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STOs On Tezos – How Could It Impact XTZ?

Story Highlights
  • STOs On Tezos - The Present Landscape
  • Why Tezos?
  • How Could It Impact XTZ

STOs On Tezos – The Present Landscape

The race to be the go-to blockchain when it comes to STOs is on and some might argue that Tezos is leading that race with the big partnerships they have made to date. These partnerships signal the intent to tokenize over $3 billion worth of real estate and securities on the Tezos blockchain to date.

The partnerships are broken down in terms of the organizations involved and the amount they want to tokenize on the Tezos network in the table below:

Organizations InvolvedAmount Targeted To Be Tokenized
Elevated Returns/Seamico Securities$1 billion of real estate
BTG Pactual/Dalma Capital$1 billion of real estate
Vertalo/Advantage Blockchain/TZero$300 million in real estate
Vertalo/Dealbox$200 million of securities
Alliance Investments/TZero/Tezos Foundation/Megalodon$643 million (at least $25 million of River Plaza in Manchester to be tokenized initially)
Over $3 Billion Is Targeted To Be Tokenized On Tezos

There are also other large STO projects being built:

Andra Capital in partnership with Tokensoft and the Tezos Foundation plans to issue Silicon Valley Coin, which will provide a gateway to a fund investing in pre-IPO technology companies.

There are also partnerships with Globacap, who are working with Serokell and other partners on a Tezos project designed to drive capital markets automation.

Of course, these are not partnerships signed directly with the Tezos blockchain itself, as that remains a decentralized piece of software, owned by no person, or entity. The partnerships are being signed with the Tezos Foundation, which was created to look after the treasury of user funds generated from the Tezos ICO with the goal of further developing the Tezos Blockchain.

STOs and the overall security token market are a key strategic focus of the Tezos Foundation. This is why the Foundation has been funding the development of tooling, which eases the pain points of launching STOS, such as developing different token standards.

Why Tezos?

So, why are these projects building on the Tezos blockchain? There are many reasons why a company, or organization may want to launch their STO on Tezos and here are just some of the key reasons:

  • Tezos is a robust blockchain that gives developers the ability to formally verify their code and smart contracts.

This is especially important for companies who are launching STOs, or tokenizing assets that are extremely high in value, such as real estate. You can formally test and simulate if a $1 billion transaction will hit its destination, which provides much greater security assurances over other blockchains.

  • A multitude of security token standard smart contracts have been produced with the focus of STOs in mind.

To name but a few there are the following token standards, either developed, or in the process of being developed on Tezos:

  • FA1.2
  • FA 2.0
  • NYX from Equisafe
  • VEE Token from Vertalo, which was developed with Deloitte.
  • It is also believed that Elevated Returns have also created their own unique standard.
  • There is also rumored to be a token standard being developed in relation to NFTs, or Non-Fungible Tokens. As Kathleen Breitman, the co-founder of Tezos and the founder of gaming company Coase stated on Reddit:
Kathleen Breitman, Co-founder of Tezos & Coase

Gaming is thought to be a key industry in the security tokenization space, so to have many token standards covering a wide spectrum of industries and use-cases will give Tezos the ability to become highly composable in the security token space.

This is because it may be possible for these token standards to interact with each other on the Tezos blockchain, opening up many more use-cases. This could include gaming NFT token standards interacting with real estate STO token standards, to create a real-life Monopoly game, where fractions of a property can be bought and leased within a game.

  • Tezos has the ability to separate transactions from asset ownership.

As Jesus Rodriguez, the CTO of IntoTheBlock states

Jesus Rodriguez, CTO of IntoTheBlock

Let’s imagine there is an STO fund with an ownership cap table, representing ownership of a particular token. This cap table needs to be kept up to date at all times, even when it is trading. Now, imagine you connect this cap table with an exchange and tokens start trading, you need some way to separate the ownership and transaction and in real-time and keep the cap table which exists on the ledger updated.

  • On Tezos there is no need for forks.

On Tezos the Governance mechanisms built into the blockchain mean that unlike other blockchains, it can upgrade without forking. Forks can be troublesome for STOs, this is because a blockchain fork it splits a blockchain into two, the old chain and the new chain. Forks can be divisive in cryptocurrency communities – who is to say which chain is better and should hold the value? What happens if a fork occurs and token providers and issuers can’t decide which chain should hold the most value? Often, these forks can lead to community splits, weakening the network effects of that particular blockchain.

This could lead to the potential for token providers and issuers to choose different chains, thus impacting composability and interlinked systems. Forks can also make blockchains less predictable, especially when it comes to the overall evolution and upgrade process.

The Tezos Governance process also gives token issuers a chance to have a say in the upgrade process of the protocol. It’s highly likely a token issuer with $1 billion worth of real estate on a specific blockchain would want a say in how that blockchain upgrades itself. This is because upgrades to the underlying blockchain can impact the token itself, both negatively and positively.

