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Security Tokens and Why We Need Standards

Fabian Vogelsteller, Founder of Lukso,
creator of the ERC20 token standard


Fabian Vogelsteller

Founder of Lukso, Ethereum Developer and creator of the ERC20 token standard

Fabian Vogelsteller joined Ethereum before the network started in January 2015. He built the Ethereum Wallet, coming from the Ethereum Foundation - which was the first to enable smart contract interaction for non-tech people, as well as the Mist Browser, the first decentralised web3 3.0 Browser. He worked on the RPC API and still works on developer tools like web3.js, the Ethereum space's most used JavaScript library. He proposed the ERC20 token standard, and ERC725 Identity standard, and now builds LUKSO, the Fashion and Design Industry Blockchain an Ethereum sister network.

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Adam Chapnick:

Fabian Vogelsteller is not just a developer, but he is an integral part of our community, and I say it that way because I’ve been very impressed by his commitment to community, and his sort of personal mission that has manifest in things that he has built to contribute to the community. He’s a developer of the ERC 20 Token among many other things he’s also the co-founder with Marjorie of Lukso, which he may or may not tell you about right now, if he doesn’t, ask him. And most of all, we are really honored that he’s decided to join us it’s a privilege to have him with us so please welcome Fabian Vogelsteller.

Fabian Vogelsteller:

Thank you for that nice introduction.

I will talk about security tokens but I will actually take a very different angle than the whole morning because I am a software developer. You know, I come from doing things which work. (crowd laughs) The computer doesn’t you know complain too much, it just does it, that’s always good.

So security tokens and why do we need standards? And I want a little bit roll back here because all the discussions about tokens and all of these things, but it’s very important where this is coming from, and what it even is.

So everybody talking about blockchain right? At least until these last few years but now everybody is talking about tokens. Everybody’s talking about tokens. And that’s actually pretty new since 2017, mainly because that’s when all these ICO’s happened and when a lot of people waked up, woke up, to tokens and blockchain, which was before just like Bitcoin and whatever dark market and something weird going on. Suddenly it became accessible and it became interesting for a lot, a lot of people. But what is very important, and this is kind of, it’s not really part of the conversation, that’s why I want to refocus on that is, that there is actually two things here.

What is a token right? We think token that it something representing something, somehow on the blockchain and so on. But we have to really clearly differentiate there are two things we are talking here, there is cryptocurrency and there is a token and they are very distinct, different things.

Cryptocurrency is the fuel of network, it’s kind of what you use to pay for your transaction fees and what you can also use for payment on the network and for whatever use you want to have on that blockchain. It’s an integral piece of the blockchain system and it’s the lifeblood, it’s what makes it secure. So if you take out this token then somebody has to maintain the system and protect it, like put a proxy in front or do something that you cannot just attack it. If you have a digitalized system, the tokens are what makes it work. It’s the integral part to even make that function in any way. That’s very important, it has a very important functionality and is not something you can take away if you want to make an open system. It protects from spam, because it costs you to use the network and it incentivizes people to participate in running and maintaining this network.

That is very different from a token. It’s absolutely very different. And what is a token? We have to understand this. And me coming from Ethereum, worked the last three and a half years at Ethereum Foundation, and built many, many things in there that had quite an impact. It’s very important to understand how this works because all of our discussions they are kind of based on that, on understanding this. And what is a token? Right. A token is a smart contract. It’s a piece of code deployed on the blockchain sitting at an address. And in this case, it’s a smart contract which itself has an account balance, it’s kind of like vertically having an account balance of other addresses who own whatever number right now. That’s in the simplest form is what a token is.

What makes it so interesting is not that this is some new form of exosheet, which is now a distributor or something. The most interesting part of this is that this runs on a blockchain, where it’s not alone but where it’s surrounded by a lot of other smart contracts or other programs running on the same virtual computer. And this could be for example a voting system, this can be decentralized exchange, this can be a prediction market, it can be whatever we can come up with. And the very interesting part here is that this can talk to each other. The token can inter-operate with all of the other smart contracts, and the other smart contracts can inter-operate with it. And that mainly works because we have standardized it and in this case it’s ERC20 that what brings me in the picture here because I was the one who did that.

This inter-operability is the key of why this is such a big thing and why so many things are happening now; because you can have systems which are automatically inter-operable and inter-actable. So yeah, like I said ERC 20 that’s what I propose this is kind of a very simple interface, it’s actually just a few functions, and they just say, you know, if you have a smart contract which is a token at least it should have a total supply function, a balance of function, a transfer function, and a few other functions. And when you have that in your smart contract, which you build whatever you want, however you want, at least if you have those functions there’s other smart contracts that can interact with it. Plus exchanges can interact with it or wallets or any other system can interact with it. Which makes it extremely compatible. And this is what happened, (laughs) for better or worse, it created a humongous new market which is actually currently 12 billion dollars, and I just calculated this recently based on the tokens and current market cap, and this is not the cryptocurrencies, this is not the blockchains, this is purely tokens and 90% of them are on the ECM blockchain, so they are smart contracts on the ECM blockchain. And that value is in the crypto-window, where we are in right now. So it is even on the bottom, still a lot of money.

