Security Token Standards

Everything you need to know about token standards and their role in the security token ecosystem.

Overview

Token standards are a unified framework that allows tokens to interact and transact with each other seamlessly, unlocking the full capabilities of decentralized applications. Without this structure, each token would operate independently severely limiting innovation, network effects, and scalability.

Programmable scripts, known as smart contracts, govern transactions by adhering to these token standards to ensure consistent behavior and interoperability across the blockchain. This relationship guarantees that various tokens, regardless of individual purposes, can function cohesively within the broader digital environment.

Ethereum has prominently taken center stage in discussions around token standards, primarily because of its pioneering role and ease of use in developing smart contracts. As one of the oldest and most established blockchain protocols, it has become the go-to platform for developers, offering a robust and flexible environment for writing smart contracts. The plethora of ERC (Ethereum Request for Comments) standards illustrate Ethereum's dominance in setting the rules and guidelines for various types of tokens. You can find these standards in the form of technical documents on Ethereum's official website, where they contain the blueprints for creating and managing digital assets, whether for fungible tokens like cryptocurrencies or unique assets like NFTs.

The article will briefly discuss the most common token standards, all of which fall under the ERC category. Then, it will narrow the focus to explore specific token standards to address the unique requirements for buying and selling securities represented as digital tokens.

Common Token Standards

ERC-20

The widely adopted ERC-20 standard is a foundational set of rules for creating fungible tokens on the Ethereum blockchain, meaning each token is identical to every other token in its type. It provides a common interface for interacting with these tokens, including mandatory and optional functions for transferring and querying their balance. An illustrative diagram¹ showing these functions is provided below.

This standard has become essential for many cryptocurrencies and represents a significant portion of tokens on the Ethereum platform.

Examples include USD Coin (USDC), Polygon (MATIC), Binance Coin (BNB), Tether (USDT), UniSwap (UNI), Chainlink (LINK), Dai (DAI), Aave (AAVE), and Shiba Inu (SHIB).

ERC-721

The ERC-721 standard is a protocol for creating non-fungible tokens (NFTs) on the Ethereum blockchain, meaning each token is distinct and not interchangeable. This standard is widely used for digital collectibles, art, and identification, as it allows for the representation and ownership of unique items. Its creation has led to the boom in NFTs and digital ownership.

Examples include various NFT projects such as CryptoPunks and The Bored Ape Yacht Club and real-world applications such as art, tickets, car titles, etc. 

ERC-777

An advanced token standard that builds upon the existing functionality of ERC-20 by introducing new features for increased efficiency and security. It implements a mechanism known as 'Hooks,' streamlining the process of sending tokens, notifying contracts into a single function, and allowing the ability to reject transactions from blacklisted addresses. 

Examples include applications into various decentralized exchanges such as Uniswap and Bittrex.

ERC-1155

The ERC-1155 standard allows for the ability to create both fungible and non-fungible tokens within a single contract. This standard efficiently manages multiple token types, reducing the complexity and gas costs associated with deploying individual contracts for each token type. It has found applications in the gaming industry, allowing developers to create specific asset categories, such as in-game currency, characters, or skins, that are not completely unique but rather consist of 2-3 distinct types with thousands of identical copies within each category. 

Gaming platforms utilizing the ERC-1155 token standard include Sandbox and Decentraland.

Security Token Standards

Securities and other real-world assets will be treated separately from other crypto-native assets. For the next evolution of blockchain technology and tokenization to accelerate, abiding by laws and regulations is the focal point for developers, regulators, investors, and issuers. The following token standards attempt to outline the best framework allowing security tokens, investors, and issuers to interact and transact with each other in this new age digital environment. 

ERC-3643 

ERC-3643 is an institutional-grade security token standard developed by Tokeny in 2018, aimed at enhancing the lifecycle management of tokens. By offering refined interfaces that facilitate the complex management and legally compliant transfer of security tokens, this standard incorporates precision and adaptability to meet the strictest regulatory requirements. Leveraging the familiarity of the ERC-20 interface, ERC-3643 broadens the scope of tokenization, fostering the integration of real-world assets into the decentralized finance ecosystem and allowing for more diverse and secure investment opportunities.

A central feature of the ERC-3643 standard is the integration of OnchainID, a self-sovereign identity system essential for the token standard's operation. OnchainID is a comprehensive blockchain-based identity platform that identifies individuals, organizations, and DeFi protocols, enforcing necessary compliance and facilitating access to digital assets. Critical claims like KYC/AML checks, residency, and others are securely held through OnchainID, enabling a transparent and trustworthy framework for tokenized real-world asset transactions. This decentralized identity system aggregates certified information and enables multi-wallet management, enhancing the standard's effectiveness in aligning with legal obligations and broadening the potential applications of blockchain technology in real-world asset management.

