3 posts tagged with "Compliance"

Prerequisite Reading: Syndicate Update #1. TLDR: The Stellar Decentralized Exchange enables TAD3 trading.

Direct investor trading is a symbol of financial liberation. It's about breaking down barriers and democratizing finance. And in this blossoming ecosystem, each of us has the potential to grow our investments on our own terms. It's a vibrant, bustling market where anyone with an internet connection and a government ID can participate. No longer confined by the walls of traditional exchanges, direct trading hands the reins of the market back to its rightful owners—the people.

The Basics of Direct Trading​

At its heart, TAD3 is about simplicity and connection. It's the financial equivalent of a farmers' market, where producers and consumers interact without a supermarket acting as a go-between. This translates to a system where individuals like you and me can trade securities directly with each other, without a traditional broker setting the terms or taking a slice of the pie.

Exempted Transactions​

Now, you might wonder, how is this all possible? Well, it's thanks to federal trading exemptions for anyone other than an "issuer, underwriter, or dealer." Imagine the process as if you're handing over a prized painting to a friend. You have a "painting certificate," a tangible representation of your investment. Instead of going through a centralized dealer gallery, you and I sit down to make a private deal. On our own behalves, I agree to wire you money directly, and you sign the Van Gogh over to me. There's a sense of satisfaction in handling the transaction ourselves, without intermediaries. That's TAD3,powered by distributed ledger technology.

Efficient Secondary Markets ↔​

Picture this: Miguel, an early investor in an innovative manufacturing startup, can sell his shares to Sarah, a retired scientist, without jumping through the hoops of traditional systems. They find common ground in TAD3, a beacon of efficiency with no trading fees nibbling away at their finances.

TAD3 Principles​

Just as artists trust galleries to distribute their paintings, companies use transfer agents to manage their stock. There's just a smidge more compliance work on the securities side. That's why only a few companies in the entire US market act as their own transfer agent,in fear of sub-par services. TAD3 is like a public, global digital archive rather than a physical gallery on Wall Street, only for a special few. Stellar holds detailed records of every transaction, maintaining a distributed ledger that's as clear and reliable as a museum's catalog (and don't forget programmatically accessible ).

TAD3's Non-Intermediary Model​

TAD3 acts as a silent witness rather than a vocal auctioneer. TAD3 don't stand between buyers and sellers, shouting out bids and offers. Instead, Stellar enables transactions directly between investors, much like a bulletin board in a community center where people can pin up offers and requests. (Don't worry, we have systems in place to enforce SEC trading halts.) This means that TAD3 does not profit from each transaction, but rather it allows us to facilitate the smooth transfer of ownership from one investor to another. You could think of the decentralized Stellar network as a librarian who organizes books for the depository, TAD3.

Advantages​

When TAD3 don't take a cut, the savings are passed directly to your savings and retirements. Imagine keeping every dollar you earn from selling tomatoes in your backyard garden instead of paying a vendor fee at the farmers' market. This is the financial equivalent. By not charging fees or acting as middlemen, TAD3 empowers investors to keep more of their profits, which can then be reinvested or spent as they see fit—the ultimate financial freedom. Moreover, this streamlined approach creates a more dynamic market, where securities change hands more freely and efficiently.

"Atomic Swaps" Make This Work​

Atomic swaps let you trade with no middlemen. They are a revolutionary piece of blockchain technology using math and the foundational principle behind the SDEX's global decentralized limit order book. Offers are "atomic" because either a trade happens in its entirety, or not at all. This eliminates counterparty risk, which removes the need for a centralized clearing system entirely.

Facilitating Trustless Trust​

Atomic swaps are a cornerstone of direct trading in TAD3. By using automated, decentralized protocols, the SDEX lets investors privately trade securely at scale in a way never before seen. This approach streamlines the trading process, reduces dependency on third parties, and (importantly) removes transaction fees that would otherwise go to intermediaries.

The Stellar Consensus Protocol underpins these transactions, ensuring they are fast, reliable, and tamper-proof. It's like a global farmers' market where companies can send crops to investors in exchange for payments, all through one email. The distributed network checks for fair trade conditions before finalizing all transaction. Seamless, secure, and nearly instant swaps—that's TAD3.

