The digital transformation of the financial industry is at a crucial juncture with the advent of blockchain technology and the rise of decentralized finance (DeFi). This whitepaper presents a detailed account of a Proof of Concept (PoC) conducted by ADDX, aimed at exploring the potential of permissioned DeFi protocols in the Web3 environment for the issuance of digital securities. At the heart of this PoC is the integration of Soulbound Tokens (SBTs) — a novel form of non-transferable digital tokens — to ensure compliance with regulatory frameworks while leveraging the inherent advantages of blockchain technology.

The PoC examines the feasibility of a self-service decentralized application (DAPP) that allows for the issuance, management, and transfer of digital assets within a regulatory-compliant framework. This includes a deep dive into the technical architecture of the protocol, showcasing the successful deployment of smart contracts on an Ethereum Virtual Machine (EVM)-compatible blockchain network. The whitepaper articulates the challenges and triumphs of embedding compliance mechanisms, such as Know Your Customer (KYC) and Anti-Money Laundering (AML), within the decentralized constructs of blockchain.

In this exploration, the PoC aligns with the Monetary Authority of Singapore's Project Guardian, sharing its vision for a secure and regulated DeFi ecosystem. A limitation of this PoC, however, is its focus on a single solution within the vast landscape of possibilities. The whitepaper concludes with a reflection on the learnings from the PoC and its implications for FIs considering their digital asset strategy. It emphasizes the need for ongoing innovation, robust technological infrastructure, and a regulatory-first approach to navigate the future of finance in the Web3 era. The ultimate goal is to present a scalable, interoperable, and user-friendly platform that can set the standard for compliant digital securities issuance and pave the way for future advancements in the sector.

Executive Summary

Digital securities, a significant innovation in financial markets, have emerged as a key player in the blockchain revolution. They encompass tokenized versions of traditional financial assets, including stocks, bonds, and real estate, leveraging blockchain technology for issuance, trading, and management. This evolution offers numerous advantages such as increased liquidity, global accessibility, fractional ownership, and reduced operational costs, making private and illiquid assets more accessible to a broader range of investors.

As digital securities continue to reshape the financial landscape, one critical issue stands at the forefront of this evolution: on-chain compliance. Ensuring that transactions and issuances of digital securities adhere to regulatory standards on the blockchain, especially on decentralized public network, is not just a technical challenge, but a fundamental necessity for the legitimacy and long-term viability of this emerging market.

On-chain compliance is the embedding of regulatory requirements in the financial world such as KYC & AML into the blockchain itself. For instance, in Singapore, financial institutions engaged in transactions involving digital payment tokens (DPT) are required to adhere to the Payment Service Act. This entails conducting due diligence on customers, monitoring transactions, screening wallets, and maintaining diligent reporting and record-keeping practices. On-chain compliance is crucial for protecting investors and ensures that digital securities operate within the bounds of the law, safeguarding investor interests and maintaining market integrity. Financial Institutions grapple with the primary challenge of enforcing on-chain compliance especially when operating on decentralized public networks, a task that hinges critically on the accurate identification, authorization, and authentication of pseudonymous blockchain addresses. As the Web3 domain continues to expand, a variety of techniques have emerged to associate blockchain addresses with real-world identities, each presenting its own set of intricacies and possibilities. The upcoming section will explore these strategies, explaining their importance for the future of finance and highlighting why soul bound tokens are, in our opinion the preferred solution.

View / download the full report, 'Compliant Web3 Digital Securities Issuance' by ADDX here.

ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require millions or more to enter. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.