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Compound's General Counsel: Why bother with Security Tokens/STOs?

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Quick Overview: What is a Security Token?

In simple terms, a security token is the tokenization of securities, with stocks being the most familiar type of security. The benefits of security tokens are often highlighted in terms of significantly increased liquidity, fractionalized investment opportunities, enhanced credibility, and efficiency.

Under the 1933 Securities Act in the United States, the definition of securities is broad, encompassing stocks, treasury stock, bonds, investment contracts, and even cryptocurrencies, if they are offered with an expectation of profits. For instance, the well-known Telegram blockchain project TON was fined $18.5 million by the U.S. Securities and Exchange Commission for selling unregistered securities, leading to the project's failure.

Compound's General Counsel: It's not that you can't do it, but why do it?

Jake Chervinsky, the legal counsel of decentralized lending platform Compound, posted a thought-provoking tweet today (26th): "Security Tokens: It's not that you can't do it, but why do it?" This sparked some interesting discussions.

Chervinsky believes that security tokens can only be traded on compliant platforms, with all trading addresses required to be whitelisted (note: due to strict qualifications, only a limited number of people can participate, and retail investors cannot directly engage).

Industry insiders argue that even if all trading addresses need to be whitelisted, it is still faster and more efficient than traditional securities trading systems.

Chervinsky, however, questions this perspective. He points out that all transactions can be unilaterally rejected by centralized third-party institutions. All tokens can be unilaterally frozen, revoked, and redistributed. Additionally, there are currently no regulated trading platforms (note: there are actually some). Is this really better?

Some industry players suggest that the value of security tokens lies in the digital innovation of securities in terms of storage, credibility, and content efficiency compared to paper-based securities.

Chervinsky does not deny these advantages but categorizes them as "saving some money for businesses." He argues that the trust cost has not been significantly reduced; it is pseudo-custody, still subject to off-chain legal procedures.

He also expresses skepticism about the potential benefits of security tokens:

  1. The finality of settlements is still uncertain; if there is a right of revocation on third-party platforms, is it really faster?
  2. Expected benefits cannot be guaranteed. After entering the whitelist, brokers conduct pledge transfers off-chain.
  3. Security tokens are subject to strict regulatory restrictions.

Regarding real estate derivative security tokens, he also questions whether putting them on-chain is cost-effective given their complexity.

The Block's Research Director Larry: This Makes DeFi More Meaningful

The prominent figure and Research Director of The Block, Larry Cermak, responded:

"Allowing only whitelisted individuals to hold security tokens is super boring." He argues that the interesting aspect of tokenizing assets lies in improving composability and accessibility. However, these aspects may not materialize as securities could be traded on decentralized platforms like Uniswap, rendering regulators completely powerless.

He further states that when you realize regulators will never allow securities to operate anonymously, assets like stablecoins and permissionless protocols with stock-like structures (such as DeFi) become more intriguing.

Jake Chervinsky echoes a similar concept. He expresses that he would be extremely excited if security tokens could benefit from composability in open-source protocols (like DeFi), but given the existing regulatory framework, he believes this will be very challenging.