Transcript: AMA Securrency

Coinchange research team had a chance to chat with the core team of Securrency and learn about the Institutional DeFi and the Real World Asset Tokenization. They have been co-authors on our newly published 40+ pages research report titled, “Institutional DeFi in 2023, Regenerative Finance (ReFi): fostering adoption through blockchain innovation” . 

Following is the transcript from the video interview:

Hello, everyone. Welcome to another AMA episode for Coinchange. Today, we have guests from Securrency, a tokenization platform specializing in digital tokenization.

They offer institutional-grade compliance, boasting a patented system that we'll delve into shortly. Moreover, they incorporate capital markets as part of their offerings. Thus, they're actively participating in an industry that's projected to be worth 16 trillion by 2030. Quite substantial, wouldn't you say?

Specifically, they cater to institutional DeFi. This coincides with the research that our team at Coinchange is currently undertaking. Our research team is drafting a report on institutional DeFi, and it was through this effort that we came across Securrency. Naturally, we're eager to learn more about their services.

Securrency’s journey from 2015 to present

Securrency is the company that handles tokenization, including compliant tokenization. However, it's just a small part of the overall technology stack that the company has built. This stack is an end-to-end infrastructure designed to support digital assets in regulated contexts.

Securrency began in 2015, like many startups, with a few developers building technology based on an idea. The idea was not only to tokenize assets but also to incorporate business logic (smart contracts) and compliance logic.

Securrency aimed to automate compliance and business functions, streamlining the movement of value. The primary objective was to construct a comprehensive infrastructure based on a universal compliance framework. The principles on which Securrency based its infrastructure were as follows:

Firstly, compliance is the key to liquidity, enabling the ability to move assets between different institutional environments. This movement must comply with the rules applicable in various jurisdictions and across different environments.

So, for example, payments are treated differently than securities are treated. However, in some cases, the same asset can be a security at one moment and a payment in a different context. It is crucial for the company to comply with all regulations in these various contexts and do so in real-time without halting at every border.

From the perspective of regulators, the boundaries may be in place, but in the crypto world, it is widely known that things become more liquid when these boundaries are removed. Nonetheless, when regulators are involved and the boundaries are established, the same velocity of movement is still required and for that reason, compliance is a fundamental component.

Another key focus for Securrency is being ledger agnostic. Different blockchains may be preferred for different reasons, depending on the situation at hand. Therefore, interoperability becomes essential, resulting in the development of a layer 3 type infrastructure solution.

Additionally, it was necessary for them to offer a white-label implementation of this infrastructure, catering to both institutional purposes and smaller brokerage levels. This approach aimed to create what they call the "global liquidity network" within the company's terminology.

The ability for all these different platforms to interoperate with each other and expose value across a broader ecosystem, facilitating transactions, was the core idea since 2015. It was ahead of its time. As the company grew in 2016 and 2017, transitioning from a garage setup to a more conventional startup environment, that particular moment was dominated by ICOs.

Despite that trend, Securrency stood out as the nerds in the corner, adorned with bow ties, diligently working on institutional-grade compliance solutions. They had a keen foresight of the upcoming convergence between the institutional world and the DeFi (Decentralized Finance) world. Recognizing this, Securrency positioned itself at the intersection of these two realms, firmly believing they were in the right place at the right time.

Examples and Use Cases

The infrastructure is intended to be universal. And it's not just about security. They have a saying that ‘tokenization is not enough’. KYC/AML is not enough either. If you're developing tokenized securities, they need to comply with sophisticated and sometimes interpreted policies related to securities regulations. And if that asset is going to move between jurisdictions, it needs to comply with the securities regulations of both jurisdictions. So, the framework for building out those policy sets needs to be robust.

But you need to go even further. You need to build robust identity services. You need to incorporate account management or wallet management services. What Securrency has built is a truly deep institutional-grade infrastructure. And what that means is that we can deploy it for a large bank, such as a custodial bank. We could deploy it for a transfer agent or a CSD. We could deploy it for a large asset manager who wants to perform their own issuance. We could also deploy it for a government that wants to issue tokenized bonds, fixed income assets, or other government-issued securities.

So, it's designed to be white-labeled and implemented in various contexts. When implemented in different environments, it becomes interoperable. 

Their clients fall into different categories. You've probably heard a lot about WisdomTree, one of their main investors and a leading asset manager. WisdomTree is deploying Securrency’s technology and has launched 17 SEC-approved 1940 ACT funds, which are public funds. Their thesis is to use this tokenization vehicle to go direct to retail. They have launched an app called Wisdom Tree Prime, where they can directly engage with retail customers and create their own ecosystem of value around tokenized assets. These assets coexist with regulated digital dollars and other crypto assets in that environment.

