Security Token Standards – An Interview With R3 Co-Founder, Todd McDonald

In the opening part of our “Security Token Standards Series, we interview Todd McDonald, Head of Digital Assets at R3.

What is the perception of the financial services industry of the blockchain and crypto industry, and more specifically the security token industry?

There are players and practices in the wider token and crypto industry which have created justified caution among regulators and institutions. But when we get away from the hyperbole, there is a recognition that this technology will be extremely positively impactful.

Many of the biggest and most influential financial institutions, from leading investment banks to central banks and exchanges, have seen that blockchain points to some really profound changes in the way financial markets are organised and operated. In a lot of ways, this was the driving force behind the creation of R3 in the first place: to make blockchain technology enterprise grade and fit for purpose.

There is currently a lot of interest in the topic of security tokens, and we are seeing more direct investigation and involvement from the leading financial firms.They are attracted by the promise of provably scarce digital assets, both native assets and asset-backed tokens, that can trade and be serviced with much less friction.Yet one of the key questions is how to ensure that security tokens fit into existing regulatory structures while still maintaining their innovative advantages.

What lessons have you learnt at R3 about deploying cutting-edge technical standards into financial services organizations?

Corda-based token examples actually emerged in 2016, when we began a collaboration with Bank of Canada, Payments Canada and others under the name Project Jasper, where a token called CAD-COIN represented collateral held by the central bank. Since then, we have seen pilot and production examples from our partners, in particular from HQLAx in securities lending and Tradewind Markets in gold trading.

Right from its inception, we took the decision to design Corda differently to many of the blockchain projects. Our aim has always been to solve the problem of how to represent real-world agreements on a blockchain in a canonical and enforceable way, and this approach can be directly applied to security token issuance.

As a result, R3 is uniquely positioned to facilitate the emerging ‘token economy’ in a secure and regulated manner. The same enterprise-ready focus that led to the design and capabilities of our Corda platform can be extended to bringing the best innovations of the ‘wild west’ of the token world to institutional finance. We also recognize that creating standards work is not really about the technology, it is about consensus and right-sizing the standards. This is why, for example, we are such big supporters of ISDA’s Common Domain Model work, which is doing the hard work of bringing key industry participants along on the standards journey.

What technical milestones do you think must be reached before security tokens will be used in mission-critical financial systems?

The big hurdle here is to design security token standards so that they can function within the existing financial system. Without this, the total addressable market for these instruments would be entirely too small to warrant the investment in the infrastructure. This means that digital CSDs, digital broker/dealers and other market infrastructure providers must be part of the process so that security tokens can exist more seamlessly within existing architectures.

With reference to the STN article, would you advise the Web Approach or Standards Approach, and why one and not the other?

I think that it might not be such a binary choice, and it also comes down to aligning with the maturity of the market segment. I do not think that the mental models for security tokens are understood well enough across market practitioners. In fact, one could argue that the models themselves aren’t ready to be understood as we are still iterating them!

Therefore, it is a risk to move too quickly into the ‘industry standards’ approach. In the near term, a focus on more emergent standards would be lower risk, and at the right time, the industry could and should come together to work on further defining longer-lived standards.

What are your plans for Corda within the security token ecosystem?

Just as the development of enterprise software bought the ideas developed by early crypto-currencies forward, digital, tokenised assets embraced by institutional finance will be another major chapter for this technology. As one of the leading platforms in this first wave of enterprise applications for blockchain, Corda is perfectly positioned to play a key role in this next big shift.

In particular, connectivity with the established financial services community differentiates Corda from any other platform in the space. R3 is already in talks with a number of major market infrastructure providers about creating regulated environments for security tokens, underpinned by Corda, and the 200+ member ecosystem includes most of the biggest names in financial services, giving token issuers access to a vast network of high-quality investors. Corporates, banks, asset managers, and market infrastructure providers are also crowding in to provide a stable, regulated settlement asset on Corda. We recently launched a Digital Asset Working Group that has quickly grown to over 40 members across the leading banks, FMIs, law firms and asset managers.

Platforms like Corda provide the catalyst and foundation to enable security tokens to become a new and potentially invaluable tool in the capital markets toolbox. This third blockchain revolution of digital assets will arguably be the most important and impactful to date.