.

We have implemented this on the Verified Network by making it possible for digital cash token holders to purchase bonds (which has the effect of lending money) to issuers of bonds (which has the effect of borrowing money) where issuing of bonds is based on posting collateral of a liquid financial asset.

The above cash flow diagram is self explanatory. It applies to both remittances which are one way transactions where digital cash moves from the remitter to the recipient, as well as to settlement of trades which involve an exchange of physical goods or services or securities with digital cash that is paid for them.

Note : We are setting up a DAO or a decentralized organization of interested parties in the payments ecosystem in many countries. If you are interested to know more, please write to us at interest@verified.network.

You can also sponsor our work on the open payments system here.

Payments and Securities settlements with multi-currency digital cash tokens was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Security tokens and Digital securities are terms that are often used interchangeably. They are not the same. Digital securities are electronic records of shares, bonds, fund units and other financial instruments with centralized securities depositories that are directly supervised by securities regulators in national jurisdictions. For example, in the countries we operate in, the Swiss depository is run by SIS and the Indian depository is run by NSDL and CDSL. Digital securities are often identified by an unique securities identifier such as ISIN and are credited and debited from the brokerage accounts of their investors as they trade securities.

Security tokens, on the other hand, are digital securities recorded on a blockchain. A blockchain is a decentralized, digital ledger that is made tamper proof by a number of validators that have to reach consensus before recording each entry on the ledger. Therefore, although security tokens are digital securities, they are not regulated unless they are specifically approved by regulators. In a handful of countries such as Switzerland, Germany and Japan, security tokens now have regulatory cover. For example, the financial supervisory authority in Switzerland FINMA announced the coming into force of the DLT Act from February 2021 that recognizes securities recorded in decentralized ledgers or blockchains. More recently, in May 2021, the Electronic Securities Act (eWpG) was passed by the German Parliament that recognizes crypto asset registries as an alternative to centralized depositories. Earlier in 2020, the Financial Services Agency (FSA) which is the regulator in Japan introduced ERTRs or Electronically Recorded Transferable Rights that represent security tokens under the Financial Instruments and Exchange Act.

But how does the mere fact of recording securities on blockchains or DLT registers benefit investors ? This is an open question that needs an answer. After all, even if a security token is issued which is recorded on a blockchain, the issuers of such security tokens still need to comply with prospectus guidelines, regulations with respect to distribution and marketing of security tokens, and trading of security tokens. The Swiss regulator FINMA recently announced that DLT trading facilities will function as regulated marketplaces for security tokens in Switzerland. Are DLT securities therefore a solution looking for a problem ? Besides the fact that DLT securities confer legal rights of ownership to security token holders in only a couple of countries.

One key problem our work on the Verified Network has identified is the ability of tokens that represent securities to aid in price discovery of private, unlisted assets and their trade over the counter. The Verified Network is a Layer 2 Ethereum network of financial service providers that enable tokenization of private financial assets, investments in and trading of tokenized assets.

The Layer 2 network does most of the transaction processing and heavy lifting without incurring Ethereum gas fees and validators on the L2 network stake their share of fee from transactions on the network. Balances of securities and cash in custody are rolled up to the Layer 1 Ethereum main net which reinforces security and the ability to interface with individual users on the main net, in addition to users who interface with digital security token issuing, transfer, trading and settlement related smart contracts directly through L2 using Decentralized applications (Dapps) with built in ERC20 compliant wallets.

Tokens representing securities and cash balances on the Verified Network are utility tokens that aid in price discovery and their over the counter (OTC) trade. Utility tokens have a lower regulatory barrier and are sufficient to address the real problem of lack of liquidity in private, unlisted assets. In this article, we will be referring to utility tokens representing securities as digital security tokens.

Businesses wishing to raise capital or letting their investors access liquidity need to register their securities such as shares and bonds with the centralized depositories. This usually requires amendments to the articles of association of a company, passing of board resolutions and appointment of a depository participant such as a paying agent that dematerializes any physical or bearer securities and registers them with the depository. Investors in such businesses with an account on the Verified Network can request issue of digital security tokens. Depository participants on the Verified Network confirm ownership of securities and trigger the issue of digital security tokens and their credit to Verified accounts of investors. Digital security token holders can then offer them for sale on the Verified Network. As described in the previous article, digital security token issuing contracts do not just make their balances available to their holders but also report credit scores and corporate actions.