They also work extensively with large institutions like US Bank and State Street. Both institutions serve as custodians, but they also have different focal areas. Within a bank, multiple projects may be underway. For instance, they might collaborate with them on transfer agency. Or they might collaborate with them on a private assets issuance platform or a fixed income platform, among other things. It's all built on the same infrastructure, but with different front-end workflows. Additionally, they work with large exchanges, they work with Layer 1 blockchains, providing them with tokenization and compliant wallet solutions. 

They also collaborate with major digital custodians. Although their clients come from a wide range of participants, the commonality among them is that they fit into one of the three main segments: asset creation, asset servicing, or asset distribution. Our infrastructure, coupled with our compliance and token framework, supports all of these roles.

This question could be for Tyler or anyone else on the institutional side. What do you think traditional finance institutions lack that tokenization can help them overcome? How are you assisting them in this regard?

Definitely. I believe the main answer to that, moving forward, is decentralized finance (DeFi), right?

The core issue revolves around why one should tokenize when there are already well-established, efficient, and cost-effective fund markets. In addition to the various benefits tokenization offers, such as 24/7 trading and fractional trading of shares, it has so far failed to fulfill its promise.

What Patrick explained is what allows these assets to advance in terms of liquidity—transportability. Securities tokens can move across ecosystems, whether it's peer-to-peer or between centralized exchanges and decentralized exchanges (DEXs).

Our compliance framework enables this. Defi provides the solution to the question of why people would want to tokenize, offering additional products and services not available in traditional markets. This includes new types of yield and expanding access to institutional offerings for retail investors.

For example, consider securities lending, which is similar to what Maker DAO is discussing when onboarding RWA collateral. It's a product and service that has been predominantly reserved for high net worth individuals and institutions. Now, we can make it accessible to retail investors, and I believe this is just one example of what motivates people to invest in tokenized assets.

From a policy and government relations perspective, we're observing an increasing number of discussions on how to bridge the worlds of traditional finance (trad fi) and decentralized finance (defi) in a compliant and responsible manner. Organizations like the Bank for International Settlements collaborating with monetary authorities in Singapore on Project Guardian and the recent release of Project Mariana align closely with our focus over the past eight years.

These conversations are gaining momentum across various jurisdictions, not only in Europe but also in Asia. Being positioned in the intersection of trad fi and defi gives us an advantageous position, both in the industry and from a policy standpoint.

The inclusion of Courve V2 in the Mariana report was significant for the industry. I highly recommend checking out that paper.

That's a good point, relating to my question about permission and permissionless. Our report argues that there is a high likelihood of institutions entering defi, but through the permissioned route.

I'm curious to know if your framework supports deployment on both permissioned and permissionless blockchains. Is it simply the interface that institutions need to go through, and whether they choose a permissioned or permissionless blockchain is up to them, not your responsibility?

This is a question for all three of us, and I'll start. Tyler will have some interesting points to add, and my thoughts will lead into Jackson's perspective from a policy standpoint.

To answer your question, our framework supports both permissioned and permissionless blockchains intentionally. WisdomTree has deployed on public ledgers, including Ethereum and Stellar, simultaneously. Additionally, when working with large institutions, we accommodate their permissioned ledgers, such as their internal version of Hyperledger Bezu.

Philosophically, we strongly believe in public ledgers and permissionless systems. However, recent concerns from institutions revolve around the network token and the provenance of crypto assets, rather than the ledger's security or KYC/AML compliance. Regulatory uncertainty has led some banks to start with permissioned versions and gradually consider transitioning to permissionless systems. This cautious approach has been observed over the past several months.

Tyler, over to you.

Permissioned ledgers have become a hot topic. I don't think public ledgers will disappear. Instead, institutions may utilize private permissioned blockchains or subnets as sandboxes to test concepts privately and keep certain products and services private in perpetuity. They can connect these private systems with public ledgers for specific activities, creating a hybrid system that benefits everyone. While we are advocates for public ledgers, we can also create subnets for individuals or organizations. Our compliance framework allows individuals to interact with security tokens within a permissionless DeFi ecosystem, while still maintaining control and traceability through the entire asset lifecycle.

Unfortunately, it seems Jackson is experiencing technical difficulties. Moving on, I believe there will eventually be a convergence between permissioned and permissionless systems. There are significant cost savings for institutions when utilizing decentralized mechanisms, such as mapping out decentralized securities lending frameworks. While we may not have all the answers yet, the potential value on the table suggests that positive solutions will emerge, even though they are not fully developed at this stage.

