Tokenizing both tangible real-world assets and already-digitized securities is expected to have great potential. This is what Rune Christensen, founder & CEO of Maker, calls the first-generation tokenization. But there is a new generation of tokenization just around the corner, where security tokens serve as a high-octane fuel in multi-collateral credit systems: the Maker platform. The potential here is to increase liquidity even further, to improve stability in the token economy in general, and to permit access to faster and less expensive loans for a wide range of investors and companies.
Michael Juul Rugaard (MJR): In your opinion, what have been the main triggers of the current development within tokenization and security tokens? To what extent is it connected to the collapse of the ICO industry?
Rune Christensen (RC): Security tokens go back to before the ICOs. I think the very first was Patrick Byrne, founder of Overstock, who realized that you could use blockchain for traditional-world stuff. But at the very beginning, it wasn’t even seen as tokenization in the way it is understood now. It was just seen as using blockchain to build a kind of clearinghouse. So, it was more constrained than now.
An important difference between security token offerings and ICOs is that if an ICO fails, it is because it doesn’t become popular, and the bubble deflates, and consequently, there are losses all the way around. With security token offerings, it’s different. We are in fact creating some real value here, and if a token offering doesn’t go so well, that just means: “Okay, I have to do another type of offering,” right? The security token space is less hype-driven than the ICO space, and it seems to become more and more open as the regulations start falling into place in the blockchain world. It’s a much more honest search for real value.
MJR: There is an interesting connection between the emerging tokenization industry and what you are developing at Maker. You once said that all the tokenization companies are in fact working for Maker, whether they know it or not. You also talked about the difference between first-generation and second-generation tokenization where the first is about turning assets into security tokens, while the second is about the use of security tokens in a multi-collateral credit system like Maker’s. Can you explain this further and shed some light on this rather complex field?
RC: I think the first generation of tokenization is driven by the inherent qualities of tokenized assets on their own end. You want to tokenize something so that you can more easily track it and hold it in a wallet, and you have more freedom in how you use it. It is a finite list of advantages that you can get from tokenization by itself.
The second-generation pathway begins when you can use the security tokens in the Maker system, and you realise that the power of the blockchain really starts to shine. Tokenization has been driven by the first-generation use cases, but it’s going to be the second-generation that pulls it in, in some sort of exponential fashion. The second-generation use cases – like cheaper credit – is going to make it uncompetitive not to follow. It is the beginning of what people have been looking for in blockchain this whole time, and it is the thing that is going to put those who do not adapt out of business. Simply because it’s impossible to compete with a securities issuer who can offer way better credit.
For Maker, the first-generation tokenization is great because it means that we will have so many initial tokens to choose from now that we are about to launch the multi-collateral Dai credit system. So, we will get that initial push, and then eventually we will sort of pull the entire rest of the global economy in on the blockchain. And even though there are lots of tokenization products today, it’s still only a tiny, tiny fraction of the real market of assets.
MJR: Could you explain a bit more about how people will be able to use security tokens in the Maker system going forward?
RC: The typical situation is that Maker functions like a mortgage broker. You come with your asset and take out a loan, and eventually, you pay back your loan, and once the entire loan is paid, you wholly own your asset again. Right now, this can only be done with crypto, but once we are able to use security tokens in the system, it opens up a more diverse space of assets to back the stability of the system. This means that you can take a security token, deposit it into the Maker Smart Contracts, and you can borrow money based on that security token. If it is a very stable security token, sort of like a bond, you can get very high leverage this way.
Also, if it is a security token from a jurisdiction that is not very well represented in the Maker system, or if it is a kind of asset that does not have a lot of exposure, you will get extremely cheap credit, because then you will be favoured by the system’s attempt to balance its risk. And then it is an extremely flexible loan in Dai that is optimized for low rates. There is no duration on the loan, so you can keep the position as long as you want, but the interest rate is variable. There are no extra fees taken by the Maker system, and the interest rate charged is incredibly low.
MJR: Whether we are talking about first or second generation tokenization, the tokenization industry is still in its infancy, and there must be some obstacles on this early stage?
RC: True. The biggest challenge currently is that if you use a security token inside a system like Maker’s, you must follow all the relevant regulations for that kind of transaction, which in most jurisdictions we believe is a repo transaction. And in most jurisdictions, the transaction has to be facilitated by someone with a broker-dealer license. So, one of the first challenges is that it needs to be done inside a regulatory environment.
MJR: So, the biggest challenge used to be technical. Now the main challenge is legal?
RC: Yes. Over the last couple of years, it has been increasingly clear that you can do whatever you want from a technical point of view. Now, the primary challenge is about regulation. I am confident that we will be able to reach our goals from a regulatory point of view, but we still need to figure out exactly how. That is the next wave, and once the regulation part is solved, things will move incredibly fast.
It is interesting to compare the US regulatory environment with the EU environment because the US is common law and the EU is civil law. So, in a way, everything was legal in Europe from the beginning. Whereas in the US everything was kind of illegal.
