What Are Security Tokens?
Everyone has been buzzing about Security Tokens for some time now, but those talks are all over the map. What do you say if we put it all under a microscope and get to know what exactly is a security token, where did it come from and what is its future?
What Is A Token?
First of all, let us remind you of the meaning of a token. Token — a representation of something virtual or physical (concept, value, right, access key, debt, etc.) in its ecosystem. It is not really a currency, but more like a tool with a specific function in its environment. You are usually able to get these tokens during the fundraising period of the project. We have talked about these different funding types in one of our previous articles — What Is The Difference Between IPO, ICO, IEO, And STO?
The project itself sets the value and limits of the token. William Mougayar did a great job defining these principles in his The Security Token Thesis. It helped us separate several possible roles that can be set for the token. Each of them has specific features and purpose, which defines its value.
Some tokens give you a certain amount of rights within the ecosystem. It can be a right to vote where the project is going and somewhat of control of its development.
Toll or Function
The token can be used as a gateway to access the product. It works as a toll that allows you to enter the ecosystem. Also, some projects might have some parts of it, such as tools or features, that are accessible only when you have their token. It is more like paying for a premium user experience.
A token can be set to be a reward for some kind of tasks. It works as a value exchange and builds a native economic system between buyers and sellers on the platform at the same time helping the project to develop.
These tokens represent the distribution of the project earnings or other related financial benefits among investors in that environment.
Of course, the token can represent a currency too, which could be exchanged in the native and foreign exchange. The token can have either a single or multiple roles. The value is fully controlled by the project.
Security Tokens Vs. Utility Tokens
There are two main legally recognized types of tokens — utility and security. Tokens qualify as securities, only if they can pass tests such as Howey Test.
Howey Test is an analysis of the investment, where the project is required to follow these criteria:
- It has to be a financial investment.
- There is an expectation of a profit.
- It is an investment in a common enterprise. The definition of common enterprise is open for interpretation, but it is usually defined as one that is horizontal meaning that investors join their money or assets together.
- The profit comes from the efforts of a promoter or a third party, and not the investor’s own actions.
To put it simply, Utility Tokens allow you to benefit from using the product(s) and building the internal economy system of the ecosystem. While Security Tokens allow you to profit from the project. The value of the security token is directly tied to the value of the project.
Here’s how Anthony Pompliano defined Security Tokens in his Official Guide To Tokenized Securities: ‘If cryptocurrencies like Bitcoin are considered “programmable money” then you can consider Security Tokens a version of “programmable ownership.”’
Also, it’s important to note that Utility Tokens are more prone to scams. Security Tokens are a safe option due to them being more of an investment contract that must comply with numerous regulations. You can look at a Security Token as a representation of the company’s debt to you.
Pros & Cons
Great minds of the blockchain were looking for a solution after so many of ICOs ended up being scams or failures. There was a need for a change. So what exactly has been changed by bringing in Security Tokens?
- Regulations (such as 2017/1129 Prospectus Regulation and 2004/39/EC MiFID II in Europe and Reg D in the USA) and legal agreement of accountability brought back the credibility.
- Getting rid of the middleman (such as financial institutions and lawyers) reduced the process complexity, length, and costs of transactions. Also, it drastically decreased the levels of corruption and manipulation.
- The token being a legally binding contract between the project and the investor gave an option for a smart and safe investing, that attracts more people. If the team fails to deliver what was promised, the investor has a legal right to go to court and demand what is contractually his/hers.
- Opening up the free market resulted in a higher volume of investors from all around the world.
Of course, Kate Mosse could come in and quote herself once again as “there’s no black and no white.” There is so much good about Security Tokens, but everything has its price.
The main and perhaps the only issue that people can see in Security Tokens is that when you remove the middleman, you shift their responsibilities to the creators of that ecosystem. This means that the team of the project has to work on solicitation of interest, investors’ security, and compliance regulation by themselves. The project needs to have a strong legal team, that will be able to take proper care of these tasks.
Yes, Security Tokens are still a pretty new thing. However, as S. Khatwani wrote — the crypto community is bullish because of the unlimited possibilities that these tokens bring, so big bankers and institutional investors are betting high on their future.
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