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This year, there has been a significant increase in regulation and compliance initiatives as the cryptocurrency market saw the fallout from initial coin offerings (ICOs), of which many were poorly disguised securities offerings and many more were outright scams. Earlier this year, Satis Group reported that 92 percent of ICOs were scams or have otherwise failed to list on exchanges, resulting in billions of dollars in losses for investors. Still, there are further billions wrapped up in non-compliant tokens and projects, all at risk of becoming the Securities and Exchange Commission’s next target. Airfox and Paragon will not be the only companies that face legal action, they are merely a signal fire to let everyone else know — the SEC is coming.
Now more than ever, it’s important to track the industry as it shifts its focus from ICOs to security token offerings (STOs). However, navigating these changes can be difficult as new companies, offerings, and compliance solutions appear by the month. Pink Sky has been working to prepare for these changes and would like to share our thoughts with you.
We want to initiate dialogue regarding various issuance platforms and financial instruments that are ripe for tokenization. To do this, we are releasing our Security Token Series—a collection of articles on new protocols, offerings, and assets as they pertain to current news events. In this article we will discuss Harbor’s asset tokenization, the platform’s usage in the real estate market, and their Regulated Token standard.
Harbor
The Harbor platform is an all-in-one service for asset tokenization with an emphasis on security, compliance, and ease-of use. Harbor’s current focus is on tokenizing real estate, private equity, and funds, and their first decentralized compliance protocol—the Regulated Token—is an open source effort to standardize the issuance and trading of security tokens on the Ethereum blockchain. The R-Token is a permissioned ERC-20 that checks an on-chain Regulator Service for transfer logic, and has already been used to tokenize a privately owned housing facility in South Carolina.
“The Regulator Service can be configured to meet relevant securities regulations, Know Your Customer (KYC) policies, Anti-Money Laundering (AML) requirements, tax laws, and more. The R-Token Standard enables ERC-20 tokens to become compliant crypto-securities that can be traded across any ERC-20 compatible platform.”
— Bob Remeika et al., The Regulated Token™ (R-Token™) Standard, 2018
Tokenizing Private Equity
Two days ago, Harbor launched their platform with an offering of US$20 million of tokenized private equity in The Hub at Columbia, a student housing high-rise located near the University of South Carolina. The offering is available to accredited U.S. investors, as well as investors in select jurisdictions, and it has been made available by Growth Capital Services.
Why is This Important?
Perhaps more than in any other sector, real estate and private equity investors stand to benefit from the myriad advantages of tokenization: namely, the increased liquidity that tokens may bring to previously illiquid investments. By abstracting equity-based financial instruments into programmatically compliant tokens, the friction and cost that exists in acquiring and selling such assets can be removed and a secondary market built around the protocols defined by the tokens themselves.
The Regulated Token Standard
Growth Capital Service’s recent offering was made possible by Harbor’s Regulated Token (R-Token) Standard. The R-Token standard is a protocol comprised of three on-chain components: the RegulatedToken, a RegulatorService contract, and a ServiceRegistry contract. This standard codes compliance into the token itself by overriding ERC-20’s Transfer and transferFrom methods and calling the ServiceRegistry to handle all transfer logic by referencing the RegulatorService, which either permits or restricts the transfer of a given token between wallets.
“R-Token is a permissioned token on the Ethereum blockchain, enabling token transfers to occur if and only if they are approved by an on-chain Regulator Service. The Regulator Service can be configured to meet relevant securities regulations, Know Your Customer (KYC) policies, Anti-Money Laundering (AML) requirements, tax laws, and more. Implemented with the correct configurations, the R-Token standard makes compliant transfers possible, both on exchanges and person to person, in ICOs and secondary trades, and across jurisdictions. R-Token enables ERC-20 tokens to be used for regulated securities.”
— Harbor, “Regulated Token System (R-Token)”, GitHub, 2018
Harbor’s open source protocol also allows transfer logic to be modified by deploying a new instance of the RegulatorService contract and updating the ServiceRegistry contract, permitting issuers to continuously maintain token compliance as regulation changes.
From the R-Token GitHub repository:
RegulatedToken
– Permissioned ERC-20 smart contract representing ownership of securities
– Compatible with existing wallets and exchanges that support the ERC-20 token standard
– Overrides the existing ERC-20 transfer method to check with an on-chain Regulator Service for trade approval
RegulatorService
– Contains the permissions necessary for regulatory compliance
– Relies on off-chain trade approver to set and update permissions
ServiceRegistry
– Accounts for regulatory requirement changes over time
– Routes the R-Token to the correct version of the Regulator Service
To provide some context and explain the protocol in plain language, Harbor uses smart contracts to restrict how R-Tokens can be held and traded. Legislation clearly dictates which individuals may hold or transfer a security and Harbor allows an issuer to code regulatory compliance directly into the token itself. The only way an R-Token can be held or transferred is by obtaining approval from the RegulatorService contract that controls the token. This ensures that the token is only traded by registered users in accordance with the governing legislation.
More importantly, the fact that all compliance and transfer logic is handled on-chain indicates a full commitment from Harbor into blockchain technology, its principles and benefits, and represents another step toward democratizing access to private equity and the ability to easily raise capital.
Final Thoughts
Tokenization provides a number of new features that are not available with traditional financial instruments. One of the most appealing to the market is likely to be the creation of liquidity from normally illiquid assets.
As a new instrument, security tokens create greater opportunities for liquidity events—and therefore price discovery—beyond what traditional financial instruments possibly could. Tokenization has the potential to provide investors with the ability to quickly enter or exit a position and realize profit on an investment’s speculative value without having to wait for that investment to mature. Furthermore, tokenization makes illiquid assets easier to market to investors that may not have the desire or means to invest in a long-term fund.
On the other side of that exchange, tokenization allows a corporation or individual to convert an otherwise illiquid asset—such as real estate—into fungible currency by issuing and selling fractional ownership interests in that asset. The issuer can otherwise avoid paying interest on a loan or mortgage while simultaneously taking advantage of the accounting profit from the asset’s depreciation.
Simply put, tokenization provides opportunity.
Important Disclaimer:
Information is Opinion and Provided “AS IS.” The information provided herein is the opinion of Pink Sky Group. Certain information has been provided to Pink Sky Group by other third parties. Pink Sky Group has relied on information provided to it by such parties that it has not independently verified. Pink Sky Group cannot guarantee the accuracy of any such information and does not represent that such information is accurate or complete.
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