When people ask me about the things that excite me the most about security tokens I often respond “the ones that we are not working on right now” 😉. I firmly believe that the biggest opportunities in the security token space are not about tokenizing existing assets but reimagining the financial system using open programmable protocols. Programmability give us an opportunity to create new forms of finance that are difficult or simply impossible to create within the walls of traditional financial systems. One of those new forms of crypto-securities that I’ve spent a lot of time thinking about it recently is what I like to call collateralized multi-asset digital securities(CMADS). Even if you don’t like this thesis, I beg you to help me find a better name for this type of security token 😉
The idea behind CMADS is to create crypto-securities that can accrue value based on a dynamic pool of underlying assets. The concept might seem similar to financial products such as collateralized debt obligations(CDOs) or real estate investment trusts(REITs) just if those were open, programmable, simple and transparent and…you know…not fraudulent 😉 Let’s imagine a security token that is collateralized by a dynamic pool of real estate assets or a dynamic pool of US municipal bonds. By dynamic, we meant that the number of collateralized assets will vary over time. To understand CMADS, let’s compare it with the existing generation of security tokens.
Single-Asset vs. Multi-Asset Security Tokens
The traditional model for security tokens typically generates a crypto security correlated with assets owned by a specific entity. For instance, a security token can represent shares(asset) in a specific company(entity). In that model, the asset and its valuation are well known pre-issuance and its composition is not likely to change throughout the lifecycle of the token. In the collateralized multi-asset digital security(CMADS) model, assets are going to be added or removed dynamically influencing the price of the overarching security.
Let’s illustrate CMADS in the context of an example. Suppose that we create the Muni-Bond Token(MBT) as a tokenized representation of US municipal bonds. If you are not familiar with municipal bonds, they are this not-very-sexy financial vehicle that represents debt obligations in entities owned by states, US municipal bonds have three key characteristics: they are relatively stable, relatively liquid and relatively boring 😉.
Our MBT security will start with an initial pool of municipal bonds valued at $100M under current market conditions but we would like to increase the valuation over time. The MBT protocol will allow any holder of municipal bonds to received MBT collateralized by their holdings( how we can achieve this will be the subject of the part II). Similarly, MBT holders can redeem their tokens and receive their municipal bonds back. This model borrows a few ideas from stable coins such as Maker DAO but also brings the unique angle of applying that model to digital securities.
Comparing CMADS with traditional security tokens shows important differences across several dimensions:
CMADS vs. Stable Coins vs Tokenized Baskets
Collateralized multi-asset digital securities(CMADS) borrow ideas from other tokenized products such as stable coins or tokenized derivatives such as tokenized baskets. CMADS differ from stable coins in the sense that they are not necessarily “stable” if by stability we assume a one-to-one correlation to a fiat vehicle. However, the collateralization, redemption mechanisms and programmatic stability maintenance mechanisms of stable coins are incredibly relevant to CMADS. The process of receiving a CMADS by registering an ownership position in US municipal bonds is not different that the mechanisms used by stable coins to issue new crypto-coins based on fiat reserves.
Digital baskets are a concept championed by protocols like SET that create crypto-token derivatives that are a composition of other crypto-tokens. In the context of security tokens, we can imagine a digital basket that represents a pool of underlying tokens representing US municipal bonds. The difference here is pretty obvious: digital baskets require an underlying security token while CMADS derive the value from the underlying assets directly. Additionally, we should consider that digital baskets are still in a very early stage and there are not known applications in the security token space.
If we need to picture CMADS in a timeline compared to other sophisticated forms of digital securities, we will get something like the following:
To wrap up the first part of this article, I would like to highlight some of the key benefits of the collateralized multi-asset digital securities(CMADS) model.
For a security token to achieve a multi-billion-dollar valuation is either because is based on a multi-billion-dollar asset or because the valuation of the underlying asset explodes over time. Both scenarios are a very small statistical representation in the broader context of tokenized securities. CMADS vehicles are more likely to achieve large valuations as they can represent a large number of underlying assets. Stable coins are a great example of this dynamic.
Single-asset security tokens are vulnerable to the market performance of a single-assets. CMADS provide a mechanism to maintain certain price stability resilient to different market conditions. For instance, a CMADS that represent real estate properties in Manhattan, Shanghai and the United Kingdom can hedge its price against the performance of real estate market in those individual markets.
CMADS are a great lending mechanism. For instance, in our US municipal bond token(MBT) scenario, a bond holder can receive MBT collateralized by their bond holdings. They can trade the MBT for US dollars to, for example, pay off a specific debt and then they can redeems their US municipal bonds by sending MBT to the CMADA smart contract.
Stable coins are a great commerce mechanism but not very attractive for investors as their price doesn’t fluctuate too far from the underlying fiat currency. CMADS vehicles offer some of the benefits of stable coins while also resulting attractive to investors. A CMADS that represents a pool of US Treasury Bonds will still yield between 2–3% every year.
Liquidity remains the biggest challenge in the current generation of security tokens. One of the mechanisms to inject liquidity in the space is by tokenizing assets that have access to liquid markets such as stocks, bonds or commodities. CMADS are a near-perfect vehicle to enable this.
By now you are either really confused or really intrigued by the idea of collateralized multi-asset digital securities(CMADS). While the CMADS concept might seem obvious, the protocols for creating this type of asset are far from it. In the second part of this article, I would deep dive into some protocol models that can enable the first wave of CMADS.