Just like securities custodians or depository participants trigger issue of digital security tokens on the Verified Network, cash custodians such as banks or payment service providers confirm ownership of cash and trigger the issue of digital cash tokens and their credit to Verified accounts of buyers. Buyers can bid for offers of sale by digital security tokens holders and current implementation supports market, limit and stop loss orders. Once orders are matched on the Verified Network, the system triggers the off chain transfer of securities and cash settlement for securities that is executed by regulated securities and cash custodians.

Therefore, the Verified Network itself does not serve as an exchange or a centralized counter party, and digital security and cash tokens facilitate price discovery and off chain over-the-counter trade settlements. Which brings us to the title of this article — Issuing and Trading of digital securities on the Blockchain- that refers to digital security tokens representing traditional, dematerialized, depository registered securities resolving the problem of lack of liquidity of unlisted securities efficiently and inexpensively, that security tokens or DLT securities as defined by regulators may find more expensive and time consuming to achieve.

Digital cash tokens are fully described in a separate article here.

Issuing and Trading digital securities on the Blockchain was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

The focus so far in the decentralized finance (Defi) and digital assets space has been on issuing and trading of collateralized crypto assets. While that is new and interesting, tokenization of financial assets is the big opportunity.

Tokenization of privately held, unlisted financial assets will enable distribution of tokenized assets to a larger investor base and will help investors access liquidity by trading tokenized assets. However, the success of tokenizing assets is based on the ability to price them and pricing is based on credit scoring tokenized assets.

This article explains how we can profile assets and is a result of our work on the Verified Network which is a Layer 2 Ethereum network of financial service providers that enable tokenization of private financial assets, investments in and trading of tokenized assets.

The Layer 2 network does most of the transaction processing and heavy lifting without incurring Ethereum gas fees and validators on the L2 network stake their share of fee from transactions on the network. Asset balances and credit scores are rolled up to the Layer 1 Ethereum main net which reinforces security and the ability to interface with individual users on the main net.

Businesses wishing to raise capital or let their investors access liquidity create a profile on Dapps that connect to the Verified Network where smart contracts for credit scoring are deployed. A business profile would include business registration details, and optionally an approval for accessing income and sales tax data, and banking data. The screenshot above is for a business in India where CIN refers to the business registration for companies (or the Company Identification Number), PAN refers to the income tax registration (or the Permanent Account Number) and GST refers to the sales tax number (or the Goods and Services tax). The terms and sources of data vary across countries. For example, in Europe, PSD2 based open banking standards enable approval based access to data from hundreds of financial institutions. Companies registry data is usually public and offers data on financials, shareholdings and more.

The credit scoring contracts are different for businesses and financial institutions such as non bank lenders. In the case of businesses, the assessments take — computed financial ratios, the track record of ability to raise financing, management and ownership risks, debt servicing track record, liquidity and cash flows, capital efficiency, business stability based on customer and supplier analysis, fraud and compliance checks — into consideration for credit scoring. In all, the credit scoring contracts for businesses on the Verified Network use 174 metrics computed out of thousands of data points on every business every month. For financial institutions, additional metrics related to capital adequacy and provisioning are taken into consideration.

While data used for credit scoring and assessments are viewable by businesses that provide them, credit scores and reporting on a large number of events of interest such as change of directors and auditors, new shareholders, litigation, ratings by credit rating agencies, debt repayment defaults, record of charges and mortgages, and many more corporate actions are recorded in security tokens. As security tokens are issued to investors, credit scores and corporate actions are available to investors in addition to balances of such assets they hold on security token issuing contracts.

For trading of tokenized assets, the credit scoring tools also provide a guidance on pricing and valuation of assets. Valuation of shares is done by providing analysis of financial multiples and comparing them to competing businesses in the industry the business operates in. Pricing of bonds take face values, discounts, accrued interest income, cash flows and analysis of any options that bond holders have into consideration.

We will cover the issuing and trading of tokenized assets in the another article. Where security tokens are traded, prices at which trades are settled are recorded on the issuing contracts that provide pricing guidance to new investors.

Credit scoring and pricing security tokens was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

While the discussion on stable coins and their design in the crypto community has been going on for the past couple of years, the public hearings and the huge interest around Libra are highlighting a number of issues that any digital currency will face in the real world if it has to hold up to mass adoption.

I am summarising these issues and my views on future design directions for digital currencies and their designers and sponsors.