A Unique Network​

The SDEX is part of the actual Stellar core protocol. Most DEXes (if not all other than 0x ) rely on smart contracts, external service providers, or secondary layers for trading. Stellar's direct integration cuts out common security risks associated with those additional systems and provides a transparent, efficient trading experience.

Regulatory Compliance​

Based on extensive legal investigation, securities trading systems using those additional technologies would today be classified as Alternative Trading Systems, which must be registered with and regulated by the SEC (example ATS which presently charges 1% trading fees).

Because they're centralized, ATSs can and do discriminate based on traditional access methods. It’s essential to establish a fair and equitable system that provides equal opportunities for all investors, aligning with the ethos of decentralization and inclusivity that blockchain advocates. That doesn't happen when brokers require a US social security number because they can't bother with an international "low-value" user's government ID, or transfer agents require a medallion stamp.

Moreover, ATSs are "black boxes," which means you can't actually review how they operate. Investors have to rely on regular thorough broker investigations to ensure fairness, which gets quite expensive. Take a guess who those compliance costs get passed on to. Further, regulators can only act so quickly when it comes to the 49 ATSs in operation today. This oversight process can and does go wrong, at the expense of investors.

Despite illegality, stock exchanges and ATSs by ownership extension sell faster trading data to HFTs. That means that market makers can know the price of a stock up to three or four seconds before you. Remember, these exchanges are all for-profit corporations with shareholders to satisfy. Investor advocate Mark Faulk says:

" When the Exchange went from not-for-profit to for-profit...

the utility function of the marketplace of the exchanges disappeared.

Because once you... flipped the switch to make these exchanges, not utilities,

but for-profit vehicles, now you have shareholders to answer to... and obviously the largest customers are the HFTs. " We need to level the playing field for all investors, regardless of their trading frequency or volume.

Transparency is key in a new, trusting financial system. We shouldn't need to worry about when our broker is trading against us. Clear, auditable processes must allow users to understand how their trades execute—that's TAD3.

Lastly, for the finance geeks, all these different ATS trading venues split volume apart, segmenting the entire stock market. The implications and costs of this practice are very difficult to quantify, but they dramatically affect your investment returns over time. ⌚ This leads to higher spreads, a fragmented view of transaction history, and other problems detrimental to ' smarter markets.' A unified, or at least interoperable, recordkeeping system could eliminate this fragmentation. Not one controlled by a private for-profit monopoly.

The Takeaway​

There are a lot of very smart people working on the problems TAD3 solves. For instance, we spoke to a co-founder of the first widespread decentralized order book platform, launched in 2018. The system was built on extremely innovative P2P file-sharing technology, with transaction costs originally starting between 50 ¢ to a dollar. They got a knock on the door very early on since they'd processed millions of trades almost immediately after launching. For regulatory reporting, they told us you had to scan through dozens of Ethereum ledgers to find a certain kind of specific trading code signature to match a nuanced distributed data/ math scheme. That's impossible to conduct efficiently at scale or effectively oversee.

"Someone needs to build a unified system for trading," has been heralded for decades by market advocates,researchers, and investors alike. That's why we built TAD3.

Team Members: 1​

Payroll Annualized: $0​

This is something from the origin story of DRS.

The Dr. Trimbath interview with No Safe Bets brings up:

In 1971, there was a group called the Banking And Securities Industry Committee...

These BASIC bankers got together and argued against creating something called

the transfer agent depository which would have given us direct registration back in 1971.

But instead, we were given the Depository Trust Company. — Bibic at WhyDRS.org ↗

Prerequisite Listening: Direct Registration System Provenance. TLDR: Wall Street gets all your money.

According to the U.S. Securities and Exchange Commission: The transfer agent depository ("TAD" ) would replace the certificate with computerized stockowner lists... which would serve as both the issuer's stock records and the shareowner's evidence of ownership.

SEC commenters supported the TAD. They thought the only investors should be registered investors (not interchangeable with book entry ). They wanted a world without a convoluted, oligopolic, and opaque trading system.

Beginnings​

Block Transfer started at an online Atlanta Web3 hackathon. I was trading international forex markets 22 hours a day at the time, using polyphasic uberman. I needed to do a "restart" because I decided to get a full night's sleep for finals. That meant staying up for 36 hours before starting my revolving 20-minute naps.

