What are Security Tokens

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Purchase securities easily on global markets.

It’s 2019. Investors all over the world are watching as fintech developments change the way investments are being made every day. The cryptocurrency trend proved successful for many but left others burned through fraudulent ICOs. Crypto, however, opened the doors for many other innovations through the digital, public ledger of blockchain.

One of the newest, and most innovative developments gaining momentum this year is the tokenization of assets, more importantly, security tokens. Security tokens are an efficient, inexpensive, and compliant way to invest in securities with the security benefits of blockchain technology.

What is a token?

Tokenization works by taking an asset and converting the rights of a hard asset into a digital token. Popular assets like stocks, real estate, carbon credits, oil, and gold can be difficult to physically transfer and/or subdivide, leading buyers and sellers to utilize paper trading that represent some or all of the asset.

There are two different kinds of tokens to define, utility tokens and security tokens.

Utility Tokens

These tokens are what most people are talking about when they are talking about tokens. A utility token is a virtual coin that is back up by a project, which is the type of investment most individuals are making.

When an investor purchases a utility token, they will receive a definable benefit in return. In most cases, the benefit is access to a particular system, or a coin that offers them access to a service. For example, the investor gains access to cloud storage space.

Security Tokens

A security token is a kind of token that does not need a utility. Instead of giving investors a tangible benefit, this kind of token usually represents a share in the company that issues it. Also known as equity tokens, security tokens are compared to purchasing shares on the traditional stock market as it offers partial ownership of a company.

While the differences between the two don’t seem to be vast, as you will see below, security tokens are much more heavily regulated, at least in the US government.

Security tokens offer users a quicker and easier transaction, with the benefits of blockchain technology and strong legal protection. They are a digitized conventional security that many investors are already purchasing, including stocks, bonds, property, and so on. When an individual purchases a security token, they are investing in an underlying asset, traded on global marketplaces that can represent fractional ownership of the asset. This gives security tokens a level of liquidity that wouldn’t be feasible with traditional securities.

The tokens are equipped with smart contracts, simple programs that are designed to execute as soon as a criterion is satisfied. The smart contracts can determine how the token is purchased, traded, or sold. Additionally, since tokens are based on blockchain, transactions are immutable, traceable, and transparent.

The Howey Test

In the United States, securities and security tokens are regulated by the Securities and Exchange Commission (SEC). To be considered a security, the investment or token must best what is known as the Howey Test. The Howey Test comes from a 1946 Supreme Court case in which an orange grove company, the Howey Company, was selling plots of land without promising investors to work the land and pay out part of the profit.

The SEC wanted to stop the sale of the land plots, saying that this was an investment contract and the investors should be promised protection. The Howey Company did not agree, claiming the transactions was simply a sale of land.

The Supreme Court sided with the SEC, creating the current definition of a ‘security’ and a test, the Howey Test.

In order to pass the Howey Test and be considered a security, a transaction must meet the following requirements.

  • There is an investment of money.
  • There is an expectation of profits.
  • The investment of money is in a common enterprise.
  • Any profit comes from the efforts of a third party or promoter.

Security Token Offering (STO)

For those who may be worried about a security token’s relationship to an ICO or cryptocurrency, there is a major difference.

Initial Coin Offering, or ICO, is like an IPO for cryptocurrency. When a new digital currency is developed, money is needed to fund it. Those who invest are hoping the currency will gain a lot of traction and raise the price of the coin. Unlike IPOs, investing in an ICO cannot gain you ownership stake of the company. During the ICO phase of a cryptocurrency’s life, interested investors buy some of the coins with virtual currency. The coins are known as tokens and act similarly to shares of a company when they are sold during the Initial Public Offering (IPO) step.

Unfortunately, many eager investors learned the hard way that many ICOs were fraudulent. With the added security and regulation of a security token, investors can rest easy knowing that Security Token Offerings aren’t the same as cryptocurrencies, nor are they related to ICOs.

An individual who is comfortable purchasing a traditional security will be comfortable purchasing a security token. As stated above, a security token is simply a digitized version of a traditional security, replacing a stock certificate with a digital copy.

Fintech and You

The shift we are seeing is that of a digital age. Tech-savvy individuals are seeking easy access, convenience, efficiency, and speed in every part of their lives, including their finances. Having the ability to make transactions from the convenience of a phone or other electronic platform is what is creating this strong push towards Fintech.

Looking beyond blockchains, we are seeing technology have a hand in simple things such as payment and holding money, and more complex life aspects like investment advising. Some companies are even developing ways artificial intelligence can assist in hedge fund managing!

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