I agree.

Adding on, I apologize for the interruptions, but I'd like to mention that the policy and regulatory concerns arise in terms of how interoperability between decentralized networks and traditional systems can be achieved.

Secur has catered to addressing this challenge by providing a framework that facilitates both permissioned and permissionless deployments. We have observed the growing sentiment that everything should exist on the blockchain, but we have also engaged in conversations with regulators who express concerns about the security and operational aspects of solely relying on the blockchain.

It is worth noting that organizations like the Bank for International Settlements and various central banks are working on projects such as Enbridge and the Multi-CBDC Ledger, aiming to establish networks of networks. There are ongoing pilots in several jurisdictions, which generate a significant amount of activity and reports.

When we analyze these reports and identify the challenges and potential they highlight, our team, including Tyler, Patrick, and myself, spring into action. We proactively reach out to regulatory authorities, not to criticize or condemn them but to extend a helping hand and offer our expertise as a resource. We focus on the underlying challenges and seek to bridge the gaps faced by regulators and the industry.

Jackson made a great point. Instead of engaging in Twitter tirades, we recognize that achieving the $16 trillion opportunity mentioned earlier requires figuring out the regulatory aspects. Positive conversations and collaboration are essential to unlock the full potential of this space, and we are just beginning that journey.

I want to emphasize that we are not advocating for a complete replacement of existing frameworks. Many traditional assets can be tokenized and distributed across distributed networks while adhering to the regulatory constructs that have been in place for years or even decades.

Regulation and compliance are already in place, and while certain amendments and reconsiderations may be necessary, it doesn't require a complete restructuring of decades-old regulatory frameworks.

Let me provide a specific example related to SEC-registered funds. In the ETF industry, we built upon mutual fund registrations, which were established many years ago. Initially, some features were limited, but through the exemptive relief process, ETFs obtained new powers and capabilities to fully utilize their structure.

Tokenization follows a similar path. The first SEC-registered tokens utilized the Mutual Fund Registration Act of 1940, and we will need to go through the exemptive relief process to realize features like 24/7 trading. While we can currently incorporate such features in a manufactured way, it is a gradual process. We start with existing regulatory frameworks, demonstrate their effectiveness, and then add additional features and services once proven.

To conclude, I want to touch upon our Composer product, which forms the core of our DeFi capabilities. During a recent conversation with a large institutional client, they expressed a preference for using the term "smart contracts" instead of "DeFi" to alleviate concerns. The 24/7 functionality relies on real-time pricing, an essential component of automation, along with real-time compliance. This combination eliminates the manual process of striking the net asset value (NAV). The focus should not solely be on whether these assets trade away from NAV but rather on having a real-time, automated value that adjusts accordingly and can be reconciled across all layers.

For instance, in managing collateral, institutions can automate functionality within their securities lending frameworks or repos. However, it is crucial to ensure that real-time data reaches the ultimate beneficial owner for purposes like taxation. A unified data source that seamlessly integrates with all functionalities is the true promise of DeFi and blockchain technology.

This is a valuable conversation. In a previous Ask Me Anything session, we discussed a similar topic, where individuals tend to criticize SEC regulations on Twitter. However, such actions are counterproductive.

It is more constructive to focus on working with regulatory bodies and collaborating to achieve progress. Without their cooperation, we cannot reach our goals, and institutions will be reluctant to participate if we continuously criticize regulators. It is refreshing to hear this perspective.

Exactly. It's crucial to acknowledge that you don't have to agree with everything regulators do, but shouting at them won't lead to productive conversations. They are more likely to listen and recognize their mistakes when engaged in a constructive dialogue.

Tyler's example of ETFs and mutual funds highlights the need for a gradual transition from legacy laws and regulations to accommodate innovation. Institutional adoption cannot occur without this transfer and necessary adjustments.

The value proposition becomes evident when considering the automation of the entire management life cycle of tokenized vehicles through smart contracts. From data ingestion from providers to automating back and middle office functions, significant cost savings can be achieved compared to traditional ETFs. Institutions are beginning to grasp this potential, and as more of them enter the space, it will drive regulatory advancements. The magnitude of the opportunities at stake is too significant to be ignored.

I have a question regarding tokenization and what will drive the advancement of this sector in terms of DeFi adoption by institutions. I'm interested in your opinion on which major asset needs to be tokenized or is currently being tokenized that will propel widespread adoption. Is it CBDCs, securities, bonds, or something else? We have seen examples of organizations tokenizing each of these assets. But in your view, which asset will truly entice institutions to participate?

