Before we dive into the conceptual and technical specifics, and explore all the different aspects of Polymesh, let's take a closer look at the value proposition of Polymesh.
Polymesh is a technology that enables you to create, issue, and manage digital securities on blockchain. Its quick-to-market approach aims at connecting regulation and compliance of traditional securities with blockchain technology. The main difference between Polymesh's approach and that of a general-purpose blockchain, such as Ethereum, is that Polymesh's design focuses on a precise solution to specific requirements, rather than a generalised solution to abstract requirements.
Until today, the creation, issuance, and ongoing management of traditional securities have been inefficient and ineffective. There is a solution to these inefficiencies and ineffectiveness: security tokens.
A new infrastructure for a new asset class
Similar to traditional securities, security tokens represent ownership interests in an asset. They can represent ownership of:
- traditional assets, think publicly-traded equity, bonds, debt, etc., or
- traditionally illiquid assets, think private placements, real estate, artwork, intellectual property, synthetic asset baskets, etc.
At the same time, they are created digitally and use blockchains to structure and automate functioning.
Tokenisation, STOs, and security tokens
The act of issuing a token on the blockchain to digitally represent an asset is called tokenisation. When the represented asset is a security, the token is called a security token. The process by which security tokens can be distributed is called a security token offering (STO). STOs are similar to initial public offerings (IPOs) in that they allow an organisation to raise funds against the distribution of their asset. This distribution, when done through Polymesh's settlement mechanism, ensures compliance and meets regulatory requirements for the transfer of assets. The assurance is dependent on compliance rules that are ultimately under the control of the asset originator. A not-improbable case exists where the originator has not done their homework and therefore doesn't understand what their compliance rules ought to be and makes it too permissive.
The value added of security tokens
Security tokens bring multiple benefits. Let's dive right into them!
Through the use of security tokens, legacy middlemen can be removed to save costs. In addition, efficient fundraising and trading, reduced settlement times, as well as improved processes of dividend issuance, voting capabilities, and liquidation preferences are among the efficiency gains. The tokenised cap table reduces overhead, administrative work, and general transfer time. These gains in efficiencies can be, and are, passed on to the issuer and investor of the token.
Security tokens make 24/7 market access possible, thus allowing for greater accessibility and opening up liquidity opportunities. These tokens are divisible in ways traditional tokens aren't, which is dubbed hyper-fractional asset ownership. They enable greater liquidity by tokenising traditionally-illiquid assets, thereby opening access to a global investor pool through new asset classes for assets that used to be indivisible.
Investors have the opportunity to diversify their portfolio as they gain access to previously unavailable or traditionally-illiquid assets. In addition, a perfect digital record of ownership and of all transactions is maintained at any time. This increased transparency protects investors and mitigates actions of foul play, such as the back-dating of documents.
Overall automation, as in the case of automated compliance and payments, is another benefit of security tokens. Jurisdictional regulations can be enforced by being built-in and customised into each security token's configuration. The same applies for automated payments, for example in the case of dividends.
Polymesh – An institutional-grade blockchain for security tokens
Polymesh, a blockchain built for regulated security tokens, materialises their benefits. This purpose is reflected in Polymesh's enterprise features, governance, security, and consensus.
The network provides functionalities for asset management, and includes financial abstractions at its base layer (i.e. as primitives) or intrinsics. A layer above those, a user can initiate a set of embedded on-chain actions, called extrinsics, like creating an asset, settling instructions, or taking part in on-chain governance. On top of that, with the help of so-called smart extensions - smart contracts deployed on top of the Polymesh blockchain – it is possible to add functionalities to the base layer primitives. For example, asset issuers can implement additional transfer restrictions through smart extensions.
Users can benefit from the advantages of standardisation and deep integration of the primitives, and they can built-in complex and customised functionalities to meet regulatory and capital market demands.
Compare this to general-purpose blockchains, in which programmable and automated security tokens need to be coded individually via their own smart contract as the foundational layer.
Polymesh provides further foundational layers to fulfil regulatory compliance and foster institutional confidence, thereby enabling and facilitating security token creation, issuance, management, and liquidity.
Architecturally, Polymesh is a public, permissioned blockchain. Meaning anyone can run a regular node, as well as check the upholding of network rules and the public state secured by the blockchain. However, not everyone can run nodes that author new blocks or vote on block finality. Only specific entities, called operators, can.
Moreover, the Polymesh blockchain has its own native token for payments and security requirements called POLYX.
To provide a blockchain specialised for security tokens, Polymesh is built on four pillars: identity, confidentiality, compliance, and governance.
Challenges of security tokens - Polymesh vs general-purpose blockchains
General-purpose blockchains, like Ethereum, have their challenges when faced with the demands of regulatory compliance and global capital markets. As it turns out, the main challenges focus on questions relating to identity, compliance, confidentiality, and governance.
