What You Need To Know About Security Tokens

Blockchain technology facilitates the creation of many different tokens and assets. Security tokens are an exciting addition, as they provide a modern take on traditional securities. These vehicles also offer a more regulatory compliant investment option for those who want to explore that option.

The Origin of Security Tokens

It is a well-known fact the blockchain industry has given rise to numerous exciting concepts. Ranging from cryptocurrencies to tokens and DeFi assets, it was a matter of time until digital securities became more outspoken. Known as security tokens, they are assets issued on a blockchain to represent a stake in an external company or asset.

Issuing a security token is possible by both corporations and governments. These tokens have similar functionality to stocks and bonds at their core, even though they exist in digital form. It is a viable option for modern-era investors who prefer digital investing over more traditional solutions. 

There are several reasons why security tokens are crucial in this modern age. Companies looking to distribute shares to investors will need to explore the options at their disposal. Doing so in digital and tokenized format will prove benefits to certain types of investors. After all, the tokenized version has the same benefits as traditional shares, including dividends and voting rights.

More importantly, these tokens benefit from the technological benefits provided by the blockchain. With more transparency, no risk of manipulation, and rapid settlement, tokenized securities have numerous advantages. Although the market is still relatively small today, several prominent companies have already begun options in this space.

The Main Benefits of Security Tokens

As mentioned earlier, there are distinct advantages to tokenizing securities on the blockchain. They can be classified in four main categories: transparency, rapid settlement, uptime, and divisibility. These aspects matter significantly in the grand scheme of things, and should never be taken for granted.

Transparency

The main draw of security tokens is how they are more transparent compared to traditional securities. Everything that is issued on the blockchain is visible for everyone to see. That doesn’t mean personal information regarding participants is visible by default, but the overall holdings and distribution are. This approach also allows for the auditing of tokens and the smart contracts responsible for managing them. 

Uptime

Contrary to what some people may think, traditional financial markets are not known for their accessibility or uptime. Trading is only possible on certain days and during certain hours. On the other hand, security tokens can be traded on a 24/7 basis all year long, creating many new opportunities for traders to explore.  

Rapid Settlement

Speaking of traditional finance, the legacy system doesn’t lend itself well for settling things rapidly either. Transfers can take hours, if not days, to complete, which is far from efficient. Clearing and settlement remain two crucial bottlenecks in this situation, both of which can be resolved through automation and faster transfers over the blockchain. 

Divisibility

Securities often need to attain some degree of divisibility. Unfortunately, that also means very few real-world assets are viable in this regard. By using blockchain technology, it is essentially possible to tokenize a lot more assets. Options include art, real estate, and other valuables, all of which can be provided to investors worldwide. More importantly, everything can be divided into as many pieces as is necessary to increase accessibility and granularity.

The Difference With Utility Tokens

On the surface, the differences between security tokens and utility tokens might not be too outspoken. There are numerous similarities to take note of. For example, both assets are issued and managed by smart contracts on a blockchain. They are -most likely – tradeable across most exchanges and can be part of peer-to-peer transactions.

That is where the similarities will end, however. The economic and regulatory aspect of security tokens is very different from utility tokens. Either option can prove valuable for startup companies looking to raise funding for their technology or services. In exchange for contributing funds, users will receive digital tokens with varying degrees of benefits. Utility tokens will often provide voting rights, whereas security tokens can yield dividends. 

It is essential to understand utility tokens are not necessarily valuable. They often have 0 value, other than what speculators are willing to pay for them, especially where DeFi tokens are concerned these days. Utility tokens do not provide profits or dividends in any way, although they can have other financial benefits, such as a reduction in trading fees for exchanges.

Different Issuance Model

What makes security tokens very different from utility assets is the way they are issued. A security token is often sold through a Security Token Offering or STO. That particular model has some extra benefits and regulatory requirements for issuers to contend with. It is an approach that instills a lot more confidence and compliance than selling utility tokens, which often occurs through An Initial Coin Offering, Initial Exchange Offering, or Initial DEX Offering. 

For institutional investors, the STO model is more appealing. The regulatory compliance aspect has spawned some successful token sales over the past few years. Even so, the market remains relatively small – for now – as the viability of security or utility tokens remains to be determined.

To some, it may not be clear as to what makes these tokens securities. It all comes down to how one identifies the smart contract interaction. If this is considered an “investment contract” – based on the Howey Test – the participant will often seek out a profit through the efforts of others. 

Although the Howey Test is commonly used in the United States, things may differ from one region to the next. There is no global framework for cryptocurrencies or tokens of any kind. It is unlikely such a framework will exist anytime soon, leaving governments to make their own decisions and guidelines.

Security Tokens In Finance

The main appeal of security tokens is how they can help modernize the financial sector. That may seem easy in theory, but in reality, things are very different.  Tokenization of securities can usher in the era of digital-only financial instruments, yet only if entities can secure sufficient market participation. That is not the case today, but the industry keeps growing and evolving.

Solving the current inefficiencies in finance is a necessity. The use of centralized databases is creating too much friction to provide viable services. Far too much time, money, and energy are spent on administrative processes to manage data that may not be compatible with an institution’s internal systems. This creates a delay in settlement, unnecessarily high fees, and an overall unenjoyable experience for the users.

By embracing blockchain technology to issue digital securities, all of these concerns are alleviated. Anyone can interact with the blockchain, removing the majority of friction from the equation. The advent of an interoperable financial network is almost upon us, assuming the institutions are willing to embrace this new option.

The use of blockchain technology can also bring much-needed automation to the industry. Advanced smart contracts can take care of identity verification, compliance, investment vesting periods, and so forth. Going down this route creates more efficiency, lower costs, and faster overall execution. 

Existing Projects Today

Numerous companies and projects have begun experimenting with security tokens recently. Overstock and tZERO are two of the most successful ventures. With a market cap of $323.38 million and $116.725 million, respectively, the global interest in these security tokens is tangible. However, there is still a lot of work to be done before this industry can take off.

It is interesting to see the many different approaches in this industry. The possibilities are virtually limitless, ranging from company stock to investing in real estate or investment funds. Although not every project is overly successful, one should never ignore the experimentation phase. It is a viable way to gauge investor interest in security tokens.

The big question is whether other issuers will get in on the action eventually. Gauging by the success of the current offerings – or lack thereof – there may not be too much interest in exploring this option. Without new participants, the industry will grind to a halt, which is far from ideal. 

Closing Thoughts

On paper, there is a lot of potential for security tokens. The financial industry, which remains analog and inaccessible for most people, needs to be brought into the modern era. Doing so will require a very different take on how securities are created and issues. Using blockchain technology can offer numerous benefits, although it is still too early to go all-in on this option.

The coming years will prove crucial for the security token industry. It is essential to ensure ongoing market participation and attracting new investors. Those are two key challenges to overcome, and the uphill battle will only get steeper. However, the interest from some very prominent companies in security tokens can set an example for others to follow. 

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