10 Things Everyone Should Know About Security Tokens
by Herwig Konings, Founding Partner and CEO of Security Token Group
The security token world can be a daunting and confusing space. The technology was spawned by geeks, traders, bankers, and lawyers united by the blockchain. Here are 10 pointers to help you understand security tokens.
Security token: A digital representation of the ownership interest in an asset or security that was created using distributed ledger technology.
1. Security Tokens Are Just Software
Security tokens are lines of code tied to a blockchain that read and follow instructions. Think of it as a smart Excel sheet connected to the internet. Since most private companies use Excel sheets to track ownership already, security tokens are just a more advanced version of exactly that.
2. Security Tokens Are Completely Legal
Due to the rise and fall of initial coin offerings (ICOs), the term “security token offering” (STO) sometimes carries a negative connotation.
But there are important distinctions to be made between ICOs and STOs.
Most ICOs were conducted illegally and violated securities laws. And because almost no virtual token projects provided any actual utility (you couldn’t use them anywhere), the industry gained a bad reputation.
As a result, the stigma attached itself to security tokens. Some have even gone so far as to question their legality.
This is completely ridiculous. Simply put, as long as your security token offering follows existing securities laws, you can legally tokenize any asset or security.
3. Not All Security Tokens Are Destined To Trade
One of the biggest benefits of digitizing ownership through security tokens is that it’s dramatically easier to transfer or assign ownership. The technology enables selling or buying assets to be a completely digital transaction that is faster and more efficient.
Today, online marketplaces and exchanges are forming to create liquidity pools for security tokens. But just because something can be traded doesn’t mean that it will be. Security tokens offer many benefits beyond transferring ownership — therefore, not all tokenizations are done just to trade securities easier.
4. Most Security Tokens Will Not See Daily Trading
At the end of the day, many projects will go on to list their tokens and become digitally accessible to investors all around the world. Some tokens will represent individual houses, others venture funds, startups, or even physical assets… At the end of the day, any asset or security can be tokenized and listed.
However, most tokens will never see daily trading. If there were a demand for massive liquidity, the issuer would likely head for the traditional stock market. Instead, even just the potential for one additional buyer can help create liquidity and ultimately add value. Security tokens aren’t promising IPO level trading demand, they are promising the capability of trading — which is better than no trading option at all.
5. Security Tokens Do More Than Enable Trading
The value-add of potential liquidity is so enormous, it definitely will change the behavior of markets… eventually.
As we just discussed, building liquidity for assets is an entirely different challenge than building technology to enable it. But why would someone tokenize an asset that isn’t destined for trading?
With security tokens, an issuer can manage payments programmatically to investors. This means sending dividends to equity holders or paying coupons to debt holders is done automatically and electronically, leading to cost savings and governance efficiencies.
Security tokens also enable fractional ownership to a greater level. Many assets, like a commercial real estate building, for example, are limited to big investors due to their investment size. With security tokens, managing 500 investors is the same as managing 10. Therefore you can expose a lot more investors to an opportunity.
Finally, security tokens also enable digital voting using the tokens as authentication to participate and record votes on a distributed ledger. I just described 3 different governance processes that are digitally transformed with security tokens that enable all kinds of benefits to both issuers and investors.
6. Most Tokenizations Will Be Completed Quietly
On Security Token Market, we’re tracking dozens of private issuers that have tokenized their equity and were listed on a secondary market. Combined, they represent roughly $500 million worth of equity. All of their trading history is available publicly.
Meanwhile, HSBC just put $10 billion worth of private placements on the blockchain. Big institutions like asset managers, investment banks, and funds will leverage the efficiencies of security tokens that will not end up being available on a secondary market for large portfolios. A majority of the tokenization that will occur in the next few years will be done behind the scenes and will not be publicly available.
7. Most Security Tokens Will Be Niche
Functioning capital markets have been formed around the world to provide retail access and liquidity to most major commodities, currencies, and big companies. The assets and securities that will benefit the most from tokenization (and therefore will likely be the first adopted) are typically inaccessible, illiquid, and niche.
A great example is investing in supercars. Investors from around the world will soon be able to buy a small piece of ownership in Ferraris, Lamborghinis, and other rare cars that those very same investors could never afford to buy on their own. The same logic applies to investment opportunities like individual real estate, energy, municipal bonds, and more. These asset classes will most likely never reach the retail investor demand and trading volume that goes for publicly listed securities. But with security tokens, they will reach more trading volume and more new investors than they ever could before.
8. Not All Trading Tokens Will Be Accessible By Everyone
One of the restrictions for private assets and securities is that they can’t openly trade in the same way that publicly listed stocks do. Most tokens around the world will have to follow regulations similar to those of the U.S., which limits participation to accredited investors — the top 10% wealthiest Americans. Some exemptions like Regulation Crowdfunding or Regulation A+ enable access to all Americans, but their usage is low due to several factors. Consequently, most security tokens that end up trading will be purchased by private institutions, wealthy individuals, and international funds, which is how most markets function today. However, thanks to tokenization, some issuers can be exposed to retail investors enabling new opportunities for more investors. Combine that fact with niche markets and the result will be hundreds, or potentially thousands, of small liquidity pools dedicated to specific securities or asset classes all around the world.
9. Capital Markets Will Become Globally Accessible
Issuers all around the world will now have an option to list in foreign markets. For most issuers, they previously only had the option of going public or having no secondary market. Now, exchanges and private marketplaces all around the world will offer their investor bases foreign securities options. From the Caribbean Islands to licensed exchanges in financial centers like London, Hong Kong, and Singapore, issuers from countries all around the world will now be able to list their security on a foreign exchange at highly reduced fees compared to a traditional IPO.
10. Most Assets and Securities Will Be Tokenized In Their Lifetime
Remember that Excel spreadsheet we talked about? That digital spreadsheet replaced pen and paper. Blockchain is the next evolution. The benefits of a blockchain-based digital governance solution enables new capabilities, just like the spreadsheet did with formulas and data storage. This digital transformation is inevitable and the traditional adoption curve will take hold for security tokens — of this, I have zero doubt.
Over the next few decades, a race to tokenize will take place around the world where issuers and asset owners around the world will look to try and extract more value out of their assets. Some asset and securities types will see greater efficiencies and benefits than others but most, if not all, will eventually be managed using a distributed ledger and tokenized.