One negative example could be that a security issue could occur when an upgrade has taken place, which could leave security tokens vulnerable. A positive example could be that new features have been enabled such as privacy on the blockchain, which would enable security tokens to implement this feature into their technology. Overall the security token space is a developing industry and therefore more predictable evolution and upgradability are considered key attributes.

  • Tezos can offer suitable financial contract structures, which enable a lower-cost trading.

As Dave Hendricks of Vertalo states:

“So some smart contracts that had been created and used for security tokens can cost 50, 60, $70 per contract to trade. That’s a lot more expensive than trading on E-Trade. And they’re very difficult to configure for different ATSs and so we developed over two years ago, a very simple standard with Deloitte called the VEE token. And so we now natively write the Vertalo VEE token standard for every issuance, and we basically do that for free. And so we basically create free security tokens if you launch on our platform. And the VEE token is written natively Tezos and it works very nicely.”

Dave Hendricks Founder Of Vertalo

This can actually impact the tokens ability to be added to exchanges, as this extra transaction cost can cause big friction for the exchange and also its users.

So, unlike token standards like Ethereum’s 1404 where heavy costs can occur due to adding compliance for jurisdictions it would never trade-in, it actually pays to be skinnier in design when it comes to security token transaction costs. Rather than develop a security token standard which is all things to all people, it will be more beneficial from a transaction cost point of view to develop multiple different standards and then combine the smart contracts for the benefit of both evolution and transaction cost.

As Tezos is developing multiple token standards across many different jurisdictions the composability should eventually bear fruit for issuers. This is because they will then be able to cherry-pick the regulations and standards they need in a token, whilst maintaining a low transaction cost overhead.

  • Proof of stake.

Many issuers and companies looking to tokenize will often have obligations and intentions to be kind to the environment, that already exist within their companies policies. Any issuer launching a token on a proof of work network, may have a hard time justifying the energy and resources allocated to securing the network and validating the transactions of their security tokens.

  • Collateralization opportunities with a proof-of-stake network.

It will give flexibility to both issuers and investors. In fact, future staking income could even be used as collateral means to participate in certain token offerings, meaning leverage and even more liquidity for the markets. A proof-of-stake network can also help with the insurance layer that will inevitably follow large STO projects.

One such example could be if the issuer decided to become a baking service. In this instance, then the staking rewards accumulated could be used as collateral to buy even more tokens from the issuer.

  • It’s possible for investors not only to generate yields from dividends of the tokenized asset, but also through staking too.

This will enable the tokenized assets to have a clear advantage to investors over their more-traditional counterparts. There has been much speculation on how this would be one, one line of thought is that issuers could create an automatic loan on the asset token and use the proceeds to buy base-layer protocol tokens, which are then staked to create a second revenue stream. This could in turn be used to collateralize the investment, however many other use-cases may come from such novel ideas.

  • The custody of staking on Tezos is inherently less risky and complex than on other platforms.

On certain blockchains users who wish to stake (including those delegating) have to lock up funds in order to receive rewards. On Tezos, although bakers do that to put up a significant bond the flexibility of the staking features allows delegators to remain in full control of their funds at all times. This makes the custody of holding Tezos easier to manage for large institutions.

This flexibility allows user funds to remain offline in cold storage or in HSMs (Hardware Security Modules), rather than reside in a hot wallet meaning the funds can remain more secure. If indeed issuers are looking to create automatic loans in order to offer both dividends and staking rewards then safe custody of the underlying asset and staking rewards become an important piece of the jigsaw.

  • Privacy – With the upcoming introduction of Sapling to the Tezos protocol.

With privacy potentially coming on-chain to the Tezos network in the form of the potential Sapling Zero-Knowledge Proof upgrade, it means that the privacy layer would not be centralized. Being able to create STOs, which can have privacy enabled will enable many more use-cases and will enable larger institutions that require stringent privacy to take part, opening up much more liquidity and market participants.

  • Compliance with multiple regulations and jurisdictions. 

As emerging Tezos STO standards such as FA2, NYX, or VEE token become compliant with key jurisdictions, it makes sense to transact with these tokens using the Tezos blockchain, which these standards operate within. As they are a Tezos standard, then it is more convenient to lock XTZ inside a contract than Eth or BTC as an example. Many STOs will want to talk to each other to become interoperable and in order to do that XTZ will be needed.

  • As proof of stake provides many benefits to security tokens, the main competition is losing ground everyday that they don’t implement POS.

With Ethereum 2.0 still seemingly having many months, if not years of transition to a proven POS network, Tezos is gaining ground and momentum in terms of POS/security token innovation. POS can enable many novel use-cases when it comes to security tokenization and it is likely Tezos will gain first mover advantage in this crucial area.

