Security tokens provide investors with the ability to invest in financial securities in tokenized form. Read on as we discuss security tokens, list some examples, and explore their benefits and drawbacks.
What Are Crypto Security Tokens?
Crypto security tokens are blockchain-based tokens that represent financial securities.
Traditionally, securities in the financial markets refer to financial instruments such as stocks, bonds, and options. Security tokens are a digital representation of these instruments. As such, security tokens may include benefits such as owning dividends, voting rights, or interest payments.
How Do Security Tokens Work?
The management of crypto security tokens using smart contracts means their processes are automated. During the development phase, the issuing company will set the conditions within the smart contract. The requirements include aspects like the ownership rights afforded to the token’s holder.
Despite the limited regulatory framework governing the blockchain industry, security tokens are subject to stringent rules as they are regulated by securities law.
For example, issuers need to adhere to KYC and anti-money laundering regulations. This may involve whitelisting wallet addresses approved to purchase the security token to ensure that only screened parties participate in the offering.
Unlike utility tokens that rely on speculation on the project’s success to drive up their price, security tokens typically represent a stake in off-chain assets. Consequently, purchasing a security token amounts to agreeing to an investment contract that confers ownership rights of real-world assets.
Common Types of Security Tokens
While security tokens can be structured in different ways, the three most common types of security tokens include real estate tokens, equity tokens, and debt tokens.
Real Estate Tokens
Holders of real estate tokens enjoy ownership rights to real estate investments, enabling investors to have fractional ownership in real estate properties.
Equity Tokens
Equity tokens are the blockchain version of shares in a corporation, with the method of recording ownership being the distinguishing factor. While ownership records of traditional shares are documented in a centralized database, and the owner is issued a certificate, equity tokens involve keeping records on a public blockchain.
The token holder may enjoy profit participation through dividends and voting rights. For companies raising funds for development, such tokens offer them an opportunity to reach out to non-traditional investors.
Debt Tokens
Debt tokens represent debt instruments such as corporate bonds. In the smart contract, the interest rate, the debt’s maturity, and other factors are coded into the token.
Examples of Security Token Platforms
Various platforms enable companies to create and offer security tokens to investors:
Polymath
On Polymath, users can create security tokens and manage assets tradeable on secondary markets. The platform offers entities the creation tools and access to a network of experts in different fields to ensure regulatory compliance and optimize investor relations.
tZero
tZero operates as a marketplace that connects companies and investors. Once a company is ready to issue its security tokens, it can offer them to verified investors on tZero. Investors can use the platform to access trading and investment products, including digital assets, funds, and private companies.
Securitize
Securitize is a digital securities issuance platform that promises a frictionless and accessible space to trade and fundraise. Companies enjoy the platform’s tools at each stage of issuing security tokens, providing easier access to the tokenized capital markets. Securitize boasts several firsts in the security tokens space, including class A common stock, venture capital funds, and debt tokens.
Advantages and Disadvantages of Crypto Security Tokens
Now, let’s look at the pros and cons of security tokens.
Pros
- Increased Access to Capital: Projects wishing to raise funds can access a global network of investors.
- 24/7 Trading: Unlike traditional securities markets that operate during business hours, security tokens are always tradeable.
- Automated Compliance: The programmable nature of security tokens ensures compliance is integrated into the smart contract. No additional resources are spent on ensuring regulatory compliance.
- Fractional Ownership: Traditional markets may lock out investors who don’t meet certain thresholds. Fractional ownership breaks down assets into smaller units to increase market access.
Cons
- Changing Regulatory Landscape: Given the everchanging regulatory landscape regarding blockchain technology, there is always a possibility that what’s legal today will not be legal tomorrow. Laws may change on issuing and holding security tokens, making it important to stay posted on the security token market before investing.
- Limited Accessibility: The extra scrutiny on security tokens from regulators places strict conditions on who is eligible to invest.
- No Security Guarantees: Malicious actors can exploit the vulnerabilities in the smart contracts.
Wrapping Up
Security tokens present a new way of participating in the financial markets and help companies raise capital from non-traditional sources. While this new way holds great promise, most projects utilizing security tokens are still young, adding to the risk of these types of crypto tokens.
As the space develops, it will be interesting to see if more companies embrace security tokens as a method to raise capital. The regulatory landscape governing security tokens will have a significant say in how the concept develops in the future. As usual, always do your own research before investing in any crypto project, including security token offerings.
