Security Tokens vs Utility Tokens

Initial Coin Offerings (ICOs) have become a very effective means of raising seed capital — as demonstrated by projects which have successfully raised millions in under a minute. As this new means of raising capital investment has become increasingly more popular, regulators have noticed and are questioning whether some of these ICOs are securities disguised as coin offerings. This has sparked the need for a clear distinction between the classification of a security and utility token.

History of securities:

It was in 1946 when the Howey Company of Lake County, Florida began leasing parts of their farm. They offered buyers the option of leasing the land back to the company, who would then harvest and sell the citrus. Since most buyers had no agricultural expertise, they were more than content with leasing the land back to the company and signing off on a service contract for both cultivating and harvesting the oranges.

While the firm insisted that they were selling real estate, the SEC disagreed, claiming that buyers had little to no control over the performance of their investment because they relied entirely on the efforts of Howey-in-the-Hills Service, Inc. for a return. Based on this argument, they proceeded to charge Howey Company for not filing a securities registration statement.

As a result of this lawsuit, it was established that The Supreme Court would determine whether or not certain transactions are to be considered investment contracts if:

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

This process became known as the Howey test.

Essentially, if an investment opportunity is open to many people, and if those investors have little to no control over how the invested capital is managed, then the investment is likely to be considered a security. Otherwise, if the investment opportunity is made available to only a few friends and/or associates and if these investors have significant influence over how their investment is managed, then it is likely not considered a security.

Fast forward 70 years and we now face a similar challenge when it comes to evaluating whether or not a digital token is considered a security. Distributed ledger technologies and cryptocurrencies have revolutionized the way we think about money, trust and information security. They’ve opened doors to a new world of possibilities and improvements to existing infrastructure so as to share information, transfer value and maintain a ledger of transactions all in a decentralized and fault-tolerant manner.

Utility Tokens

Tokens which provide a means to transact within a platform for goods/services that don’t have any attributes or expectations of profit, as defined by the Howey test, are generally considered utility tokens. Classifying a token as a utility, however, can be difficult as there is usually a finite amount of tokens available and people all around the world continue to purchase them expecting profits.

To avoid being classified as securities, some ICOs are now being framed as Token Generation Events (TGEs) in which the tokens function as a means of accessing content, incentivizing user behaviour and securely embedding various processes within immutable smart contracts.

Some projects have also adopted a closed-loop approach to the implementation of such tokens, which usually involves using private blockchains to restrict the ability to send or receive transactions based on a set of rules encoded in smart contracts — often requiring the completion of a KYC process in order to liquidate or trade the tokens.

Security Tokens

Securities are considered fungible and negotiable financial instruments that are assigned a value, which can be traded. They represent an ownership position in a publicly-traded corporation by:

  • Issuing stock;
  • Creditor relationship with a governmental body or a corporation in the form of a bond; or
  • Rights to ownership as represented by an option.

Security tokens represent the evolution of traditional securities with the digital world. Security tokens are digital representations of traditional assets. They are fully regulated and compliant to all existing securities laws. Security tokens could act as digital representations of shares in a company, a limited partnership, a member share in an LLC or fractional ownership of property.

In order to participate in a Security Token Offering (STO), investors must be vetted based on Know Your Customer (KYC) and Anti-Money Laundering (AML) guidelines, and verified as accredited investors within their region. Platforms like Polymath and Tokeny provide businesses with scalable blockchain infrastructure, access to advisory firms, connections to legal services, marketing resources and KYC/AML guidelines necessary to launch a successful security token.

It is important to note that the term ”security token” has neither been defined nor is it currently recognized by the SEC. (See disclaimer below)

How Security Tokens Provide Liquidity to Real Estate.

Security Tokens Enable Fractional Ownership

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset’s price. The higher the volume in a given market, the more a specific asset can be regarded as liquid. Security tokens are divisible, which enables high value investments, such as real estate, to become fractionalized. This provides a level of liquidity that is very uncommon in the realm of real estate investing, where funds are usually locked up for 5+ years.

Liquidity in REITs

Real Estate Investment Trusts (REITs) are securities traded on national exchanges or in the over-the-counter market. They enable investors to pool their funds together and invest in a collection of properties or other real estate assets. Typical average daily volume for REITS is between 2–5% of the market cap. Unlike traditional listed equity assets, REIT holders tend not to trade the assets actively and instead hold shares with the expectation of profits through dividends.

Leaseum’s Approach

Much like REITs, the Leaseum token will be tradable on exchanges following our token sale. However, tokens will be much more liquid than existing REITs due to their uniquely decentralized nature, coupled with low transaction fees and their capability to be traded 24/7 on an international scale.

In addition to added liquidity, the underlying blockchain technology of the token model opens doors for fund managers, like us, to explore new ways in which we can maximize our profits using technology. In Leaseum’s case, we accomplish this through our unique Smart Net Asset Value (NAV) tracking mechanism. Our Smart Nav Tracking Mechanism dynamically adjusts rental income yields relative to the price of our token — ensuring the fair distribution of dividends to investors. Thus, liquidity is generated through the implementation of this mechanism which narrows down the price tunnel between an upper and lower bound. This mechanism will be described in great detail once our official white paper is released in the coming weeks.

We believe security tokens represent the next chapter in the evolution of blockchain adoption and innovation. A token backed by a real asset class, such as real estate, bridges the existing gap between the traditional financial sector and the blockchain sector. Although the SEC has yet to impose clear regulations specifically for “security tokens,” we understand that we will need to comply to current security laws and have begun to submit all of the necessary documentation. We are also working with Tokeny to guide us in maintaining the highest level of compliance.

To learn more about how we leverage distributed ledger technology and arbitrage mechanisms to maintain price stability, follow us here on Medium and stay tuned for more in-depth articles on this topic.

About Leaseum Partners

Leaseum Partners is utilizing blockchain technology to disrupt traditional processes associated with investing in commercial real estate by providing token holders with dividends, voting rights and capital gains rights.

We are currently finalizing our White Paper, which will fully detail our business model as well as the technical aspects associated with Leaseum.

In the meantime, stay updated on our progress:

This article is given for information purposes only and no part of it is legally binding or enforceable, nor is it meant to be. Whilst we believe that the information provided in this article is reliable, its accuracy is not guaranteed and no warranty is given or implied. Certain statements contained in this article constitute forward-looking information involving known and unknown risks and uncertainties, which may cause actual events to differ materially from the estimates implied or expressed in such forward-looking statements. More information about the ICO is available at https://www.leaseumpartners.com

None of the information in this article is intended to provide a basis for an investment decision, and no specific investment recommendation is made. Accordingly, nothing in this article shall be deemed to constitute a prospectus of any sort or a solicitation for investment, nor does it in any way pertain to an offer to sell or a solicitation of an offer to buy any securities or rights of any nature whatsoever in any jurisdiction.

The ICO is not intended for jurisdiction where sale or use of digital crypto-assets may be prohibited. Moreover, the ICO, if launched, will be limited to accredited investors within the meaning of Rule 501(a) of “Regulation D” of the Securities Act 1933 under U.S. law or any equivalent qualification under local laws. You are strongly advised to carry out a legal and tax analysis concerning the participation to the ICO according to your nationality and place of residence.

This article shall not be copied, reproduced, disseminated or disclosed in any way in whole or in parts, nor shall it be distributed to a “U.S. Person” within the meaning of Section 902(k) of “Regulation S” of the Securities Act 1933 under U.S. law.