This is an excellent question. One of the key challenges in the industry is the lack of recognition regarding the asset class that presents the most significant opportunities for tokenization. While private assets may initially come to mind due to their illiquidity, tokenization can offer promising liquidity solutions. However, it's important to note that this doesn't automatically make private assets the catalyst for widespread adoption.

The dilemma lies in the chicken and egg problem. Investment into infrastructure is hindered by the wait for adoption, while asset creators hesitate due to the absence of infrastructure. To address this, infrastructure needs to be established first. Simply having a tokenization platform without a comprehensive infrastructure is insufficient. It's like having a roller coaster that's only a hundred feet long - it lacks the full experience. Therefore, we require a robust infrastructure that supports multiple use cases.

To identify the asset class that will drive adoption, we should consider an asset class that is already liquid and where people are exploring new possibilities. It should also offer sufficient liquidity to enable exciting opportunities and innovations.

The asset class that holds great potential for driving adoption and is currently being advanced is public funds. Tokenizing public funds goes beyond simply tokenizing a fund; it creates a versatile instrument that can serve multiple roles. For example, tokenizing a money market fund not only transforms it into a tokenized fund but also establishes a stable instrument that can act as collateral in other transactions. While it may not appear attractive in terms of yield, its utility value is significant, and further development can be built upon this foundation.

Real estate tokenization projects have also gained attention, but they face challenges due to the lack of core infrastructure for global pricing and compliance. Nevertheless, public funds are positioned to lead the way in tokenizing real-world assets, thanks to their established presence and market size. Private assets, on the other hand, hold tremendous promise for transformative impact, but infrastructure development is required to fully unlock their value.

Tyler agrees that public funds will play a crucial role in driving adoption, given their substantial assets under management (AUM) and market presence. Additionally, when considering developing markets, the ability of public funds to interact with decentralized finance (DeFi) becomes particularly valuable. DeFi is currently the most mature market capable of supporting businesses in this space.

These perspectives reflect my own personal viewpoint, and Tyler and Jackson may offer different insights.

Unlocking economies and enabling consumers to access compliant and securitized products will be a significant aspect, as Patrick mentioned. Trade finance is a prime use case for automation and smart contracts. The trade finance industry is highly fragmented and manual, creating opportunities for positive impact through smart contract technology. The trade finance gap, which amounts to hundreds of billions of dollars, presents a massive opportunity considering the global dependence on trade. Utilizing a CDP (Collateralized Debt Position) or a variation of MakerDAO can potentially close this gap. Even if DeFi yields alone may not be attractive enough, trade receivables can be used as a basis for generating yield. Trade finance companies can operate their own capital pools, utilizing pooled funds to finance trade deals and bridge the gap. These are real-world use cases that are being explored, and the infrastructure is already in place, awaiting active participation. We are witnessing the initial movers entering this space.

Tyler's point on trade finance is significant, and I fully agree with him. Debt, along with trade finance, is an asset class that aligns perfectly with smart contracts and blockchain technology. The letter of credit (LOC) in trade finance, for instance, has tremendous potential for improvement and efficiency.

Trade finance, although streamlined in the manual world, remains cumbersome, inefficient, and unnecessary when automation can eliminate counterparty risk and streamline processes like release triggers. Debt instruments, in general, are ripe for automation and offer significant value. Bringing automation to the underlying level, where a fund owns debt instruments and enables straight-line automation, holds immense power and implications. These use cases present significant opportunities.

Adding some numbers to the discussion, a recent Bernstein report forecasts a $5 trillion tokenization opportunity within the next five years across various asset classes. Private market funds have a projected opportunity of $650 billion, securities at $90 billion, corporate bonds and equities around $400 billion each, residential real estate at $260 billion, commercial real estate at $300 billion, and currency-related opportunities, including stablecoins and CBDCs, at $2.8 trillion. These projections add up to a $5 trillion opportunity within the next five years. Additionally, if we consider the idea that blockchain moves value as the internet moves information, the total opportunity across all assets could reach approximately $100 trillion.

Indeed, there is a substantial opportunity at stake.

I believe you've addressed our question about the TAM. We were wondering about the total addressable market in this section. Regarding infrastructure compliance, Jackson, could you explain the Compliance Aware Token Framework you've developed?

Well, this is our centerpiece and the core of our operations. Our token framework's compliance is a hybrid of on-chain and off-chain components. It involves record keeping, record correction, and pre-trade compliance automation.

To simplify, tokenization platforms usually focus on two aspects of compliance. First, onboarding compliance, which includes AML and KYC. Second, white listing, which confirms if a wallet is authorized to interact with an asset. While these are important starting points, we believe in a better model.