It created this humongous market and it created this whole new industry. Why? Because of the synergies it creates. Of all that interoperability that is possible. And if you look at most of these things here on the list, we go back, these are all decentralized systems and protocols who try to achieve something. They are not trying to be an asset itself by representing shares or whatever. They are actually decentralized systems. They are decentralized exchanges or they are wallet systems or they are even pre-tokens for a future blockchain or in this case the Binance is an exchange. Right?

So it can be many, many things built on whatever these smart contracts do and how they interact with other systems. So what we have is especially in the times from 2013 on, cryptocurrency is first in 2013 all the forks of bitcoin, the Litecoin and so on. And then later the tokens, they were the lifeblood of decentralized systems. They have a functionality and purpose. Obviously the most necessary purpose of a token is the cryptocurrency because it is necessary to run the system, otherwise you have to find out another way to protect it which ends up being just an old web server proxy system which you already have from 30 to 40 years. But it’s the lifeblood system and now there is a lot of token economics where people think okay what can these incentive systems, what can these lifeblood systems be. But ERC 20 and all of these ICO’s we saw in 2017 actually opened up a complete new picture. It opened up this picture of endless possibilities. These tokens don’t necessarily need to be part of a de-centralized system, they can actually represent anything. And that is what happened- a lot startups thought okay I can raise money here in a new form. I can engage differently with my customer, I can engage my community around my product on my service that I want to create.

But most all that we see now of the security token industry and all of this discussion is it can be real world assets. It can be anything which sits outside of the blockchain. Which is not easily directly verifiable by a smart contract. And this endless possibilities is what is creating this new wave and to understand this and understand what this even means and how we can inter-operate and interact with this. We have to understand where this is all coming from. And actually a root of all of this and a root of the ERC 20 and so on. There is something called Ethereum Improvement Proposals, and Ethereum Improvement Proposals is basically a place where it was meant to be hosting discussions for how we can improve the Ethereum protocol. So how we can change the consensus algorithm or remove proof of work, the mining, and blah blah blah. So the idea was to discuss with the community and have technical proposals and so on.

Back in the day in November 2017, I proposed to ERC 20 as a specification I called it ERC, Ethereum Request for Comment, and the whole idea was we have a standard here of what a smart contract, or token smart contract, could look like let’s just talk and figure out if that makes sense. And I called it ERC, the idea was that we’d talk and that there would be a standard coming out of that. It ended up that the talk is the standard anyway, or at least this specification was then kind of what happened. So what this created is now a bunch of people are creating ERC’s. I think we have, I don’t know I think we have a thousand something, so probably have 800,000 to 900,000 Ethereum Requests for Comment meeting standardization proposals or all sorts and all angles of blockchains and smart contracts. Because if we standardized things and we adopt these standards, that doesn’t mean that system has to function only this way it just has to be interacted this way. It’s just the interface which is standardized. We have a compatibility and a synergy level which is unprecedented. Which creates whole industries as we have seen.

What happens there is a lot of people talk a lot and discuss does this make sense, give input and so on and in the regards of ERC20 and at some point people felt it’s not changing too much anymore, it’s kind of like solid enough and then people started to use it and integrating themselves. The real proper format and this involved over time to make this better, is that you create a draft- a draft specification, after you discussed it a little bit in the issues and you create a draft, for example, this is the identity standard called ERC 75 which I proposed a year ago now, and there is now an alliance forming around. You put it as a draft and then people could propose improvements and then you can discuss on these improvements. But this is all happening completely public out in the open. There is no committee, there’s no secret room meetings, this is all just everybody can come and chip in, basically. It’s all open source, so to say.

The bigger things that it creates is interoperability and this is the key factor of all of this. And this is where security tokens come in and that the new wave of tokens where it’s about the real world assets and creating the non-blockchain tangible things. As long as a token sits on the blockchain and interacts with smart contracts it’s all perfectly automatable, right? Because it can talk to these other smart contracts. When it sits off chain that’s a different thing and here you need tricolations and you have to have intermediary and all of these things. So there are efforts on the way to standardize this.

This is actually based on ERC20 backwards compatibility, it’s kind of like an extension of what came out ERC20 and other standards and the idea on this case, for example, is to add more regulatory friendliness and automation in that system, by design. And if everyone adopts it every exchange can interact with those things and process them properly and wallets can be done in a way that they can signal the proper behavior and just make it very convenient. So there can be a lot of interfaces being built which makes it fun and more. Create a whole ecosystem around it.

