OSL Digital placed a ‘tokenised bond’ in July – what’s next for blockchain values?

OSL Digital Securities Ltd., which operates a cryptocurrency exchange in Hong Kong, tested a new potential industry in late July when it distributed a so-called tokenized bond on Ethereum, the world’s largest public blockchain.

The instrument falls under what are known as “tokenized securities” or a digital representation of a traditional security that works in the same way except that they can be stored, sold and exchanged on blockchain networks.

In OSL’s bond instrument, each token represents a $10,000 share with a fixed interest coupon and a bonus coupon tied to Bitcoin price movements, valid for three months. Five companies invested in the bond, including crypto investment company Animoca Brands.

CEO Gary Tiu of BC Technology Group — the parent of OSL, which also has a crypto exchange in Singapore — discussed the bond and the potential for tokenized securities with Forkast, including use cases and regulatory issues for what are also called security token offerings, or STOs.

The following interview has been edited for brevity.

Ningwei Qin: Can you walk us through the issuance of the tokenized bond.

Gary Tiu: The project was done as a proof of concept with parties who also shared our belief in the development of the STO space. The issue itself was made as a private placement in Hong Kong. For the future, we see further interest from companies and financial institutions who want to do similar projects with us. But for now, that project is complete and we look forward to actually completing the entire lifecycle of that token.

Qin: How many bonds were sold in the first issue?

Tiu: As I said, it was done as a proof of concept with a small group of investors, it was not for fundraising as BC Group is already well capitalized. What was important to us was to complete each of the issuance steps and execution. We did the transaction to prove that a private placement of a security token can be done in Hong Kong and can be done through licensed intermediaries. These are the important reasons.

Qin: Can you explain more about the process?

Tiu: From a technical perspective, some of the traditional requirements for issuing a bond are necessary, but there is additional work with tokenization and quality assurance on the tokenization itself to ensure that, for example, smart contracts work as they were intended and the tokens can actually behave on the way we intended them. All this is done by OSL as a licensed intermediary to comply with requirements such as anti-money laundering and wallet verification. All of these are fairly new to the industry, because right now OSL in Hong Kong is the only platform licensed by the Securities and Futures Commission to carry out these types of transactions. Therefore, from a market perspective, this was an important milestone.

Qin: Anything else you can explain about STOs?

Tiu: One feature we have structured into this particular token is the ability for investors to choose to hold the token in their own private wallet. In other words, the investor can hold the tokens with a licensed intermediary or a custodian or take the token from such platforms. We’ve built in compliance checks for anti-money laundering and other requirements, but we’ve built in this flexibility for investors to choose how they want to hold their tokens.

Qin: Can tokenized securities be stored in third-party crypto wallets like regular crypto, such as Metamask and so on?

Tiu: Well, as a licensed intermediary we want to build in controls, for example to ensure that all parties comply with anti-money laundering requirements. So the token is designed to be freely transferable between whitelisted private wallets and other wallets whitelisted by the transfer agents. This is an attractive feature for many investors. This is also a difference between this project and those carried out by banks using private blockchains. We used a public blockchain to actually create tokens, so the wallet movements, asset movements are transparent on public blockchains. And provided the parties are whitelisted, they can freely transfer.

Qin: What about trading in secondary markets.

Tiu: Again, this project is by design a relatively small one and is a three-month instrument, so secondary market trading was not seen as an important feature. But for future much larger projects, the secondary market can be an important factor.

Qin: What are OSL’s future plans with tokenized securities?

Tiu: So the next chapter is realizing the network effect of what OSL has built in recent years. An important part of our business strategy is B2B, so in addition to serving our direct customers, we also serve many other financial institutions. An example of this is our engagement with DBS Bank in Singapore and Standard Chartered Bank in the UK and Europe. It is our technology and know-how that helps very large global financial institutions serve their clients when it comes to their digital asset trading needs. So this network effect is the next step with our institutional partners in projects like STO distribution and trading.

For example, the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) announced in January that banks and licensed brokers can offer digital asset trading to their clients provided they partner with a provider in Hong Kong licensed by the SFC to operate regulated business related to digital assets. And right now OSL is the only licensed platform [for Type 1 and 7 regulated activities related to digital assets] in Hong Kong, then again we see a network effect of this in not only distributing and placing security tokens for our customers, but allowing our partners to reach their customers with these products.

Another example, during the announcement by the HKMA-SFC in January, Interactive Brokers Hong Kong will use OSL as the exclusive digital asset partner to support its clients in digital asset trading.

Qin: Would you consider any B2C services in the future?

Tiu: We have B2C services in Hong Kong, Singapore and America. In Hong Kong, due to the nature of the regulatory framework, our direct clients are all professional investors. In Singapore and our operations in the Americas, we see a mix of high net worth individuals, institutional clients, as well as other digital asset platforms using our services.

Qin: Crypto exchanges, such as Huobi, are also applying for licenses to provide STO services to businesses. How do you see this competition?

Tiu: First, the licensing structures are different between Hong Kong and Singapore. The Hong Kong license regulates our activities on digital assets, but allows us to handle securities as well. While in Singapore, digital asset platforms licensed under the Payment Services Act are generally not allowed to deal in securities. So in Hong Kong, OSL has the benefit of a license to handle digital and virtual assets for clients and their investors.

I think the competitive landscape for the STO space is relatively green and still being adopted, but has a very important future. And it’s a view shared by many of our financial institutional partners, including Animoca, which joined the digital bond offering.

Qin: If STO is still a growing sector, how do you convince customers of its benefits?

Tiu: Right now, many parties see it as building the knowledge and technology to actually execute transactions in the future. Many customers see it as an opportunity to learn. Since announcing the tokenized bond, we have had a lot of interest from corporates as well as financial institutions. The companies are typically the more innovative institutions, as well as a small number of traditional institutions. So if the question is, “How do we persuade people to be interested?” The short answer is: we didn’t have to, they came to us, and I think interest will continue to grow.

Qin: Is it just because it is a new technology or other reasons?

Tiu: I think one aspect is new technology, but from a commercial point of view it’s to see if they can improve the way they structure their financial products or if they can reach a wider audience.

In the case of Interactive Brokers, they already have a lot of traction with existing customers, so the challenge is to bring these customers more interesting and innovative products. This is a challenge for many financial institutions. How do you bring more products? How do you continuously improve the user experience to keep your customers on the same platform?

We are certainly positive about our B2B business because we have many institutions coming to us as we can offer new products on a platform for existing clientele. This is one of the biggest drivers for many institutions.

Qin: What kind of financial products will they tokenize?

Tiu: The most common product proposals are structured debt instruments or simple debt. These two areas are the most discussed.