Traditionally, security regulators seek to protect investors from unfair and/or fraudulent practices, while promoting fair and efficient markets, as well as stable financial systems with reduced systemic risk. That is because stability and efficiency have been observed to drive capital formation. Therefore, issuers are required to present fulsome public disclosure and reporting, and customer identities have to be validated through Know-Your-Customer (KYC) checks.
General-purpose, permissionless blockchains are typically built on a philosophical and technical core of pseudonymity. This pseudonymity makes it very difficult to establish and validate identities in a way that would meet most regulatory requirements addressing identity. It is possible to add on identity-related solutions as second layer, increasing unwelcome complexity in the end-to-end solution.
Polymesh has an advantage over general-purpose blockchains because asset issuers and other financial intermediaries can examine the Polymesh blockchain to confirm questions regarding participant identities. This assists with regulatory compliance. For example, token holders cannot subvert rules by using multiple unlinked identities to hold assets, as all users can only act through their on-chain identity and all on-chain identities are referenced through decentralised identifiers (DID). An asset issuer can enforce that different DIDs belonging to the same off-chain entity must be publicly linked in order to invest in their asset.
Also issuers and institutions don't need to re-identify users and users don't have to re-submit their information streamlining the identity verification processes, and at the same time, reducing costs. In effect, this purpose-built blockchain is more resilient and less vulnerable to attacks targeting its reputation system (i.e. Sybil attacks).
When it comes to compliance, requirements continuously evolve. This leads to further complexities and a remaining need for often-proprietary systems with added elements of automation. Manual intervention remains a big element of compliance systems. This ineffective automation creates costs and inefficiencies for all participants.
General-purpose blockchains cannot help with the solving of ineffectiveness and inefficiencies. Implementing evolving compliance regulation would be complex, and it would bring high computing costs and processing times with it.
Polymesh addresses compliance questions by implementing comprehensive automation that enables faster processing and lower protocol fees. Issuers can set flexible and extendable rules, thereby automating rule enforcement without the need to manually or semi-manually approve individual transfers reducing costs. Rules can be combined and tailored to the asset's type, jurisdiction, and regulatory regime. These make on-chain compliance implementation possible.
In Polymesh, compliance management, so to say, is built into the security token.
Another essential feature of capital markets is confidentiality. One should neither know who holds a security, nor how much of a security is held by someone. Institutions protect private and financial client information as part of privacy requirements.
In a general-purpose blockchain, anyone can observe the holdings of any public address. As pseudonymity rules, token holders don't have complete anonymity and could be uncovered. Adding a second-layer solution for confidentiality can maintain privacy of transactions, but the token issuer would not be able to satisfy compliance and ownership reporting demands.
Future releases of Polymesh we will integrate confidential assets, based on the MERCAT protocol, where the amount an asset holder holds and transfers is encrypted and private through zero-knowledge proof. With its confidential transactions, the permissioned blockchain lets issuers configure the security token as confidential. Polymesh's focus on the confidentiality of assets, trades, and positions is central for its identity model and assists with obfuscating a user's positions. There is ongoing research on how to improve and update confidentiality in Polymesh to support the full spectrum of confidentiality and securities use-cases.
General-purpose blockchains especially have difficulties with governance, i.e. how changes are decided, managed, and implemented. Change management requires significant coordination between the blockchain's nodes. At the same time, disagreements on changes have the potential for disruption. In case a disagreement on changes and their implementation cannot be resolved, the blockchain can split into two separate chains operating differently, i.e. a hard fork. This leads to legal and regulatory uncertainty, all stemming from the difficulty of conducting upgrades, i.e. including changes.
Polymesh provides the opportunity to upgrade seamlessly without forks since upgrading is a feature of the chain. Additionally, its on-chain governance process allows users to create proposals for upgrades and support changes on the blockchain. This sophisticated governance mechanism allows the blockchain to grow and develop through a built-in on-chain control. Forks are avoided while providing a functioning infrastructure for digital assets.
The so-called Polymesh Improvement Proposals (PIPs) can be introduced by any user. They are evaluated through a combination of signals from the community, input from technical experts (Committees), and decisions by the Governing Council. PIPs can be submitted for network upgrades to set parameters related to consensus and security, or other actions. The governance system is also inherently designed to decentralise over time.
The value-added of Polymesh
Polymesh offers solutions to drive business by facilitating the entire token journey, from its creation to ongoing management. Dividend issuance, report generation, and new investor management make for an easy and fast token management. This is an improvement for today's businesses and allows to tap into new sources of liquidity.
Its modularity offers a flexible token build with jurisdictional and regulatory compatibility, while also being focused on the technological backbone driving efficiency and transparency for security tokens.
Furthermore, the platform connects one with a network of trusted partners, such as KYC/AML providers, broker-dealers, and custodians assisting users that want to go to market.
Polymesh solves the inherent challenges of public general-purpose blockchains in regard to identity, confidentiality, compliance, and governance with a bespoke end-to-end solution.