Security Tokens: A General Understanding
What are these types of tokens, what is their history, and what are their benefits?
You probably have heard of or read in newspapers the words cryptocurrency or utility token when it comes to describing types of digital assets. Cryptocurrency implies desire to function as a currency — think of Bitcoin, Litecoin, Monero, or even the stablecoin DAI. As for utility tokens, my previous post explains what they are and how they are functioning within the cryptosphere.
Security tokens are another type of digital asset, or what I like to call a cryptoasset, that have been garnering quite a bit of attention lately.
Security tokens are essentially digital contracts for fractions of any asset that already have value like real estate, vehicles, or art. Security tokens are also digital contracts for financial securities. A security token can take the form of any of the following types of financial securities:
The above diagram shows how the cryptosphere is thinking about security tokens now, but the conversation around security tokens has gone through several stages.
History of the Conversations Around Security Tokens
Originally, the conversation regarding security tokens revolved around whether ICOs would be considered securities by the SEC or not. Many blockchain companies were (and are) issuing tokens through ICOs in ways that would let them avoid having to register them as securities. This article by David Gobaud is a great overview about the regulatory landscape around ICOs, even if it is a bit outdated.
The discourse on security tokens then shifted towards tokenizing venture capital and/or private equity funds to provide liquidity to their Limited Partners (LPs) that would normally have their capital tied up for 7 to 10 years. Blockchain Capital experimented with this approach but reverted back to a standard structure since their LPs were not equipped to handle self-custody of their tokenized investment.
The most recent focus of the conversation (and the one I find most intriguing) centers around blockchain companies issuing security tokens (e.g., equity tokens) to raise capital versus issuing utility tokens. Documo is an example of a company conducting an equity token offering (ETO). Note: not endorsing Documo, but just listing them as an example. I expect to be seeing more and more companies raising capital through security tokens, whether that be via ETOs or debt token offering (DTOs).
Benefits of a Security Token
I could rewrite an explanation as to all the benefits a security token provides to its holder, or I could admit that someone else has already written them out for us. I’ll admit to the latter. Stephen McKeon wrote a great post titled “The Security Token Thesis”, which gives detailed explanation to the list of benefits I have below. Yes, I did take the list from his post.
· 24/7 markets
· Fractional ownership
· Rapid settlement
· Reduction in direct costs
· Increased liquidity and market depth
· Automated compliance
· Asset interoperability
· Expansion of the design space for security contracts
Raising capital through security tokens will become the standard in the space, and it will force investors in the space to reconsider the fundamental value of utility tokens. My next post will explore why blockchain companies need to adopt security tokens as the standard for raising capital.
Hopefully you have a better grasp of security tokens after reading this post. I’m not the first person to write about security tokens. See links to further readings below:
· ICO 101: Utility Tokens vs. Security Tokens (Josiah Wilmoth, Strategic Coin)
· Is 2018 the Year of the Security Token? (Joe Liebkind, Investopedia)
Disclaimer. This post is intended for informational purposes only. The views expressed in this post are not, and should not be construed as, investment advice or recommendations. This document is not an offer, nor the solicitation of an offer, to buy or sell any of the assets mentioned herein. All opinions in this post are my own and do not represent, in any manner, the views of CMX Capital or affiliated companies.