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Connecting the worlds of security tokens and decentralized finance (DeFi) is the logical next step for Securitize, a kind of regulatory compliant fixer when it comes to tracking and trading blockchain-based securities.
Announced Monday, Securitize is partnering with a protocol called Centrifuge’s Tinlake, which uses an intelligent non-fungible token system (NFT) to allow real-world assets to participate in DeFi.
In an ideal world, any element within the Ethereum ecosystem should be able to integrate into one another, sharing new and useful features such as automated market-making or other functions. This concept, a fundamental principle of DeFi, is known as “composability” (the often used analogy is the omni-building capability of Lego bricks).
But there is a problem: digital securities, like their traditional counterparts, are regulated and have different control mechanisms that must be applied. All securities, whether private or public, require customer identification (KYC) of the person buying them, as well as the mandatory investor status to determine what type of investor they are (retail or accredited, depending on the rules of their local jurisdictions).
This is where Securitize comes in. Focused on smoothing out the fragmented world of private securities trading, the firm has refined its approach to identifying asset owners and peer-to-peer regulated transfer of private security tokens. As such, the system is already 90% of the way to DeFi composability, said Carlos Domingo, CEO of Securitize.
“Many DeFi protocols are designed for unregulated utility tokens or cryptocurrencies, so they aren’t really suitable for security tokens,” Domingo said in an interview. “We have a thesis on how to make this work legally, and then allow the things that exist in traditional capital markets, like market making, or lending and borrowing, all in an automated way.”
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DeFi protocols often manage pseudonymous liquidity pools powered by automated smart contracts. The Securitize Tinlake integration, by contrast, will be strictly for the wallets associated with Securitize ID, so that the person on both sides of an exchange is known, Domingo said.
Tinlake’s smart contracts group NFTs that represent real-world assets. For example, a pool could be dedicated to invoices that could be used in a trade finance scenario, which are then used as collateral to finance stablecoin loans such as DAI or USDC.
DeFi dive
The current Tinlake-enabled pools are short-term loans that return money to the investor in a short period of time, but the next step is to explore rolling pools that reinvest dividends and also receiving tokens that can be used by others investors to receive contributions from the pool (the latter is known in DeFi as a liquidity provider, or LP, token).
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But diving head first into DeFi presents some interesting challenges, Domingo said. Keeping ownership of stocks in check has contributed to a pool on some automated market making protocols like Uniswap containing hundreds of stocks, which is very complex to implement, he added.
“It’s not impossible, but it will take some time to integrate with our protocol to control transfer restrictions,” Domingo said.
Another key question is who can actually advertise private securities trading as a multilateral trading facility (MTF) license or, in the US, an alternative trading system (ATS) license is required. “So even though we may be 90 percent with the technology, there is still some regulatory uncertainty,” Domingo said.
Securitize isn’t considering adding governance tokens like Uniswap’s UNI, Domingo said, because it’s unclear whether these types of tokens are legal. But regardless, he said there are still scenarios where it will be more profitable to contribute stocks against a pool of cash rather than waiting for them to appreciate over time.
“If you go to buy Apple stock on Robinhood, the only thing you can do is wait for it to appreciate over time. That’s it, “Domingo said.” But if these DeFi protocols become available over time for security tokens, as we think they will, suddenly there are other ways to make money than just hold on and wait. “
