Whether you are an active crypto enthusiast or entirely new in the space, “ERC-20” is something you’d have likely heard of before. Perhaps, you want to receive a few tokens from someone, and they are asking to send your ERC-20 address.
The ERC-20 token standard wasn’t just for sending and receiving fungible tokens; it allowed developers to launch their tokens on the Ethereum Network, providing a way for crypto/DeFi projects to start up without having to build a cryptocurrency from scratch. For example, Binance Coin (BNB) was initially launched in 2017 via an ICO as an ERC-20 token after raising $15milion in Bitcoin and Ethereum. After its success, it moved to its own Blockchain (the Binance Smart Chain).
Thousands of other tokens and ICOs have launched via the ERC-20 standard; however, the nature of the token standard makes it unsuitable for launching security tokens.
What Are Security Tokens?
A security token is a blockchain-based form of traditional securities (stocks, bonds, options, ETFs, etc.). Hence, we can define security tokens as value-transfer instruments that show your stake/ownership of something on the Blockchain; however, unlike typical crypto assets, Security tokens are regulated.
Let us paint a scenario;
If you go to the apple store and buy a MacBook, you have an asset from the company, “Apple.” However, it isn’t the same as going to a stockbroker to buy Apple stock. In this case, you are getting a share/fraction of the company’s ownership.
Now bringing it back to the Blockchain, buying crypto “assets” like Bitcoin, Ethereum, Solana, etc., is entirely different from buying security tokens that only represent someone’s stake in a company.
Of course, you may wonder why someone would invest in securities rather than crypto assets could appreciate (unlike many real-life assets). The simple answer is that security tokens are NOT in competition with crypto assets; instead, they provide a way to further integrate Blockchain into the traditional world by allowing investors to buy/sell securities without involving the traditional paperwork, which is usually cumbersome. With the Blockchain, all transactions are regulated and immutable, without involving the complex traditional processes. In the future (Web 3.0), the Blockchain will host all aspects of our life, in which finance is a big part, hence the reason for so many cryptocurrency applications. To learn more about security tokens and their advantages, kindly read our article.
Why was the ERC-1400 created?
Initially, Security Tokens were not tokenized on the Blockchain as ERC-1400; instead, they were tokenized as ERC-20. However, the ERC-20 was explicitly created for fungible tokens, which had utility, like real-life assets. Hence, the ERC-20 token standard could not sufficiently fulfill the typical regulations of securities; since they had to be entirely unregulated and decentralized to maintain their standard.
Of course, companies issuing security tokens are real-life companies, which required them to regulate the token standard to comply with Federal regulations. As a result, the ERC-1400 token standard was created.
With the ERC-1400 standard, the following regulations can be enforced:
· The holding period of tokens in a wallet can be regulated
· Transactions could have a threshold
· The number of tokens allowed per wallet could be limited
· KYC is enforced, and sales can be restricted if the KYC document expires
Below are some token standards that fall under the ERC-1400:
1. ERC-1594: Core Security Token Standard
This standard supports off-chain data injection into transfers, issuances, and redemptions. It is also used to check the validity of a transfer and determine if it will go through.
· Token Issuance and Redemption: The ERC-1594 standard enables the security token issuer to specify when issuance for the security token has finished (after an STO). This is also the time when holders can redeem their tokens
· Off-Chain Data Injection: For securities to be tokenized adequately to the Blockchain, the transfer of these assets must incorporate data, on-chain rules (in smart contracts), and off-chain rules. ERC-1594 supports these off-chain inputs by supporting off-chain data injection into transactions.
· Trading Restrictions: The ERC-1594 token standard also contains on-chain functions to determine whether a transaction will be completed or not. In the case of a failure, a reason will be stated. (Typically, transactions fail because they counteract the regulations set by the issuer).
2. ERC-1410: Partially Fungible Tokens
Partially-fungible token standards allow people’s tokens to be organized and partitioned. Each partition contains metadata attached to enable flexibility in token functionality. For example, partition metadata showing the mint date enables the implementation of a lock-up function (if the security token’s regulation requires it).
3. ERC-1643: Document Management Standard
Although blockchain-based securities require less cumbersome documentation than traditional securities, documentation still exists; it is not totally wiped out. The ERC-1643 standard enables the attachment of documents to security token transfers, enabling token holders to receive information via these documents.
4. ERC-1644: Controller Operations
This token standard allows issuers or third-party regulators to control sovereign power to force token transfer in case of suspected foul play/fraudulent activity. In other scenarios, if a token holder has lost their private keys and has no access to their account, the ERC-1644 standard enables the controller to force a token transfer.
Is The ERC-1400 Token Standard Counteractive to Decentralization?
As said earlier, security tokens do not compete with individual assets’ token standards like the ERC-20. Instead, they only provide a way to apply blockchain technology to the traditional securities and benefit from the 24/7 availability of the Blockchain, the divisibility of blockchain-based tokens, the security, and the transparency the Blockchain offers.
Security Tokens ARE NOT supposed to be decentralized because of their nature; hence, they are not against the foundation on which the Blockchain was created.
Blockchain technology is set to transcend our lives in every possible sector; with the promise of the blockchain-based internet (Web 3.0), all human activities will be recorded in decentralized ledgers.