Regulation

Considering the regulatory landscape and how a digital currency might fit into existing regulation is very important since most currencies and their designers/sponsors won’t generate the sort of hype that Libra has and no new regulation for a currency is likely to be drawn up. From a regulatory perspective, the sponsor/operator of the currency could possibly fall in three buckets — banking regulation, securities regulation, or payment systems regulation. Taking fiat deposits from the public and issuing them digital currency tokens with guarantees that they can be redeemed for the same value could possibly attract banking regulations and being a bank means getting a banking license, maintaining enough capital, etc and it is territory that one perhaps should not go into. Instead, if the digital currency operator mints tokens like Libra where they take in fiat and peg it to a basket of assets (which could be other currencies and securities), the currency operator could be seen as an asset/fund manager and the issue of currency tokens can be classified as an issue of securities. While Alternative Investment Funds (AIFs) are popular in all major jurisdictions among fund managers, the transfer of the currency token from one person to another would attract capital gains taxes which could be substantial and render it absolutely useless. The most appropriate regulation for digital currencies could be for currency operators/sponsors to be regulated as payment institutions/e-money operators which means they would be able to issue e-money/digital tokens against fiat deposits that they keep as deposits with public/scheduled banks. Being a payment system also means lesser capital requirements (eg, ~EUR 100k for Authorised Payment Institution in EU), standard rules on managing customers and KYC/AML, and most importantly no ambiguity on taxes for both issuing (VAT/GST for selling) the currency and redeeming (withholding tax on gains in buying back) the currency. However, it also means that the currency operator can not profit off the fiat reserve, and think about doing fancy things with it.

Currency Pegs And The Issue Of Control

If a digital currency is designed to be a fast, simple, inexpensive medium of exchange of value between people in different countries with different fiat currencies, the focus should be just on that. For example, if a user wants to transfer or convert 1 dollar into euros where the exchange rate is 0.9 dollars to a euro, and if that user has a digital currency equivalent to a euro, it should convert into 0.9 dollars. So much is well understood but if the digital currency is pegged to the dollar by requiring all fiat currencies (eg, euros, yen, pounds, rupees, etc) deposited by users to be converted and kept in a dollar reserve, it creates a problem. Such a single/basket of fiat-based reserve backed pegged currency would increase the demand for the currency in which the reserve is denominated (ie, dollar in this case) and reduce the demand and suck out liquidity in terms of the originating fiat currencies (ie, euros, pounds, rupees, etc in this example). Extrapolated on a macro scale, this could possibly mean ineffective fiscal and monetary policy control by governments in countries of originating fiat currencies. Imagine the government in such a country trying to sell its treasury bonds (for let's say, funding development expenditure) at a rate which possibly returns less than the dollar-pegged digital currency whose appreciation with respect to the local currency is giving a better RoI to its holders. Imagine a central bank in such a country trying to sell dollars (if it has any!) to shore up the price of its depreciating currency where the depreciation is partly due to increased demand for a digital currency pegged to a foreign currency like the dollar. Or imagine a central bank raising domestic interest rates to curb inflation but where prices of goods and services are in a digital currency pegged to a foreign currency. The prospect of the potential loss of fiscal and monetary policy controls by sovereign states means that such dollar/basket pegged digital currencies would face opposition and rejection by many countries. Also, given that, it will be easier to operate a digital currency under the payments systems regulations which do not allow reserves to be created in foreign currencies or in offshore jurisdictions, a digital currency designer/sponsor/operator would need to create a currency token that is pegged to the exchange rates between any two pairs of fiat currencies and not one fiat currency, using reserves kept in all these different fiat currency jurisdictions where it operates. What this means is that if a user is transferring 1 British pound to India, the recipient in India gets INR 90 or so and what the recipient gets will not depend on the exchange rate of the INR to the USD. Governments in sovereign states are not likely to perceive such a scheme as loss of control of its monetary and fiscal policy mechanism. In such a scheme, the domestic fiat currency will simply sit as deposits in a bank within the borders of the country and won’t be sucked out from the system in exchange for dollars. Inflation and interest rate controls would also not get impacted as, for example, raising interest rates would entice people to redeem their digital currency for the domestic fiat instead of redeeming it against a (possibly appreciated) dollar.

