Where it all started
The ERC 20 standard was established during the early days of tokenization and remains the foundation of most tokens to this day. However, ERC 20 was simply not designed for security tokens, ultimately creating a number of problems. For one thing, organizations couldn’t rely on ERC 20 to enforce KYC for secondary trades, which does not bode well for certainty of ownership, an up-to-date cap table, or a recovery mechanism in the event of a lost private key.
The first attempted solution
Numerous entities tried to overcome these issues with proprietary standards. Implementations included the DS protocol from Securitize, R-Token from Harbor, T-Rex from Tokeny and ST20 from Polymath. However, this multitude of implementations created friction for the rest of the industry. Specifically, custodians, exchanges, and other participants needed to perform extensive due diligence on the code associated with the tokens themselves in addition to their normal business due diligence. Security tokens were intended to bring efficiency and reduce complexity, and adding this additional barrier was counterproductive.
You can see a comparison of standards here.
Security tokens were intended to bring efficiency and reduce complexity, and this additional barrier was counterproductive.
Standardization and collaboration
To tackle this problem, Polymath brought together 25 companies including key industry professionals to propose a unified standard for security tokens on Ethereum. The goal was to ensure that the token’s code met specific requirements in order to allow organizations to integrate it without costly and time-consuming technical due diligence. This standard, ERC 1400, has since been adopted by organizations including ConsenSys and BNP Paribas. ERC 1400 brought together some of the best minds in the industry to address the landscape as it stood at the time. Recognizing that regulation continues to evolve, ERC 1400 was designed to be modular so new functionality could be added as required.
Despite these advances, standards can only take us so far. While ERC 1400 goes a long way towards making Ethereum more suitable for securities, as a general-purpose chain, there are still gaps in functionality and scalability.
For example, digital assets on Ethereum are programmed using smart contracts resulting in custodians, exchanges, and other market participants having to integrate each asset into their environment individually. ERC 1400 makes this process much more efficient by standardizing the token configuration and eliminating the need for technical due diligence, but there is still room to make the process faster and more automated.
Addressing the gaps
As the industry has evolved, it’s become clear that five keystone issues with asset tokenization on general-purpose blockchains need to be addressed in order to align the functioning of the blockchain with the requirements of modern capital markets. To address these gaps, Polymath has spearheaded the creation of Polymesh, an institutional-grade permissioned blockchain built specifically for regulated assets. Because ERC 1400 has been so widely adopted, Polymesh has been able to use market feedback to build on the foundation created by the standard. Polymesh streamlines antiquated processes and opens the door to new financial instruments by solving challenges with the public infrastructure through five key design principles built into the base layer of the chain, rather than as external add-ons.
Read this guide on making blockchain work for capital markets to learn more.