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Security Tokens: What Are They and What Do They Do?

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Security Tokens: What Are They and What Do They Do?

What are security tokens and why are they so popular? A security token is a type of cryptocurrency that represents a real-world asset, which you can trade as you would a security. Here’s everything you need to know about this game-changing application of blockchain technology.

The following article is not investment advice.

What Are Security Tokens?

What are security tokens? Above all, security tokens are two things: a security and a token.

Like securities, security tokens are tradeable assets whose value lies in something external. And like a token, they can be issued in ICO, or Initial Coin Offering, and traded on a secure cryptocurrency exchange.

What Is a Security?

A security is a broad term for a financial asset with monetary value that you can trade. In other words, a security can be a lot of different things.

Stock or equity are the main types of security that matter when answering, “What are security tokens?” In other words, a security is an investment that an investor buys from an issuer (or company).

For the investor, it represents partial ownership in a company, which can translate to payments, voting on company decisions and the ability to resell for a profit on a stock exchange.

For the issuer, it allows them to finance without borrowing money. This is called an IPO, or Initial Public Offering.

Not Just Anyone Can Buy a Security

In order to buy a security, you have to go through a stockbroker. Stockbrokers have to have studied finance and received the appropriate licenses. They also charge their clients fees for their services.

Securities Are Regulated by the SEC

Not only do you have to follow a specific protocol to buy securities but securities themselves are subject to federal regulation. The SEC, or U.S. Securities and Exchange Commission, has regulated security sales since the 1930s. The SEC’s main objectives are to protect investors and regulate the market.

What Is a Token?

Security Tokens: What Are They and What Do They Do?

Many security tokens exist on the Ethereum blockchain. Shutterstock

A cryptocurrency token is one of two main types of cryptocurrency: coins vs tokens.

  • Cryptocurrency coins like Bitcoin (BTC) or Ethereum (ETH) mostly serve as a means of exchange.
  • Tokens typically represent something besides currency.

Additionally, coins often have their own blockchain while tokens do not. Remember that, like stocks, just because tokens do not represent currency does not mean that they don’t have monetary value.


Value of Security Tokens

Why is combining cryptocurrency and securities beneficial to investors and issuers? What are security tokens in terms of value? In short, there are three big reasons why these tokens are so popular.

1. Cut Fees

What are security tokens? For investors, they are a way to avoid paying stockbroker and make trades without paying hefty fees.

2. Increase Investor Pool

For the issuer, security tokens mean access to investors around the world.

3. Replace Lawyers

They’re also a way to benefit from blockchain technology‘s other applications, like smart contracts. Instead of paying for a lawyer to work as the middleman, the investor and issuer can sign a ‘trustless’ agreement.

4. Speed Up Transactions

Fewer middlemen like stockbrokers and lawyers and less paperwork with smart contracts mean shorter negotiation times.

4. Facilitate Trading

Security token platforms let investors trade anywhere in the world. This means that you can buy and liquidate assets quickly.


Security Token Regulations

Security Tokens: What Are They and What Do They Do?

The SEC regulates security tokens. Shutterstock

Security tokens are a highly regulated type of cryptocurrency. Unlike utility tokens, which represent access to a company’s services rather than an investment in that company or external asset, these tokens are subject to SEC regulations.

Specifically, tokens are classified as such when they pass the Howey Test.

Howey Test Criteria

  • An investment involves a monetary investment.
  • The investor expects a profit.
  • It is a common enterprise, meaning the investor will make money dependent on the efforts of the issuer.
  • Profits depend on the work of a third party.

If a token passes the Howey Test, it is a security token. For the SEC, anyone asking “What is a security token” needs to understand that ICOs for security tokens fall under the same federal laws as securities.

Exemptions from SEC Registration

Not all ICOs for security tokens are SEC-registered, however. There are three regulations that allow ICOs to legally avoid registering with the SEC.

1. Regulation D

After selling securities a company can submit Form D to the SEC. It should contain information about the company’s leaders, promoters and proposal. This does not mean that the government cannot convict the ICO of fraud, only that they don’t have to register in the typical fashion.

2. Regulation A+

This is an alternative to an IPO for smaller companies. Smaller companies can raise a maximum of $50 million publicly and through VC funding. In other words, non-accredited investors, meaning an investor who has a net worth lower than $1 million, can participate.

Qualifying for Regulation A+ requires professional counsel and extensive paperwork.

3. Regulation S

This is when an offering takes place outside the U.S. and therefore falls under that country’s regulations. However, the SEC is amending Regulation S.


Investing in Security Tokens

Security Tokens: What Are They and What Do They Do?

Qualified investors can buy and trade security tokens through many accredited platforms. Shutterstock

So how do you invest in security tokens if they aren’t the same as utility tokens or coins? Instead of going to an exchange like Coinbase, investors typically use issuance platform, meaning accredited crypto securities trading platforms, or exchanges specifically for securities.

Here are a few examples of issuance platforms:

Polymath

Polymath is a security token issuance platform that has its own blockchain. Specifically, it’s a platform on which companies can create a security token, which qualified investors can buy. All this is done through the Polymath (POLY) ST20 token that only accredited investors can buy and store in their Ethereum wallets.

Securitize

Securitize is another major issuance platform. Today, over $500 million worth of STOs (Security Token Offerings) have used Securitize’s blockchain platform, according to their own estimates.

Templum

Templum is an SEC and FINRA registered brokerage firm that uses blockchain technology for Tokenized Asset Offering, or TAOs. This can mean investing in a small or large company, in real estate or in a larger fund.

Harbor

Accredited securities issuance platform Harbor also lets qualified investors trade assets on the blockchain, with an emphasis on liquidity. This is possible through Harbor’s Regulated Token (R-Token).

Swarm Fund

Private equity blockchain Swarm Fund allows issuers to tokenize using their SRC20 protocol. Anything from buildings to banks to companies can be tokenized and invested in on their blockchain.


Cryptocurrency Investing

What are security tokens? Above all, they are a way of facilitating investing and trading assets through cryptocurrency, instead of through stocks. They make it international investing easier, faster and cheaper, and give companies access to a much larger investor pool.

Like most things, cryptocurrency-related, crypto-securities are in the earliest stage of development. But as companies like Citigroup work to solve the crypto investment puzzle, the world of finance gets closer and closer to cryptocurrency adoption.