Over the past 6 months, the Polymath engineering team has been quietly but effectively developing what has grown to be named polymath-core. No public roadmap or announcements; just skunk works style R&D on what we believe to be a groundbreaking new protocol for the issuance of financial securities on the blockchain.

Background

We were going to write a background as to why we believe blockchain based securities issuance is the future, but after reading the testimony by Jay Clayton, the Chairman of the U.S. Securities and Exchange Commission, we don’t think it could be put any better:

“Through the years, technological innovations have improved our markets, including through increased competition, lower barriers to entry and decreased costs for market participants. Distributed ledger and other emerging technologies have the potential to further influence and improve the capital markets and the financial services industry. Businesses, especially smaller businesses without efficient access to traditional capital markets, can be aided by financial technology in raising capital to establish and finance their operations, thereby allowing them to be more competitive both domestically and globally. And these technological innovations can provide investors with new opportunities to offer support and capital to novel concepts and ideas. History, both in the United States and abroad, has proven time and again that these opportunities flourish best when pursued in harmony with our federal securities laws. These laws reflect our tripartite mission to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation. Being faithful to each part of our mission not in isolation, but collectively, has served us well. Said simply, we should embrace the pursuit of technological advancement, as well as new and innovative techniques for capital raising, but not at the expense of the principles undermining our well-founded and proven approach to protecting investors and markets.”

Challenges

Our thesis has never been to run from well established securities laws, but to find a way to have them work in harmony with the blockchain. In the 21st century, where the global economy is more connected than ever before and information moves instantaneously; blockchain provides some fundamentally new ways to approach securities regulation that are much more suitable. Some rules may need to adapt to survive in this environment, but there is a large amount of information and history that needs to be kept in place.

One of the biggest usability challenges with blockchains comes from their self contained nature. At inception, they contain no useful information about the real world and no ability to connect to any existing real world infrastructure. Any effort to migrate data that exists outside of the blockchain must be done manually. The best way to organically grow this usability is through the right incentive models, which is why we decided to create and launch the POLY token to bootstrap the usability of the protocol. By aligning the incentives of all participants on the network, it is possible to migrate this web of ever-changing securities regulations much faster than one person or one team manually trying to do so.

Once you have one regulatory body’s requirements migrated to the blockchain, how do you handle the thousands of others? What about if you want to offer a security to jurisdiction A, D, and Z but not the others? As you can imagine, this becomes a combinatorial problem very quickly. So another requirement for a blockchain based regulatory framework is that it must allow for experimentation with new models of regulation while being an order of magnitude faster than our current frameworks.

The final challenge was the hardest: secondary markets. Traditionally, secondary markets have been highly regulated by the SEC and other governing bodies to prevent price manipulation and fraud. Currently, most of the exchanges in the blockchain world remain unregulated and can engage in high profile price manipulation or even be outright scams. This is mainly due to the fact that token holders and exchange operators can remain completely anonymous and hard to find. Additionally, shutting down a decentralized, peer-to-peer exchange would be akin to shutting down the entire internet, so approaching it from the angle of imposing harsh regulations will likely have many unintended side effects and severely limit innovation. We needed to come up with a solution that worked to enable regulation, but did not put out the fire of innovation.

Enter Polymath

The Polymath core protocol is a set of smart contracts which allow for transfer and ownership restrictions of financial securities to occur in a trust-less, decentralized manner. They allow securities regulations of any governing body to be baked directly into the protocol and applied from the ground up, rather than having to account for it after-the-fact with top-down enforcement. With this, Polymath can enable a complex web of global regulatory requirements to migrate to the blockchain.

Polymath allows issuers to offer security tokens to investors in a regulatory compliant way through the use of security token templates. These templates can be developed within minutes by delegates (lawyers or regulators) who are familiar with securities laws, and easily applied to any security token. Reputation is earned each time a template is used. Over time, a consensus should emerge over which offering templates are safe to use for different offering types and jurisdictions. Additionally, delegates who propose templates are able to earn POLY tokens with their funds held in escrow over a period of time after the issuance, and if enough claims are made, the escrowed funds are programmatically frozen. This reduces the number of bad actors in the system as there is little incentive to be a bad actor, and a large incentive to be a good actor.

Every security token MUST be applied to a security token template, which means issuers must go through the process of reviewing the template directory and reputation history before creating a tokenized security. Once a template has been applied, the issuer can begin the Security Token Offering (STO) process which uses an STO smart contract to distribute the security to investors and collect their investments. Depending on the requirements specified by the template, only qualified investors will be able to participate in the offering.

The Polymath protocol solves the problem of unauthorized trading by baking KYC/AML directly into the token. In order to hold a security token (whether it’s through primary issuance or on secondary exchanges) you must pass through the KYC provider specified by the template. The smart contract system prevents the token from being transferred to non-verified addresses. Even anonymously run, decentralized, peer-to-peer exchanges, will not be able to transfer securities between ineligible participants. This is a major breakthrough for regulation on the blockchain.

Polymath itself is not an exchange or a broker-dealer. It is a protocol that resides on top of Ethereum that allows issuers to restrict access to tokenized securities. It allows issuers to have greater comfort with who can hold their security token, and gives regulators greater certainty that securities are not being traded freely between anonymous blockchain addresses.

Working in Harmony

Polymath-core is now deployed to Ethereum main net. Delegates all over the globe have signed up and are ready to be a part of building this new protocol for financial securities. We encourage regulators all over the world like the SEC and CFTC to not only continue their progressive view on blockchains and the power they have to make the securities markets safer and more efficient, but to work with us to help make it happen!

The Polymath-core repositories are now available for free and fully open source on Github here. We’ve also just released Polymath.js, a javascript library for building applications (e.g. security token creators, template creators, etc) on top of Polymath today, and you can view the full documentation at https://docs.polymath.network/. If you’re interested in joining the team check out our careers page. To join the community, join our Telegram, follow us on Twitter, and check out our Reddit.

Let the stampede begin.