Security tokens became the hyped ‘next big thing’ in crypto. Marveling at the success and profitability of ICOs and the rise of utility tokens, it was thought that security tokens could be the second coming.
A security token is a tokenized security. For reference, a security is a traditional tradable financial asset that can represent a piece of ownership of a company. Typically a security will have a certificate, either physical or electronic form, that proves ownership. The value of a security is derived from the performance of the associated company.
A token is a digital asset, usually based on a blockchain, which represents ‘something’. In the case of a security token, the token represents the tradable security of a company. It essentially can represent one (or many) share(s) in a company.
A company can tokenize their business and allow investors to invest directly in their company by creating a security token. This is different to buying a utility token because a utility token derives value from its usefulness in an ecosystem, rather than the performance of the issuing company.
How Does a Token Become a Security?
As cryptocurrency grows and regulations evolve, the line between utility token and security token is becoming clearer. Especially in the United States, the SEC have been known to label tokens security tokens which were previously thought the be utility tokens.
Strictly speaking, a utility token is not supposed to be an investment. Therefore, when a token issuer makes a move to enhance the value of their token, there is a danger that the token will be labelled as a security. One common example of this is a token burn – these have led to tokens being labelled securities in the past.
A traditional, clear-cut way to definitively decide whether something is a security is known as the ‘Howey Test’. This test has four requirements and if all of them are met, you’re looking at a security.
The Howey Test:
- There is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Once you look at it like that, you can see how utility tokens could be labelled as securities.
Are They Good?
Security tokens are subject to tighter regulations because of how the value is derived and because they are actually supposed to be investments – utility tokens are not. In cryptocurrency this is often frowned upon because it restricts investors from certain jurisdictions and it creates limitations of transfer and investment that clash with the ethos of cryptocurrency.
If you look at it from an outsider, security tokens are very interesting. The regulations are similar, but the benefits of blockchain are enticing – speed, low fees and a round the clock market.
Could this be the future way to invest in companies?
The development of security tokens is an exciting time.