I think the exam was on a Wednesday, and the hackathon was the coming weekend. So I started the extended wake period 35 hours before the hackathon's closing ceremony. The hackathon was great, and it resulted in our first Block Transfer implementation

Soon after, we were graciously thrust into Georgia Tech's InVenture Prize. Ever since the campus guide told me about the event during a high-school visit, I'd wanted to present. The process also introduced us to a key early advisor.

Preparation for the competition included three rounds of pitch competitions, the latter two to a panel of judges. After qualifying for finals, we went through dozens of pitch practice session with those judges, each time narrowing my idea down.

Around the same time, I also applied to other college student business pitch competitions. I further refined my idea here, and even won $5,000 from Entrepreneurs' Organization and $2,000 from US Bank.

All this pitching made me very focused on money. Combined with bona fide prodding from mentor sessions during Tech's CREATE-X Startup Launch program, we tried to close our first client in the summer of 2021 with an improved Ethereum implementation.

Talks went well with that CFO, but cost savings alone weren't enough to drive a close with this level of implementation. I'm thankful for that, looking back. I think it would have been two months tops before we got an SEC non-compliance letter, if we took on the firm.

I realized that gas costs for a stock transfers on Ethereum would be at least $10 each, and significantly more for trades. To fix this problem, we planned to scale the Ethereum implementation with "level 2" daily transaction batches, using Arbitrum.

But any netting would facilitate counterparty risk (albeit less so with crypto) and, more importantly, slow down clearing to T+1:(## TAD2

So we set off looking for another blockchain. I settled on my three most important network considerations after considerable protocol analysis, comparisons, and brainstorming: (in order of importance)

1. Cost: Cost per transaction is and always will be a number one value metric for me. Per-trade costs directly impact investor returns. They are the one thing we can directly control to facilitate building real savings and retirements for masses of people.

2. Speed: I come from day trading. I regret sacrificing joyful instantaneous trading and limited market hours that squeeze most US volume from 9am to noon. But markets were originally given trading hours due to lack of buyer interest. That's not a problem in an increasingly global world with better online connection than ever.

3. Impact: We were unbelievably surprised to learn that Stellar cared so much about comprehensive global inclusion. I first learned about Stellar in 2017 when I bought its nature currency at $0.035. I've always felt excluded from the financial system. When I was a pre-teen, I built an RPG with a video game maker. When publishing onto Steam, they asked for my bank account and routing numbers. When I asked my parents, they wouldn't share the details because "people will steal your money." Talk about trusting the financial system. Without much leverage, I moved on and eventually got my first job at Subway. I have them to thank for the muscle memory to grab things behind me without looking. My manager wasn't the nicest guy. I was okay with that because they were letting me work illegally at 15. But a lot of pressure started mounting after about a year there, when so many of my coworkers left that I was working open to close completely alone. I decided that the only way to take control of my financial future was to take it into my own hands. For the next six months, I spent every waking hour outside of work or school researching the stock market. I even made my first few investments. I had losers, some decent investments in NVIDIA and AMD, and a few stocks in-between. When summer rolled around, I turned in my two-week notice. I quit my job to trade stocks full-time. Just one small problem: I didn't have a brokerage account. I did all my initial testing with my Dad's broker. But he didn't live with me, plus his broker didn't have a very good trading interface. Luckily, my Mom set me up with her Fidelity. Sadly, my home relations were not great at the time. Every morning I had a problem logging into Fidelity, which was surprisingly often, I had to either disrupt my Mom's conference calls or watch hopelessly as the market ripped away without me (I didn't know about UTMAs at the time). But at the end of that summer, I discovered Ethereum. A solution, I thought the same technical analysis patterns in crypto—no age verification required. Imagine that Web3 experience, but for any modern financial institution—and especially for US stock brokers. Think about what your world would be like without quality, accessible investment opportunities. Would you still save for retirement? It's a lot harder without the miracle of compounding. That's a daily reality for over 7 billion people, many of whose best investment option is a metal roof or deadly weapon. What if we gave them access to the most advanced, developed, and liquid capital market the world has ever seen?

Stellar also has some other pretty cool things, all built directly into the protocol level. That means you don't need to write a smart contract for any of our current features, which historically introduce significant security risks, even for the best teams.