ERC-1400 – Polymesh

The ERC-1400 token standard created by Polymath defines attributes like name, supply, and owner and provides the ability to pause all token operations until an approval threshold is met. By supporting automated transfer control (including KYC verification) and corporate actions (such as capital distribution or voting), it offers a comprehensive framework for managing securities. Additionally, it ensures the conservation of ownership rights for custodied assets and addresses some of the challenges surrounding security token management, helping to make Ethereum more suitable for securities.

Inspired by the advancements of ERC-1400, Polymesh emerged as an institutional-grade permissioned blockchain specifically tailored for regulated assets. Launched by the Polymesh Association in 2021, Polymesh builds on the foundations of ERC-1400, adding enhanced capabilities in areas such as governance, identity, compliance, and confidentiality. The blockchain's development was further complemented by the Polymath Token Studio, a self-service application that enables users to create, issue, and manage security tokens through a simple, intuitive interface. By layering in these additional capabilities and facilitating ease of use, Polymesh offers a refined and robust platform for managing and governance tokenized assets, reflecting the complexities and requirements of the modern financial landscape.

Provenance - Markers

The Provenance Blockchain, built on the Cosmos SDK, is a purpose-built blockchain designed for financial services through its unique implementation of 'Markers.' These markers are smart contract code built directly into the protocol, providing a streamlined solution that alleviates the unnecessary counter-party risk, cybersecurity risk, and additional expenses typically associated with traditional financial platforms. By embedding these functionalities at the protocol level, Provenance offers an innovative framework for digital asset management that goes beyond what conventional smart contract code can offer. The implementation of markers serves as a base layer for various financial platforms to integrate, reducing the network effort required to manage digital assets on the Provenance Blockchain.

A core pillar of the Provenance Blockchain's architecture is the ability to natively issue, transact, and manage tokenized securities within the protocol. This integrated approach has significant implications for financial services' efficiency, safety, and functionality. Markers play an essential role in this architecture by minimizing potential risks associated with contributed and open-source smart contract code. Most notably, fintech company Figure utilizes the Provenance blockchain for loan origination, servicing, financing, and now private fund services, demonstrating this technology's real-world application and potential. Using markers thus ensures a more secure and efficient platform, fostering a more seamless integration of digital assets within the broader financial ecosystem. By reducing complexity and risks, the Provenance Blockchain provides a powerful tool for modern financial platforms, aligning technology with the intricate needs of today's financial landscape.

Other Security Token Standards

DS Token

The DS Token is a standard developed by Securitize, aimed at handling the issuance of securities, including facets like lockups, dividend distribution, and voting rights. Unlike conventional ERC-20 tokens, DS Tokens require all primary or secondary trades to be approved by their 'Compliance Service,' an on-chain control unit that verifies investor status through an on-chain registry before executing any transactions.

ERC-1404

The ERC-1404 standard, developed by Tokensoft, is an extension of the ERC-20 token standard that allows the token issuer to restrict the transfer of tokens through a simple function, aligning with the specific needs of the offering and the regulatory requirements of their jurisdiction.

Conclusion

The landscape of token standards has seen remarkable innovation in tailoring specific functionalities to meet diverse needs, particularly in regulatory compliance and transparency. The ERC-3643, ERC-1400 (Polymesh), and Provenance Markers each offer unique approaches to these ends. While each standard works to bring clarity and uniformity to meet regulatory requirements, they are archetypally distinct in their design.

ERC-3643 uniquely emphasizes compliance, security, and identity management through the integration of OnchainID, enabling a specific approach to creating and controlling tokenized securities in alignment with regulatory requirements. ERC-1400's flexibility appeals to a broader range of digital assets, providing governance support without added transfer constraints, making it adaptable to a wide range of digital assets. Unlike Ethereum-based standards, Provenance innovates with a protocol-level implementation, ensuring seamless and native management of security tokens while reducing costs and risks. Together, these standards highlight the diverse ways blockchain technology is evolving to meet the nuanced needs of various sectors within the financial landscape.

These standards are poised to serve as the bedrock for the evolution of the private markets industry, unlocking unprecedented efficiencies in the tokenization of securities. By customizing blockchain technology to align with industry-specific needs, enabling accessibility to a global market, and adhering to regulatory compliance, they lay the groundwork for more streamlined, transparent, and accessible markets. As the financial landscape continues to evolve, new and disruptive token standards are expected to emerge, with institutions continually exploring opportunities for integration. The anticipated use of account abstraction in standards like ERC-4337 is something to closely watch, as it hints at the innovative directions that future token development may take. This visionary approach broadens the horizons of current financial landscapes and sets the stage for a new era of financial innovation.

Disclaimer:

The content provided in this article is for informational purposes only and should not be construed as financial advice. All information, data, and analyses presented are for the reader's informational and educational purposes. Decisions based on the content of this article are made at your own risk, and before taking any action based on the information provided, readers are advised to seek the counsel of a qualified financial professional or other relevant expert. Neither the author nor the publisher holds any responsibility for any financial or other decisions made based on the content of this article

1. https://info.etherscan.com/erc-20-fungible-token-standard/