Identity And Blockchain

Knowing who holds a digital currency and issued one into that currency’s compatible wallets is very important from a KYC/AML/CFT perspective. And every blockchain whether Ethereum or Libra would link such an identity to a public key on the blockchain and any transactions between two or more users would then be observed as value transfers between public key/addresses on the blockchain. Placing the control of the blockchain operations (eg, validator nodes in Libra) with the same organization that is also issuing the digital currency (eg, Libra) may, however, mean that the organization can link a user’s identity to transactions on the blockchain and therefore would raise significant privacy control issues. However, if the identity provider and the blockchain itself are controlled by different organizations (eg, Calibra as wallet provider for Libra and Ethereum Foundation for the blockchain network), this will alleviate privacy concerns. For a digital currency designer/sponsor/operator, it is perhaps better to see these — currencies and blockchain- as orthogonal aspects and support as many as underlying blockchains without sacrificing the basic cost/benefit economics of operating the currency — for example, think of spending more on transaction gas prices as % of transaction value compared to service taxes and cost of doing a regular fiat exchange.

Distribution And Custody

Unlike Facebook that already has a huge reach to consumers around the world or a Visa/Mastercard that through their acquirers are accepted in a very large number of merchant business establishments around the world, a new digital currency will need massive consumer and merchant adoption. However, if the currency operator is a licensed payment institution/emoney operator, it not only helps with on/off ramps which have to do with collecting fiat in a bank account against digital currency being issued and paying out fiat from a bank account against digital currency being redeemed. But this might also help with partnering issuing and acquiring organizations to scale both reaches to consumers and businesses. Issuers are typical banks, travel operators, payment wallets, etc that have existing linkages with payment settlement infrastructure in a country. Issuing digital currencies in payment tools such as wallets or cards that consumers already use is easier and better than expecting them to adopt a newer payment tool. Similarly, acquiring businesses that would accept digital currencies may become less challenging by partnering existing acquirers such as banks, and payment processors that sell payment terminals and QR code readers. Therefore, having regulated on/off ramps is necessary for a new digital currency to thrive by leveraging existing distribution channels. Digital asset custody remains a challenge though as a currency issued in the form of a token (eg, ERC20) does need to be stored safely and banks and securities custodians still do not have the digital infrastructure to store tokens. Fiat accepting and custodial crypto exchanges are another option for on/off ramps and custody, but however, there are not many out there that are regulated in onshore jurisdictions.

Capital Controls

Coming from a country with capital controls such as India which limits convertibility on the capital account (eg, in/outbound investments from foreign jurisdictions), I know that a country like India or perhaps China may not allow a digital currency that can cross borders without the central bank being notified of it. This can, however, be addressed by operating through established and regulated cross border payment institutions such as authorized dealers for foreign currency transactions or a digital currency operator taking an authorized dealer license. Similarly, although in a very different context, countries like the USA that impose sanctions quite effectively due to the fact that the dollar is used as a reserve currency and is the most preferred currency to settle cross border transactions may not at all like that digital currency is used to settle international transactions.

With regulators and governments waking up to the opportunities and challenges crypto and digital currencies pose to existing financial systems around the world, we should expect to reach a point soon when someone launches a digital currency that checks all the essential boxes of being — non threatening to central banks and governments, widely acceptable to consumers and businesses, secure and protective of private data.

Disclosure: I am working on the design and implementation of a digital currency protocol called the Via that imbibes some of these ideas in the article. The Via is a digital currency collateralized in multiple fiat currencies that are designed to be stable and for transferring value between applications running on different blockchain platforms, hence the name Via. Please feel free to connect with me on twitter.

On The Design Of Digital Currencies After Libra was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Bitcoin and cryptocurrencies are something most entrepreneurs have probably given up on. Investors most definitely have. Not all regulators have positively treated them. So, when it comes to a topic such as digital assets or digital currencies, it is probably not the flavour of the season.

However, broadly speaking, if we add up the financial assets we hold in digital form including shares and fixed deposits for consumers and many more financial products for businesses such as bonds, these financial assets held in digital form probably far exceed the value of physical assets we hold. If we add non-financial digital assets such as assets that are sold in digital form such as content and advertising and assets that provide digital access to utilities such as e-commerce, the numbers would be even bigger.

Speaking of currencies, we certainly do not use digital currencies the way we use cash or cards, but if the definition of currency was to include anything that represents cash and is transferable, the value of currency derivatives in trading again far exceeds the physical cash in circulation in most major world economies.

Yet, when it comes to discussing digital assets and digital currencies, the first term to pop up is bitcoin. Sigh. The really large opportunities in the digital asset and currency space are ahead of us.

Let’s look at the numbers.

Although the numbers above are somewhat dated, we can see that as far back as 2007 itself, global financial assets were four times that of global GDP. And global derivatives were four times that of equities and bond market capitalization. What this indicates is that digitization of financial assets and currency equivalents is already a very large market.