In this model, participants have their own set of credentials, and assets have policies. The asset evaluates the participant's credentials to determine if they can transact with the asset. Think of it like being on a guest list for a party or having the right shoes. In the first case, if you're not on the list, you can't enter. In the second case, if you have the right shoes, you can enter. Credentials match the criteria.

Another important aspect is that we tend to limit venues based on credentials. For example, private and public marketplaces require screening at the door. However, this is not how a supermarket works. If I go to a supermarket with my 17-year-old daughter and we both try to buy beer, she will be stopped at the cash register because she doesn't have the right credentials.

We don't have to shop in separate stores, right? Our ability to interact with the inventory depends on our credentials, which is how the market should work. For example, securities regulations currently have many marketing rules.

I want to ensure that you're showing this to the right person. However, that's irrelevant because you can show it to anyone. Their credentials determine their interaction with it. These rules are the kind that regulators can easily reconsider once they become comfortable with this framework.

And, well, that leads to other questionable practices, right? Why is it that if you're a FinTech and you charge a fee based on transaction value, you're considered a broker-dealer in the US? It's because they believe you're involved in marketing, which is not allowed.

These rules are based on a "check 'em at the door" concept, and we're moving away from that. So CATF is a dynamic framework where we extract attributes. During the onboarding process, you expose certain attributes about yourself as a participant.

One attribute may be your nationality, another may be your actual residence (which could differ from your nationality), another may be your accreditation status, and another is whether a verification agent has cleared you for KYC. We also check if your funds are clean.

These attributes are then mapped to a wallet. We also have a tool called the rules engine, which allows you to create complex policy sets for the asset using plain language. These rules can be regulatory or transactional.

For example, I could specify that my asset should only be held by individuals whose first name starts with "T." This ensures that Tyler cannot send it to Jackson. This enforcement is possible within the same framework.

When a transaction is proposed, the asset declares its policy to the compliance Oracle, which then checks the participants' credentials and determines whether to proceed or not.

That's the basic CAT framework, which is interoperable across multiple ledgers and legacy systems. This framework is the crown jewel. Jackson, if you want to add on the regulatory components, please go ahead.

This is what we've been hearing recently, reflecting the CAT framework and its potential in addressing convergence between markets and products. Regulatory jurisdictions and authorities are recognizing this ongoing convergence.

Patrick, your examples are fantastic. It's much clearer now. I read a similar framework or proposal in an institutional report by Oliver Wyman. They proposed verified credentials (VCs) and designated authorities as verifiers for credentials. These participants would have permission to execute or interact with specific transactions on a decentralized and permissionless blockchain, based on their credentials.

That's correct. JP Morgan referenced Project Guardian earlier. JP Morgan is working with the verified credentials concept, which is slightly different. It's a start and an important starting point. However, we need to go beyond the verification of credentials to reach where we are with CATF. With CATF, we take those verified credentials and match them with the policy set.

Another crucial component is the ability to create a policy on any chain using a smart contract and apply it to that chain. However, without our framework, you cannot transfer that policy from one chain to another.

Currently, some people replicate the policy on both chains, but this creates a reconciliation risk if the policy changes or if there are any discrepancies. It also makes it more challenging for regulators and compliance officers to audit.

We maintain one instance of the policy that gets replicated off-chain in different environments. So there's one master instance of that policy. We can use the verification credentials as the credentials for the wallet and match them against the central policy for the asset.

This allows asset managers to do things they couldn't do before. They can distribute assets in different countries simultaneously, all in compliance. They don't need to reconcile with brokers in each country. They can see real-time compliance at the wallet level. It's a powerful solution, and we're proud of CATF, which is our centerpiece.

Additionally, we've had extensive discussions with regulators worldwide, showcasing CATF and its cross-border transaction policy, enforcement, distribution control, custody control locations, transaction reversibility, and other issues. We've demonstrated to regulators that this is possible and not a distant future possibility.

It's fascinating how this solution flips the issue and provides infrastructure for massive adoption. It removes many existing barriers to adoption.

That's great. One thing to note is that Securrency doesn't have to maintain it. This is deployed in a white label format, so issuers can manage their own control location for the asset or delegate it to a transfer agent or CSD if needed. It's designed to be flexible and used at various levels, from institutions to individual brokers and issuers, all interoperable across the ecosystem.

It was a very insightful discussion, and we learned a lot today. Hopefully, this video will reach many people and help them understand that infrastructure is the solution to the chicken and egg problem. Your analogies and examples made this topic easier to understand. It was quite insightful for us.

Thank you for the opportunity to talk, and take care everyone. Thank you all.