Security tokens, commonly referred to as tokenized securities, are regulated and compliant investment assets presented in the form of a cryptocurrency token. Combining the benefits of digital assets with traditional securities offerings, they are in the process of revolutionizing the way financial institutions store value. These tokens represent ownership stakes in assets, but unlike conventional securities, they are created digitally (tokenized), leveraging secure blockchain technology. Asset tokenization facilitates the transition of numerous labor-intensive and manual processes associated with bringing securities to public and private markets to the blockchain, enabling automation. This shift offers significant advantages for issuers and investors across various aspects of the investment landscape. In this article, we’ll give you a quick rundown of everything security tokens – what they are and how they’re made, benefits, and how regulation works.
Security Tokens: A Brief Overview
In finance, securities are tradable financial assets, generally categorized into three main types: Equity, Debt, and Derivatives. Equity represents ownership in a business, such as holding shares in a company like Apple. Debt securities include assets like bonds or notes, while Derivatives encompass financial instruments like futures or options.
On the other hand, security tokens are digitized representations of these traditional securities—Equity, Debt, or Derivatives. Beyond merely mirroring their traditional counterparts, security tokens inherit the characteristics of cryptocurrencies, affording them several advantages over conventional securities.
Key Benefits of Security Tokens
Security tokens represent a significant technological advancement in the realm of securities offerings. They combine the disruptive potential of crypto assets, the robust security of blockchain technology, and the global accessibility and transaction speed of the internet, marking a transformative step forward in financial innovation. The key benefits include-
- Instant trade settlement and finality.
- Blockchain-verified withdrawals and deposits.
- Greater control over one’s wallet, with minimal friction and high freedom of use. Investors can withdraw assets, engage in peer-to-peer trading, and self-custody assets.
- Markets are operating 24/7/365.
- A regulated and compliant avenue for global capital raising, with clearly defined obligations for issuers and rights for investors.
- Access to global liquidity pools.
- It has reduced time to market and issuance costs compared to traditional IPOs or GDRs, widening access to global capital markets for a broader range of issuers.
How do Security Tokens Work?
With the benefits of security tokens in mind, numerous corporate giants have ventured into building platforms for trading these tokens. It provides institutional investors with a convenient and secure entry point into blockchain technology. Security tokens offer investors the potential of regulated instruments coupled with the agility and speed of blockchain technology.
Security tokens operate within fully regulated securities frameworks, ensuring compliance with securities laws. Often restricted to qualified investors akin to traditional securities, security token offerings are subject to oversight by regulators or governing bodies, dictating the issuance, offering, management, and exchange processes. It works by:
Efficiency
By eliminating legacy middlemen, security tokens streamline fundraising and trading processes, reducing settlement times and costs.
Automation
Security tokens enhance compliance and automate payments such as dividends. Programming compliance rules into each token’s configuration ensures adherence to jurisdictional regulations.
Improved liquidity
Asset tokenization enables trading traditionally illiquid assets, facilitates hyper-fractional ownership, and broadens access to global investor pools.
Market access
Security tokens offer investors access to previously unavailable or illiquid assets, with trading available anytime due to the absence of weekends, holidays, or bank closures.
Rules and Regulations
Security tokens are investment contracts governed by securities laws, with regulatory requirements varying by country. Security tokens were among the first digital assets in the USA and Switzerland to receive legal recognition. In 2018, as cryptocurrency matured, the US Securities Exchange Commission (SEC) initiated investigations into crypto organizations and token nature.
Under federal law, a security token must qualify by registering with the SEC and meeting the criteria outlined in the Howey test. This test, established by the US Supreme Court, determines if a transaction constitutes an investment contract based on four conditions.
In addition to the Howey test, launching a security token requires compliance with various legal regulations, including:
- Regulation D: Allows startups to raise funds through debt securities or equity sales without SEC registration.
- Regulation S: Provides an SEC-compliant method for fundraising outside the USA.
- Regulation A+: Permits SEC-approved security provision to non-accredited investors, facilitating public and private funding integration for significant fundraising.
Compliance with the SEC’s rules and regulations means security tokens must integrate numerous legal contracts. Nevertheless, the rewards for establishing a comprehensive security token exchange system could be substantial. With an estimated $256 trillion worth of real-world assets globally, connecting them to investors via blockchain can potentially revolutionize financial markets.
Conclusion
The opportunity presented by crypto securities extends to asset classes like fine art and real estate, historically constrained by limited liquidity and commerce. Security tokens have the potential to unlock the liquidity of real-world assets by bridging them to the blockchain.