But, what are the opportunities ?

Before we go into that, we need to appreciate that the single biggest contribution that peer to peer electronic cash systems like Bitcoin and blockchain technology have made is that they have shown that it is possible to create trust worthy transactional systems without the need to have an intermediary. Using game theoretic and cryptographic techniques, it is now possible to prove or disprove a transaction that is claimed to have taken place between two parties, even when each party makes a different claim on the transaction. While this is technically brilliant innovation, the creators of bitcoin and the developers of blockchain platforms failed to bring about a link between the digital world that could clear transactions without the need for centralized intermediaries and real world financial markets, that is acceptable within prevailing regulation and provides value to current market participants. And this is where the future opportunities lie.

Take the case of investments in alternative assets.

Although investments in public stocks and bonds are a $100 trillion plus category, investments in alternative assets are now reaching $10 trillion. Investments in alternative assets are not exchange traded like stocks and bonds and are mostly all bilateral trades over the counter (OTC). Among alternative asset classes, investments in private debt, real estate, and infrastructure is growing fast. However, being private in nature, such investments do not provide a level of visibility into risks and returns as publicly traded company stocks do. Hence, the opportunity here is perhaps for blockchain applications to digitize private assets (eg, high yield debt to Small and Medium enterprises), provide visibility into the risk profile of the assets (eg, make SME loan underwriting data visible to investors), and offer a secondary market platform where bilateral contracts between investors can be cleared. Blockchain technology can lower counter party risks in such cases where the value of assets invested in, the risk profile of assets invested in and the risk of a default in a secondary market trade can be reduced.

When it comes to digital currencies, the term itself deserves some attention. A currency, digital or not, needs to be a stable unit of value that is transferable and is used to denominate assets. As crypto currencies such as bitcoin or ether do not have a price stabilization mechanism, they have merely traded as commodities (and very rightly classified as commodities by the US CFTC) while assets that are denominated by them (eg, ERC-20 tokens) are mostly all securities that provide the holder of the security a beneficial interest in the underlying asset (eg, revenue stream from a project).

Blockchain based systems have a large opportunity in the securities offering space itself.

source : Deutsche Borse Group

In the illustration above, we can see that while a lot of securities are exchange traded, there are many that are OTC traded such as credit linked notes and certificates. These are examples of financial instruments that blockchain applications should be able to issue while being compliant with existing regulation. Market making, price discovery, reporting and compliance are largely well understood for such securities rather than ill understood and un/under-regulated crypto token offerings aka ICOs.

As far as digital currencies are concerned, price stabilization mechanisms and ability to integrate to existing financial markets are key. Price stabilization mechanisms observed in so called stablecoin projects are based on a mix of fiat currency backed digital tokens. However, such stabilization mechanisms, whether successful or not, are ill suited for integration to global liquidity pools and financial markets. Fortunately, the global derivatives market where 85% of outstanding positions have fixed income streams and other currencies as underlying asset classes perhaps provide us with clues on innovation in design and operation of price stabilization mechanisms in digital currencies.

Since a large majority of derivatives are OTC traded as the somewhat dated figure of 83.7% in 2007 above shows, digital currencies have a regulation compliant framework to operate in.

We will certainly see the emergence of digital financial instruments, asset categories and currencies that are not just technically brilliant but integrate well within global regulatory and operating environments. Valued in trillions of dollars and not in billions of dollars, this disruption will probably be the largest one that we have ever seen. The question now is who does it first and how.

Originally published at yourstory.com on January 10, 2019.

Disclosure : I am working on the design and implementation of a digital currency protocol at Verified AG called the Via that imbibes some of these ideas in the article. The Via is a fiat collateralized digital currency that is designed for transferring value between applications running on different blockchain platforms, hence the name Via. Please feel free to connect with me on twitter and subscribe to developments on Via.

Digital Assets and Digital Currencies was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.

Or for that matter, is any other cryptocurrency a currency ?

This is a question that is often asked. And the answer that is often given is that just like any other currency, they allow for the transfer and store of value. By using a shared ledger that is distributed among users of a cryptocurrency like Bitcoin, their creators ensured that any transaction can be recorded, and is verifiable without a central authority like a bank. But then, the question that comes next to mind is that besides the technology, are there any economic principles behind the design and operation of a cryptocurrency ?