  • Tezos is gaining traction in the developer community as being a serious contender when it comes to DeFi products and security tokenization.

Here we see an Ethereum developer acknowledging that Tezos could be a better fit for production DeFi products than Ethereum.

Rick Dudley, CEO at Vulcanize

How Could It Impact XTZ:

  • Collecting the money in XTZ could afford issuers greater flexibility in terms of the financial products they can offer.

Any XTZ they collect the issuer will be able to be staked. This could be used to supplement dividends. A security token product that creates staking rewards, could then create tax-advantages through the issuer conducting a buyback, rather than distributing rewards as a dividend. This could be seen as the equivalent to a public company conducting a buyback, instead of distributing a dividend.

This could give an incentive to collect initial distribution funds in XTZ. The investor too may favor such an approach as an efficient way of earning rewards in the process of investing in a security token offering.

  • Any XTZ collected and rewards from staking will enable the issuer to have an important Governance vote in future upgrades – helping to direct the future of the network, which their token resides on.

This would effectively allow the issuer to grow the token with the underlying network creating unified synergies.

For example, a controversial, but closely debated proposed upgrade, may impact a particular STO tokens dynamics negatively/positively in these instances it would be beneficial to hold a large amount of Tezos, in order to contribute to Governance from the perspective of the token.

  • STOs may look to offer a baking/STO service. This would enable issuers to be able to offer unique financial offerings.

The security tokens combined with XTZ could generate dividends, or income that could be paid out using Tezos smart contracts.

Baking rewards gained in XTZ could be given out as dividends – allowing capital to be unlocked/released early, giving purchasers flexibility, and potentially lessen the time for a return on investment.

As mentioned, security token issuers may also have the option to gradually ‘buy-back’ equity in their original project, if they staked the initial contribution – subject to security laws and regulations.

This could also help liquidity issues concerning STO tokens, which may not be as liquid as large-cap cryptocurrencies such as Tezos. In the example of a real estate issuer, this could potentially allow them to pay for on-going project costs as the project develops, or even develop a reserve fund for project costs, which were not originally budgeted.

A buy-back scheme could also potentially allow issuers to fund their projects, whilst maintaining the ability to buy back their assets easily and transparently at a later date. For example, a real estate project is a prime use-case that usually requires funding before the ability to sell/lease the property assets can occur. With this method mentioned, a real estate project fund could launch a security token offering to gain funding and then gradually begin to buy back the asset through staking rewards. They can then sell/lease the property assets at a gain on those staking rewards, as well as any fluctuations within the real estate market.

  • The native XTZ token and the STO token, which reside on the Tezos blockchain will be naturally inter-connected.

This will allow seamless transactions both with XTZ, but with other tokens residing on the underlying blockchain as they share the underlying infrastructure.

  • Transaction fees – in order to launch STOS transaction fees will have to be paid for using the network.

Any STOs launching on Tezos, would mean the transaction fees would need to be paid in XTZ. Transaction fees for security tokens can be high due to the complex nature of the tokens, meaning more value can be accrued by the underlying network.

  • Account Creation Of Tokenized Asset Contracts

Every time a project wants to launch a tokenized asset on Tezos they will need to create at least one account (many need more for the different entities of a contract). Every time an account is created on Tezos, XTZ is burnt deflating the supply. The total amount burnt every time a new account is ‘revealed’ is 0.257 XTZ and many tokenized assets need to open many accounts as can be seen in this example here.

  • In order for one STO to talk to /transact/interact with another STO XTZ will have to be used in the transaction.

Having XTZ helps further integrations with the STO ecosystem.

  • Bakers could offer STOs related to their baking income, or for a stake in their baking business.

These bakers could conduct an offering and accept XTZ, with this they can then increase their staking bonds and/or stake themselves with that XTZ.

  • As Tezos is one such blockchain that creates the security tokens it makes it easier for exchanges who already list Tezos to add pairs for the security tokens against XTZ, adding more markets for XTZ and liquidity.

As mentioned previously, the underlying infrastructure of the tokens and the networks is already aligned and much like when exchanges began to add ICOs with Ethereum pairs, we could see an influx of STOs against XTZ pairs.

It is not likely to be just cryptocurrency type exchanges that look to list STOs and Tezos, standalone security token exchanges will need an efficient pairing to drive liquidity from security token markets into cryptocurrency markets and vice-versa.

If the tokens they list reside on the Tezos blockchain, then it makes sense to double-down on infrastructure engineering and to list Tezos as well. This could mean unlike other cryptocurrencies, Tezos could find a home not just on traditional cryptocurrency exchanges, but also security token exchanges too.

Who is to tell at this stage who the big security token exchanges will be, or become.

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