ERC7, ERC1400, and ERC1410 this is a sub-standard that basically says OK a token can have sub-tokens, and I just want to show a little bit of what this is. There is a discussion in the community around this for example right now, ERC1400 is basically just saying OK you have all these functionalities a token has but you also add a document, which is then either a legal document or a could be even a smart contract or something linked to this which represents maybe the legal representation or the metadata of the security. It has a functionality where you can check if a transfer would fail or not. And you can build in all kinds of checks and modules, for example you could make it that it automatically checks am I allowed to be transferred from this guy? Or am I allowed to be transferred to this person? Am I within a certain trench? Is my time already over? Can I unlock now? Am I locked? You can build everything in; it just doesn’t work or it works, right? So, you have to check if it’s send-able. Is it still issuable? So you know can there be more edit or not. You can always see how many there are. So cap tables and all these things are rather easy to do from a technical point of view. You can issue only trenches and so on and so on.

So this is the standard we try to make this more clear and interoperable to be able to build all these interfaces and there’s a discussion going on. And then there’s this other standard…and this basically means that in security tokens we have that thing that we have different types of securities within one security. There could be one that is issued to the founder, it’s maybe locked for a period of time and others are not locked. And others have certain rights but another trench doesn’t have these certain rights and therefore you need ideally a standard of what you have … of one token.

There’s also other ways that you could solve this, you could just issue multiple amount of tokens but having trenches is one way to do it. And the good thing is if you define a default trench and then we are back to standardization you are interoperable with whatever wallets already exists out there. So you can have even that security now still work in Coinbase or meta-mask or any of these crypto-wallets that we have right now. So this is the beauty of backwards compatibility and interoperability.

What this brings if this is adopted over time and used by people? You can have integrated compliance. You can have automated regulation because you can build in modules which only allow certain things or don’t allow certain things. You can have automated reporting, you actually can have real time reporting. You just can check any point in time what is the current situation. This obviously leads to fraud prevention and a lot more transparency.

And this list could probably be endless long, but the most important part again is interoperability. Because suddenly I create something which can be sitting, it sits on the blockchain meta-layer which has to be obviously a public blockchain where you have to be able to verify that and trust where it sits. But because it sits there all exchanges and everybody can interact with it and doesn’t need to have it themselves and everybody has just copies of it, right? They all just look at the same data set basically. And that’s why the tokens took off in the blockchain space and that’s why in general the blockchain space and cryptocurrencies are taking off. So it’s an endless amount of possibilities from here on.

And just to show a few of, obviously, advantages of having securities or things on the blockchain in general. The first and most important thing I find the most interesting, is in the blockchain space it’s 24-7, all the time. Like the whole thing that you have weekends where markets shut down is a very old concept. Especially for the crypto native generation - it just knows this exchange that is running all of the time because it’s automated.

You can affect your ownership, we talked here in the panel, with real estate, obviously that’s a very interesting part. Obviously the settlement goes a lot faster. Increased liquidity because if you have this asset on the blockchain. So you have liquidity because the asset sits on the blockchain it can be reached by many markets. It just receive it or reach it or even read it from the same place, so it’s not like in different silos, so to say.

You have this automation, in many ways can this be a data analytics dream basically. (laughs) Interoperability, a big part.

And I would like to expand a little bit on the new design space and this is something where we have to think outside of the box. Because everything is here, OK now how can we put the old world now on the blockchain, and that’s a nice idea and it works, but what is even more interesting is what it now allows. What are the new things which can come?

And a good example is if I have a house and it can now tokenize this house. Right now, it’s about ok, I want to make profit from you know the value of this real estate and so on, and that’s all fine, but I can have even more things coming out of this because I can say OK if I have a part of this house this means also I have certain possibility to access this. And this can all be represented through the same token. So maybe I have to stake, to lock or stake a token and then I get into the building. And then I can use it for a certain period of time and when I go out it just un-stakes my part minus maybe a cost or something. So I can now create models which combine the ownership and the securities, right? As ownership for value and so on, with functionality and with all kinds of new possibilities and rights in an automated fashion. Or I can vote on what things are done on the real estate or what it’s done for.

All of these kind of new angles of utility are possible now. They were just not possible before because going around with your certificate you got at the notary might be very slow manual process to convince anybody to open your door. So now you can have this automated and there has to be no person, you just go in and beep beep and your smartphone or your future ring or AR glasses would just open you the door. And that is actually not so far off, because the technology is here... and these standards make it possible. And we have to allow now this creativity to take place and not like down regulate it and think OK now this all has to fit in our old box all nicely because you know if it’s too wild West. It will be done anyway and it will be done to found ways around it to get this combination but the more we actually let it happen and do it in the right way because it’s about creating standards which are preventing fraud by design, you know? It’s not about letting people now go wild, and then you have a bunch of scams. It’s building things in such a way that they are not even allowing this fraud to take place in the first place.

And there’s a lot of ideas. There’s also an idea I have with a morphware version of an ICO, which we might do for our project. There’s so many ways, things you can do. But the combination of utility and ownership, and the combination of participation and new forms that’s kind of like what really is what shines here. What this becomes, and what this can make possible. And this is something we shouldn’t underestimate because I think it will rapidly change how this current certificates, let’s say, work.

So, that’s all I have. Probably a lot more to speak about and a lot more we could discuss but that’s all for now.