In this blog post we share some details about our liquidity solution, as part of our 360° security tokenization platform Freequity. We discuss the background and importance of liquidity, the market’s existing solutions, as well as our Freequity approach and its first customers.

What is liquidity?

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at a price reflecting its intrinsic value, — in other words: the ease of converting it to cash. Cash is universally considered the most liquid asset, while tangible assets, such as real estate, fine art, and collectables, are all relatively illiquid. (https://www.investopedia.com/terms/l/liquidity.asp)

The (insufficient) promise of tokenization

Tokenization: Fractionalizing a real-world asset

One of the initial promises of STO (Security Token Offerings) is that the fractionalization of an asset into tokens alone will provide liquidity. The reasoning for this is that the token could be traded on an exchange after the initial issuing. This is why many existing STO Platforms mainly care about issuing a security token and selling it to investors.

Afterwards, both investor and issuer are dependent on the so-called “secondary market”, if they want to buy or sell tokens, which has shown in recent years to be very intransparent, fee-consuming and in many cases operating without any regulatory compliance.

Insufficient liquidity, as experienced for many altcoins after the ICO hype, will be an even bigger problem for security tokens, which are intended to be long-term investments, targeting at the regional level or representing market caps below 10 Mio USD.

The main reason for token issuing platforms to leave out the trading part is the high (regulatory) hurdles of setting up a classical bid/ask exchange. Therefore, the investor is left pretty much alone after the initial process of token issuing. Moreover, this leaves out the huge business opportunity of collecting trading fees that occur with every token trade and providing liquidity to earn interest.

Huge business opportunities are abandoned on the issuing side — huge drawbacks are in place on the investors’ side.

Unibright’s approach with Freequity: Liquidity Pools

A Liquidity pool “on top” of an asset

Instead of hoping for an external exchange, or trying to set up an own, dedicated bid-/ask-exchange for every security token, the Unibright Freequity approach is based on liquidity pools, serving as a regulatory compliant replacement to classical bid/ask exchanges.

Liquidity pools are put on top of the tokenized asset, consisting of two parts: one part containing a certain amount of the underlying token (the “Token Pool”), and the second containing a stable coin backed by fiat currencies.

In contrast to existing exchanges, where every buy or sell order must rely on a counterpart fulfilling the bid/ask, the liquidity pool is always available to build matching orders to bids and asks by a deterministic price building mechanism: the fewer asset tokens are left available in the pool, the more expensive they get — and vice versa.

Let’s take a look at the trading view of Unibright Freequity:

There is no orderbook of bid and ask orders that have to be matched, but a current price (top right) that is determined by a formula (a “bonding curve”) based on the current ratio of the two pool components. After the trade, the price automatically adjusts.

Existing solutions, limitations and Freequity’s improvements

In the field of Utility Tokens, there are existing, pool-based swap-solutions. The actual amount of tokens that is swapped within a pool can be determined by different strategies, e.g. by defining a fixed exchange rate, constantly adjusting the exchange rate according to an external price provider, or using a bonding curve, like described above. For example, the Unibright Token could be swapped against ETH on Kyber or Uniswap, which are beautiful solutions for Utility Tokens.

However, in the field of security tokens there are many additional thoughts to be considered, especially on the regulatory side of things. A regulator follows one main goal when assessing specific solution: guaranteeing fairness for the participants.

Just one example: one “unfair” pattern that may occur in a swap scenario is front-running: Imagine you can see a trade against a pool on a blockchain that has not been confirmed yet. You can see the amount of tokens to be swapped and the gas amount applied to the transaction request. As the price building is formula based, you could now place a counter swap order after discovering the former order, but have it executed before the former order by applying a higher gas amount to your front-running order.

Unibright Freequity solves that problem by a hybrid setup, comparable to what IDEX invented with their “on-/off-chain architecture: the real-time orders are placed against a centralized component which guarantees that the actual transactions on the blockchain are executed in a pre-defined order. The actual price building is still secured by the formula that is set in a smart-contract, so you can not “hack” the centralised component to “inject” a malicious price-building. This ensures a real-time feel for the user, enables Freequity to hold up to different regulatory requirements in different jurisdictions and provides the required amount of fairness in different scenarios.

