Security tokens and blockchain – what is it all about?
- 14. July 2019
- Posted by: Blockruption Team
- Category: Applications
What are tokens?
Tokens are used to represent something of value, and what is being represented depends on the ecosystem in which the token exists. A token can represent a voting right, stake, or a particular value, and it is not limited to just one role.
For example, if someone has possession of a token, he or she may have voting rights that allow them to decide which projects get funding and which don’t. It may also give them access to features that enrich the user experience of an environment like a web browser.
Many people think of cryptocurrencies like Bitcoin when they think of tokens, and while they are similar, they are not one and the same. The big difference is that a cryptocurrency can exist outside of its native environment, meaning that a Bitcoin can be exchanged for value outside of the platform it comes from.
A token, on the other hand, only exists within a particular platform and usually represents a utility or asset that a company has.
Understanding security tokens
There are two main types of tokens: utility tokens and security tokens. A utility token is essentially a coin that is backed by a project, and most of these tokens are Ethereum based. If someone owns a utility token, they receive specific, predetermined benefits that can include anything from receiving a product or service to gaining access to a particular system or network.
A security token is different because it does not need to contain a utility – that predetermined, tangible benefit. Instead, a security token represents a share of the company that issued it much like a share of a company purchased from the stock market.
Since a security token does not provide a specific benefit like a utility token, it falls under the SEC definition of a security in the United States – hence its name. The Howey Test defines a security as an investment of money in a common enterprise with the expectation of profits derived from the efforts of a third party. By meeting this definition, security tokens are usually subject to federal securities regulations that protect investors.
Security token offerings
A security token offering is essentially an Initial Coin Offering (ICO) that meets certain regulatory standards. An ICO is essentially crowdfunding through cryptocurrency, where the developer issues a limited number of tokens and buyers can invest in that particular project. If someone wants to purchase a token, they simply pay for it through the platform and in return receive the token.
A security token, on the other hand, has more measures in place to prevent scams and flawed business concepts from hurting unknowing investors. In order to make an offering, a business must go through the proper legal and compliance channels before they are allowed to take funds from investors.
This is quite similar to an initial public offering (IPO), but the tokens will not actually be offered on a regulated exchange like the New York Stock Exchange or Nasdaq.
Types of security tokens
Now that you understand what a security token is, let’s look at the three main types: equity tokens, debt tokens, and real estate asset tokens.
An equity token is similar to traditional stock as it represents the value of shares issued by a company within a blockchain. The largest difference is that rather than recording ownership in paper certificates and depositories, equity tokens are recorded in a blockchain that keeps a record that cannot be altered, changed, or manipulated. If you own an equity token, you are entitled to a portion of the company’s profits and a right to vote.
Debt tokens are used to represent debt instruments like corporate bonds, and their prices are dictated by the credit risk of the company and the dividend paid.
A real estate asset token represents an ownership stake in real estate or commodities. Typically, commodities trading involves having to trust multiple parties, but the blockchain technology used to back tokens allows for greater transparency and reduced risk of fraud. Examples of blockchain and security tokens
While the concept of blockchain and security tokens are relatively new, they are already being utilized today. For example, there is a Bananas cryptocurrency backed by bananas, and another called El Petro which is backed by oil.
These projects rely on the decentralized blockchain network to independently validate transactions, which are then linked together in a chain that is timestamped and encrypted to prevent data manipulation and fraud.
Pros and cons of security tokens
Some of the biggest benefits of security tokens come from the fast execution and high level of security that the blockchain technology has to offer. Security token platforms eliminate the middlemen, vastly improving execution times and data sharing. This also provides the opportunity for lower issuance fees, as potentially multiple markups are being removed from the equation by eliminating underwriting costs.
An additional advantage includes greater exposure to the free market, as businesses can essentially transact with anyone that has internet access. This improves the financing capabilities of companies and provides greater investment opportunities for investors, and this increased exposure leads to better asset valuation.
There are some disadvantages to security tokens as well. Since middlemen from traditional financial institutions are eliminated from the process, there is a lot more trust that needs to be placed on the seller. Overall, this leads to greater federal regulation in most markets.
As you can see, the future for security tokens is very promising and it is something businesses will begin to take advantage of sooner rather than later. In order to stay ahead of the competition and remain a leader in your industry, work with a consultant to see where blockchain and tokens can be incorporated into your business.