That background was up to 2021. I spent the next two years learning to use Stellar. Personally, I never thought I'd code. I remember during my first blockchain startup thinking, "I'll never need to learn coding. I'll just hire developers with all the money I'll make trading stocks." I seriously doubt we'd be here today if I did outsource to a development team early on. Thankfully, good smart contract developers were too expensive for me at the time, so I learned how to code at Georgia Tech.

Launch​

We got our inaugural client in June, finished processing SEC registration papers for them in July, and started onboarding their investors upon receipt of a final cap table in September. We've onboarded 6 investors out of the 25 provided. There is currently a pending stock revocation for 12 investors the company claims do not actually own shares.

When this client first reached out to us, we thought they were a relatively large marketing company. But it turns out they are a small business—which is fine! Markets and stock ownership records 100% do need to exist for all businesses. If you plan to scale your business, it's very important to get your stock accounting right from day one. I've heard nightmare stories of VCs finding out three investment rounds later that they actually own another 250,000 shares per an early contract. Notwithstanding, they haven't yet paid us any communicated fees aside from an ~7% equity stake. They told us that this was due to lack of funds on a call dated 23 Oct 2023.

Next​

If you visited the last link, then you saw the actual transaction I was talking about when I mentioned our equity stake. It was a payment of 5 million shares from our Stellar "distributor account" to our treasury account. If you looked closely you can see the amount we paid for the shares in the memo and the "claimable" date we elected internally to not transfer our shares until, to both align our incentives with their long-term objectives and prevent us from dumping shares on their developing investor-base.

That's the power of Web3. Anyone can confirm information about a stock without worrying about expensive level 2 access fees, data platform access fees, or specialized market information consolidators. You can just reference the blockchain for all your needs in real time. And the transaction, which executed in about 5 seconds, cost only 0.0001 XLM, or $0.0012 today.

TAD3​

That's just the tip of the iceberg for what we're calling our "Web3 Transfer Agent Depository" or TAD3 for short. We've conducted extensive due diligence on the regulatory implications of TAD3. Despite presenting our system to even the most executive individuals at or formerly at the Securities and Exchange Commission, we've concluded that TAD3 falls outside of the current, relatively limited set of regulations on legacy transfer agents. We've always been registered as a transfer agent with the SEC, but we're happy to change filer types if the SEC thinks TAD3 should be explicitly classified as the transfer agent depository.

One particularly important aspect of TAD3 is the ability for registered investors to trade with each other through Stellar's native decentralized exchange, the SDEX. Block Transfer conducts KYC/AML checks for all accounts. The SDEX lets these investors trade TAD3 assets on a global, decentralized limit order book. Under the hood, investors use cryptography to sign bid and ask quotes which get stored on the blockchain and matched every ledger based first on price and then time.

We continually monitor all accounts for suspicious transfer or trading activities. With that said, it's worth explaining a little bit about what accounts look like in TAD3. All Stellar accounts get identified by a "public key" that looks like "GDRM3MK6KMHSYIT4E2AG2S2LWTDBJNYXE4H72C7YTTRWOWX5ZBECFWO7." Those public keys aren't very easy to share, so we give users a random permanent account ID that looks like BIYES3WTN. On the backend, this resolves to the full public key. If you visited the equity transaction link, then you might have noticed that the two accounts mentioned are identified on the ledger by their public keys. Those public keys, and thus their associated transactions, are the only user information stored on the blockchain.

It's worth pausing for a moment to talk a little more about Stellar.

Brief Stellar History​

Stellar went live one month after Ethereum in 2015. The SDEX has been there since day one.

The team behind Stellar split from Ripple in 2014 because they wanted to focus on empowering global citizens to access financial markets, not profiting from big banks (the article linked was originally titled "Jed McCaleb: XRP and XLM Visionary or Disaster Artist?" ). This decision shows in every aspect of Stellar.

In contract with other truly decentralized blockchains, Stellar does not distribute transaction fees or any other compensation to miners or validators, thanks to its unique consensus protocol. This keeps transaction costs down.

Stellar can currently process up to 1,000 transactions per ledger. That lets investors pack the blockchain with as many stock gifts, buy offers, or proxy votes as they can click away on their phones at once.