Most of the economic thinking by cryptocurrency creators and platforms have been on around how to make it cost prohibitive for anyone to overwrite a shared ledger of transactions and manipulating transactions to work in their favour, such as making transactions credit value to a hacker. Hence, while cryptocurrency creators and their developer communities focus on all sorts of game theoretic strategies, are cryptocurrencies even doing what they were designed to do — that is, used as a medium for quick, cost effective payment transactions ?

The answer is ‘No’.

Bitcoin and other cryptocurrencies are today traded and held more like assets. Like any asset, the price of Bitcoin goes up or down every day. It is not like other regular fiat currencies we hold that we use primarily for transactions. Most of us do not hold fiat currencies because their prices go up and down ! Why Bitcoin and other cryptocurrencies are not being used mostly as a way to make payments could be due to factors such as acceptance by merchant businesses, the actual speed and cost of transactions, or the ease of making such payments.

However, there is one very important difference between a fiat currency and a cryptocurrency today that might be one more important reason why cryptocurrencies are not accepted widely — that is, holding a fiat currency in an account in a bank returns an interest income, no matter how small, while holding a cryptocurrency in a wallet does not return an income. This is the ‘Opportunity cost’ of holding a cryptocurrency.

The opportunity cost is simply the income we forego by holding a cryptocurrency. And it perhaps holds a clue about another factor that makes a cryptocurrency risky to use in real life transactions — its volatility. But first let’s look at a scenario where the holder of a cryptocurrency is compensated to offset the opportunity cost of holding it.

The illustration above shows a simple demand and supply function where the supply curve for the cryptocurrency is vertical which reflects that supply is more or less inelastic during the term in consideration. The demand curve slopes downwards to the right and intersects the supply curve at a point Cx$, which is the opportunity cost of holding the cryptocurrency with respect to a fiat currency, let’s assume the US dollar for our example. The sloping demand curve implies that if the return on holding the cryptocurrency is brought down, its demand also comes down, and vice versa. Now, if there is a way to compensate the holder of this cryptocurrency with a return indicated here by iff, would the holder be indifferent to having this cryptocurrency in a wallet vis a vis having fiat currency in a bank account ?

If your answer is a ‘yes’ to the above question, it means that the cryptocurrency certainly becomes more acceptable and therefore, usable for payments. But then, how can anyone determine the return that a cryptocurrency should have ?

The illustration above shows the great variation in yields of government securities across the world. These yields reflect the opportunity cost (Cx) of holding a cryptocurrency in these countries.

If the funds rate in a country on fiat money is 3%, the holder of a cryptocurrency would require a 3% return on its cryptocurrency holdings to offset the opportunity cost of not holding fiat money. However, they are just one component of the total opportunity cost.

The second component is the return a holder of a cryptocurrency will make by lending it to someone in another country. So, if the cost of borrowing or the lending rate is 3.5%, anyone holding cryptocurrency would need to earn at least 3.5% on loans given out in a cryptocurrency to borrowers of such a cryptocurrency residing in another country.

And by corollary, the third component is the benefit that a borrower gets by borrowing cheaply from a country with low rates. After all, someone in a country with high interest rates has the incentive to borrow from a country with low interest rates. So, if this holder in a country with a 3% funds rate gets a borrowing rate of 1.5% from the holder of the cryptocurrency in another country, it makes sense to borrow instead of buying the cryptocurrency with local fiat currency and thereby, make a net benefit of 1.5% since the local fiat currency would still make a 3% if it is not converted into the cryptocurrency.

The effective return that the holder of a cryptocurrency would then make is

iff = the funds rate on fiat currency + the lending rate on fiat currency + (funds rate on fiat currency - borrowing rates on cryptocurrency).

What this means is that if the return on holding the cryptocurrency, iff is at least equal to Cx or the opportunity cost of holding the cryptocurrency, there is a business case for using the cryptocurrency. If iff is more than Cx, the demand for cryptocurrency will go up and will push up its price or, in other words, it will appreciate against the local fiat currency, and vice versa.

Considering the opportunity cost of cryptocurrencies therefore opens up interesting possibilities of making cryptocurrencies more acceptable and usable. Of course, mechanisms of administering factors that assure such returns on holdings of cryptocurrency, and devising mechanisms to stabilize returns with respect to costs are interesting challenges.

Disclosure : I am working on the design and implementation of a digital currency protocol at Verified that supports multi-currency stable coins.

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The Opportunity cost of Cryptocurrencies was originally published in Verified on Medium, where people are continuing the conversation by highlighting and responding to this story.