Currently, we are in a phase where there are still no signs of EU legislation targeting something like security tokens. In Europe, theoretically you can go ahead because there is no law forbidding you to do so, but the problem is it is hard to predict if there will be some political momentum and some new legislation that may change everything. In the US, what is happening now is that both the whole legal system and the political system on its own have become so knowledgeable about blockchain that we are at a point now where you can start operating and do business.
MJR: I guess what we are all looking for are clear regulatory guidelines?
RC: Yes. You want clear guidelines, and you also want a regulator that is signing off on what you are doing. Only then can you really feel safe doing something at scale. Regulation is often seen as slowing down innovation, but it can also have the opposite effect. Because once you do have that clarity and know what you can and cannot do, that is when things can really scale.
MJR: Once tokenization and the use of multi-collateral credit systems like Maker’s start to scale, how will that impact the financial system and the banking industry as we know it today?
RC: I think the banks will split into two. There will be the dinosaurs, who will try to fight it. Their objective will be to either keep everything in the analogue state or maybe create their own little walled garden of impenetrable systems that are not compatible with anything else. Eventually, they will just die because they will not be able to compete with the rest of the services that are available. But for a relatively large group of the banks, I think the blockchain revolution will be like a rebirth. The will start focusing more on technology and new types of services. Rent seeking will almost entirely disappear, they will rely less on their licenses to make money, and they will become more like normal companies.
MJR: Is the Maker system competing with the banks? I mean, you can open a CDP and become your own bank in a way. If you have collateral, you can give yourself a loan through the credit system. Is that correct?
RC: Yes, but what you are describing is something that a regular person will not be able to do. In fact, I think it’s very likely that the banks will be the ones who will facilitate that. They will offer their clients this new service, and because they are banks the customers will trust them and feel safe.
I think the banks will pick the technologies that are ready for mainstream, market them and take a cut. The difference will be that they will not be able to get the kind of cuts they have gotten before. In fact, a lot of the overall value that will be left for the banking bureaucracy will drastically decline, and a lot of banks will have to disappear.
MJR: So, where are we going from here? There is already a lot happening in the tokenization space, but if we try to look a little bit into the future, one or two years, what do you expect to see?
RC: Right now, the focus is on tokenizing what is already there, but very soon we will see entirely new types of assets are invented that only make sense when you can use them on the blockchain.
MJR: Could you give an example?
RC: Probably the most mind-blowing example is something that only really makes sense in the context of Maker. It’s a tokenized primary lien, which is a token that by itself doesn’t really make any sense as a token. Let me explain how it works:
A company goes to the Maker governance and asks for a loan, basically in the same way that it goes to a bank to borrow money. If the company owns any sort of assets that are not leveraged already, those can be collected into a primary lien. And now, you can create a token that says that you have the first claim on these assets in the event of a default on the loan. Now, this can be turned into a bespoke, unique asset on the blockchain that then fits into a Maker CDP and can be used as the basis for a corporate loan. In fact, I believe that this is going to be one of the most used kinds of collateral for Maker.
MJR: When do you expect to be able to launch this new opportunity?
RC: It is impossible to say, but we see both security services in general and this kind of direct lending to businesses as highly important next steps for Maker. Now we are talking about doing direct lending for businesses, but an obvious thing would be also to do it for mortgages directly. Like a blockchain mortgage where you go and you pledge your house as the primary lien, but you also actually collateralize a claim on your own future income. So, you get a holistic risk assessment just like in the bank.
MJR: In your opinion, what is the potential for all the new services following the development of the security token market?
RC: Well, it goes way beyond the financial markets. In the long run, the entire economy will be sucked into it, and there will be a time where businesses must switch to blockchain-based interaction because otherwise they will lose their ability to interact with their partners. At some point, companies will reach the conclusion that It is too expensive to keep their legal legacy systems running, and they will switch to blockchain-based systems instead. Eventually, you will see products beginning to drop if they are not upgrading to blockchain-based systems.
What I’m talking about here is obviously far ahead in the future, and something like tokenizing securities is just the beginning of all this – and it is actually the most boring part of it. A tokenized stock, for instance, in the future will be a token that represents not just a legal claim, but also a mechanical control that regulates into the treasury, the accounting system, and even the security system of a company.
Sometime in the future, you will not be
able to run a business that isn’t blockchain-powered. I think that’s
guaranteed, and there is not going to be a legacy economy eventually. So yes,
there is big potential, and I see it as a natural evolution.
 Repo – Repurchase Agreement
 The basic element in The Dai Credit System is the so-called Credit Debt Position or CDP, which is a fully autonomous/automated smart contract that basically enables in principle anyone to deposit certain types of assets as collateral on the Maker platform and take out loans in Dai against the collateral. Currently, the only accepted type of collateral in the system is the cryptocurrency ether, but later this year Maker will launch a new multi collateralised version of the system allowing also for other tokenised asset classes to act as collateral.
 A lien is a legal right granted by the owner of property, by a law or otherwise acquired by a creditor. A lien serves to guarantee an underlying obligation, such as the repayment of a loan. If the underlying obligation is not satisfied, the creditor may be able to seize the asset that is the subject of the lien. https://www.investopedia.com/terms/l/lien.asp
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