Lastly, Stellar is incredible dedicated to global financial inclusion. There are immense benefits to opening US investment markets to the world, direct foreign markets to Americans, and everything in-between (e.g. more eyeballs on stock tickers). TAD3 fundamentally connects a growing capitalistic world with a fair market for capital. We envision a future where, after proper SEC filings, a company can "go public" through an SDEX sell offer (most investors don't know that "being public" really just means that you report timely financial statements to the SEC). That why we connect investors and issuers with a standardized nonprofit global financial system.

We Will Comply​

The SEC is well within their rights to ask for programmatic access to our internal records to resolve a suspicious public key to its full internal PII record. We will grant them access to such a system, not unlike the present CIP. We built TAD3 to help investors for their entire investing career from start to peaceful bequeathment. Our general approach so far has been modeling the Syndicate based on the past 100+ years of broker regulations. TAD3 will either comply with all future transfer agent regulations, or we'll help build them ourselves.

Sources

SEC Report on Transfer Agent Depository

Read Next: Empowering Investors - Learn how TAD3 enables direct trading with zero banks, brokers, etc.

Two days ago, WalletConnect restricted its availability in Russia in response to new legal and OFAC guidelines. WalletConnect, for those who aren't familiar, is a linchpin in the Web3 ecosystem. It's a crucial bridge that allows for seamless interactions between decentralized applications and personal crypto wallets.

The update has broader implications than just affecting Russian users—it's sending ripples through the Web3 and financial spaces. T his situation is a perfect example of how Web3 innovations and regulatory preparedness intersect—and why it’s more crucial than ever to be informed and ready.

Financial Markets and Web3​

In the traditional financial world, regulations are stringent, and for a good reason. They protect investors, maintain trust, and ensure the stability of capital markets. Web3 projects, especially those related to decentralized finance, are challenging the status quo by democratizing access to financial instruments. But with great power comes great responsibility—and that includes adhering to regulations designed to promote global stability.

Non-compliance can result in hefty fines, legal disputes, and can even spell the end for your project. I've seen projects go from hot to not overnight (and vice versa ) because they ignored or underestimated compliance requirements. It's a reality check that comes in hard and fast.

Regulatory Compliance?​

In the early days of the internet, it was pretty much the Wild West. No one was quite sure what the rules were, and innovation took precedence over regulation. Fast forward to today, and you'll see that Web3, the decentralized internet built on blockchain technologies, is in a similar boat.

Regulatory compliance is not just a buzzword; it's an essential pillar for the sustainability of any Web3 project. It's the guardrail that keeps us from falling off the proverbial cliff of legal ramifications and provides a framework to operate ethically and responsibly.

What's at Stake?​

The ability for Web3 projects to interface and integrate with traditional markets largely depends on compliance. If DeFi projects, for example, are to ever become a recognized alternative to traditional financial systems, they need to play by some ground rules. If not, we're looking at isolated financial ecosystems that can't maximize their reach or impact.

A Personal Journey Through Securities Regulation​

At Block Transfer, we never considered regulations as an afterthought. Far from it! I actually began my journey into the transfer agent world through an old classic: The Transfer of Stock published in 1929 by Francis Christy. Yes, you heard that right—1929!

The New York Times hailed it as the “authoritative book on how corporate stock transfers are made.” This book was my gateway into the fascinating world of securities regulation. From there, over the course of years, I read every piece of federal US securities regulation, understanding that any innovation we drive must be compliant and reliable.

Closing Thoughts​

The WalletConnect situation showcases the complex relationship between Web3 technologies, regulatory compliance, and traditional financial markets. Web3 projects have the power to revolutionize not just how we interact online, but also how we deal with money, assets, and financial instruments. However, without proper regulatory compliance, we risk creating financial bubbles, harming investors, and missing out on creating something genuinely transformative.

Regulatory compliance may not be the most glamorous aspect of running a Web3 project, but it's definitely among the most important. Legal frameworks around investing are continually evolving. WalletConnect's recent update is a sign of how much external factors like government regulations can affect the Web3 landscape. We have to be prepared for these changes as they come. If you're a blockchain company with over 35 investors, we can make your shareholder compliance life easy.

Sources

WalletConnect Protocol Update Email