Today, we’re excited to announce Harbor. Harbor’s mission is to power the future of crypto-securities by building a decentralized compliance protocol that standardizes the way securities are issued and traded on blockchains.
Bob Remeika and I incubated this company with David Sacks’ new firm, Craft Ventures. Both Bob and I have worked with David for years, and we’re excited to have his guidance and support as Harbor’s founding chairman. In addition to Craft Ventures, we’re thrilled to welcome our Series A investors to Harbor including Vy Capital, Fifth Wall Ventures and Valor Equity Partners.
Tokenizing Private Securities
We started Harbor because we believe there is enormous value in tokenizing securities, especially private securities.
Traditional private securities are usually much easier to issue and far more cost-effective than going public. However, the process for secondary trading is highly inefficient, often leading issuers to impose trading restrictions thereby making private securities inherently illiquid. To account for the lack of liquidity, the value of private securities is often discounted (i.e. the “illiquidity discount”), preventing issuers from capturing the full value of the underlying asset.¹
Tokenized private securities (i.e. crypto-securities) on the other hand can be more easily traded on secondary markets without the administrative burdens of traditional private securities. In other words, crypto-securities can have increased liquidity while maintaining the cost-effectiveness of traditional private securities. Given the asset categories within the private securities market are massive (in the trillions) and the illiquidity discount can sometimes be as high as 20~30%², we can potentially unlock billions of dollars in value by tokenizing private securities.
The Compliance Problem
To understand what it actually takes to tokenize private securities, we took a deeper look at private real estate assets (including LP interests in real estate investment funds, fractional ownership in land/buildings, and private REITs), an asset class that can benefit greatly from the improved efficiency, transparency, liquidity and fractional ownership possibilities of blockchains. What we found were complex compliance requirements spanning securities regulations, financial market regulations, tax laws, and more.
In addition to Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements, issuers of private securities must comply with all applicable securities regulations. This could mean, among other things, restricting the number of total investors, only allowing accredited investors, and implementing a holding period—in order to be exempt from onerous public filing requirements.
In the U.S. alone, private securities need to comply with regulations such as:
- Securities Act of 1933
- Securities Exchange Act of 1934
- Investment Adviser Act of 1940
- Investment Companies Act of 1940
These regulations apply not only to the initial offering, but to all secondary trades, where responsibility is also placed on the seller.³ To further complicate the matter, securities regulations differ by jurisdiction, and compliance with both the issuer’s jurisdiction as well as each investor’s jurisdiction is required.⁴
On top of these securities regulations, private real estate assets have additional legal requirements that must be enforced under the Internal Revenue Code (IRC) and the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).
Given all of these complex legal requirements, it became clear that the compliance problem — the need to enforce regulations from ICO to secondary trades — is the key blocker to the proliferation of crypto-securities.
Harbor’s first project is the Regulated Token (“R-Token”) Standard, an open-source project that addresses the compliance problem for secondary trading. It’s built on ERC-20, which is widely supported by the existing Ethereum ecosystem.
The R-Token Standard provides an interface that embeds compliance at the token level and can be implemented with custom business logic to ensure specified requirements (e.g. KYC, AML, accreditation, total investor caps, holding periods) are met before a trade is approved.
The R-Token Standard can enforce compliance across any trading platform that supports ERC-20 tokens. While centralized exchanges can enforce regulatory requirements to some degree (including KYC, AML, and accreditation), once a token leaves that exchange, the issuer is unable to enforce trading rules. Tokens will trade everywhere, in centralized and decentralized exchanges — all over the world. As the number of tokens and exchanges increase, the ability to apply compliance across trading platforms and jurisdictions will become increasingly necessary.
The R-Token Standard is the first step in developing a decentralized compliance protocol for crypto-securities and brings us one step closer to the proliferation of securities on blockchains. We’d love to get community feedback. The R-Token Standard interface and initial implementation are available for review on Github. Please also read our white paper, join us on Telegram, and visit us at Harbor.com. There’s also a great article written by one of our advisors, Stephen McKeon, about the promise of automated compliance.
Last but not least…
Thank you to all of our investors and advisors for their help. We feel lucky to have such great supporters as we embark on this journey.
Stay tuned for more from the Harbor team.
- ¹ Marketability and Value: Measuring the Illiquidity Discount
- ² Ibid
- ³ Frequently Asked Questions About Rule 144 and Rule 145
- ⁴ Extraterritorial jurisdiction: lessons for the business and human rights sphere from six regulatory areas