Connecting the worlds of security tokens and decentralized finance (DeFi) is the next logical step for Securitize, a kind of regulatory-compliant fixer when it comes to tracking and trading blockchain-based securities.
Announced Monday, Securitize is teaming up with a protocol called Tinlake from Centrifuge, which uses a clever system of non-fungible tokens (NFTs) to enable real-world assets to participate in DeFi.
In an ideal world, any elements within the Ethereum ecosystem should be able to be built into one another, sharing new and useful features like automated market-making or other functions. This concept, a core tenet of DeFi, is known as Ã¢ÂÂcomposabilityÃ¢ÂÂ (the analogy often used is the omni-building capacity of Lego bricks).ÃÂ
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But thereÃ¢ÂÂs a catch: Digital securities, like their traditional counterparts, are regulated and have several control mechanisms that must be enforced. All securities, whether private or public require know-your-customer (KYC) identification of the person buying them, as well as mandatory investor qualification to determine which type of investor they are (retail or accredited, depending on the rules of their local jurisdictions).
ThatÃ¢ÂÂs where Securitize comes in. Focused on smoothing the fragmented world of private securities trading, the firm has been honing its approach to identifying the owners of assets and the regulated peer-to-peer transfer of private security tokens. As such, the system is already 90% of the way to DeFi composability, said Securitize CEO Carlos Domingo.
Ã¢ÂÂA lot of DeFi protocols are designed for unregulated utility tokens or cryptocurrencies, so they are not really suitable for security tokens,Ã¢ÂÂ Domingo said in an interview. Ã¢ÂÂWe have a thesis about how to make this work in a legal way, and so allow for things that exist in traditional capital markets, like market making, or lending and borrowing, all in an automated way.Ã¢ÂÂ
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DeFi protocols often operate pseudonymous liquidity pools powered by automated smart contracts. The Securitize Tinlake integration, by contrast, will be strictly for wallets that are associated with Securitize ID, so that the person on either side of a trade is known, said Domingo.
TinlakeÃ¢ÂÂs smart contracts pool together NFTs that represent real-world assets. For instance, one pool could be dedicated to invoices that might be used in a trade finance scenario, that are then used as collateral to finance loans in stablecoins like DAI or USDC.ÃÂ
The current pools enabled by Tinlake are short-term loans that return the money to the investor within a short period of time, but the next step is exploring rolling pools that reinvest the dividends, and also receipt tokens that can be used by other investors to receive contributions from the pool (the latter is known in DeFi as liquidity provider, or LP, tokens).
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But diving headlong into DeFi presents some interesting challenges, said Domingo. Keeping tabs on the ownership of securities contributed to a pool on some automated market-making protocol like Uniswap containing hundreds of securities, is very complex to implement, he added.
Ã¢ÂÂItÃ¢ÂÂs not impossible but it will take time to integrate with our protocol to control the transfer restrictions,Ã¢ÂÂ Domingo said.ÃÂ
Another key question relates to who can actually publicize the trades of private securities since in the U.K. you need an MTF (multilateral trading facility) license, or, in the U.S., an ATS (alternative trading system) license. Ã¢ÂÂSo while we might be 90% there with the technology, there is still a bit of regulatory uncertainty,Ã¢ÂÂ Domingo said.ÃÂ
Securitize is not considering adding governance tokens like UniswapÃ¢ÂÂs UNI, said Domingo, because itÃ¢ÂÂs unclear whether those sorts of tokens are legal. But irrespective of that, he said there are still scenarios where itÃ¢ÂÂs going to be more profitable to contribute securities against a liquidity pool rather than just waiting for them to appreciate over time.
Ã¢ÂÂIf you go and buy Apple shares on Robinhood, the only thing you can do is just to wait for them to appreciate over time. ThatÃ¢ÂÂs it,Ã¢ÂÂ Domingo said. Ã¢ÂÂBut if these DeFi protocols become available over time for security tokens, as we think will happen, then suddenly there are other avenues for you to make money besides just holding on and waiting.Ã¢ÂÂ
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.