The 360° approach of Unibright Freequity

We are convinced that a 360° security token platform (as outlined in our vision) should not handle issuing, liquidity, custody services and other parts as separate components! If a regulator applies specific requirements e.g. on KYC, these requirements most probably will apply on all stages of the process. Therefore, the different components should be integrated into one other. For example, just issuing a token on one platform, and hoping for another platform to handle liquidity will result in repeated regulatory assessments, leading to confusion for the investor and delays in the overall process.

Let’s take a look on different steps within Unibright Freequity:

Token Definition

Existing tokenization platforms only offer partial customization options. All the legal groundwork (like the regulatory and tax implications of the tokenization process for all involved jurisdictions, the needed KYC level and much more) is still open to the issuer. Unibright Freequity abstracts from the technical conclusion on how a token should be designed, and takes the issuer through a graphical process on his knowledge level (well-known from our Workflow Designer approach).

Unibright Freequity’s graphical token definition process

After this definition, the token and the related smart contracts are generated automatically for a desired blockchain protocol (well known from our Lifecyclce Manager approach).

Token Issuance, STO Platforms and setting up the liquidity pools

Once the token is created, it has to be issued and sold to investors. Related to that is a proper KYC process, a secure and safe solution to buy tokens by crypto and fiat transactions and a user friendly interface for all related user actions. Unibright Freequity does not necessarily have to build this part from scratch, but is able to white-label or connect to existing solutions.

The future performance of a token can be simulated within Unibright Freequity before it is issued. The deterministic price building mechanism can be matched against different buy/sell pressure scenarios, including different distributions and consideration of external events.

The simulation helps the issuer to find the right customization of the Liquidity pool during the token definition process. It also shows the simulated outcome of different investors profiles, including the option to define project specific kick-backs of trading fee to the liquidity provider, the platform or the token holders.

Unibright Freequity’s Token Performance Simulation Engine

Derivatives and Portfolios

With the implementation of the above-mentioned concepts, we are in a first-mover position offering the first fully integrated platform/environment for issuing and trading security tokens. Our concept of automated liquidity can be added to other platforms and all security tokens as well. Thus, we make Tokenization work for all players involved by providing fully-fledged liquid markets.

All derived financial instruments (as seen on classical markets) are relying on a reliable liquidity of the underlying assets. They cannot be built in the tokenization world, prior to the existence of such a liquidity concept.

From the very beginning, Unibright Freequity is designed to offer derivative issuing and software driven, rule-based portfolios, automatically trading underlying assets with automated liquidity.

Portfolio Building with Unibright Freequity

Big Data

The deterministic price building of all these products allows us to offer calculation and simulation on future performances of assets. This helps building optimally sized liquidity pool solutions. We will offer and sell AI driven solutions based on big data resulting from the automated trades.

Unibright Freequity and the Unibright Token

The liquidity component is completely developed and ready to use. We will start by adding it on top of existing STO platforms, providing our solution as a technical provider. First clients are currently onboarding. For each trade, a specific amount of UBT (our utility voucher) has to be redeemed.

Being an early player in the field, we will expand to custodian services. We are building partnerships with leading players in the field, offering software solutions for distributed key management as well as hardware solutions and data-center design.

Our concept is highly automatable and designed to be integrated in systems and processes from the very beginning. It is blockchain agnostic, relying on automatically generated and integrated smart contracts and ensuring a huge scaling potential. An integration of all asset related trades (and corresponding price movements) into the FI module of SAP is ready for use; integration in other major ERPs will follow. All integration matters will be handled by the Unibright Connector and underlying adapters, including the precondition to use UBT as the voucher for the needed integration transactions.

We will learn from all partial component implementations, from all collaborations with 3rd party providers and bundle our learnings and developments in Unibright Freequity to become a 360° security token platform.