Why Security Tokens Are Inevitable
The ICO craze is ongoing and continues to draw in money from every corner of the globe, courtesy of investors who want a piece of the blockchain phenomenon. It isn’t without turbulence, amid multi-million-dollar hacks in the headlines, the proliferation of “scam” ICOs, and relentless capital flight from fiat monies of all kinds.
The risks of contributing to an ICO during this “Wild West” period are perilous, and have begged intervention from authorities of all shapes and sizes. Facebook went as far as an outright ban on all cryptocurrency-related ads on their site (though they’ve since relented), entire countries such as China have made ICOs illegal, and even the US SEC weighed in on the issue.
This last event was crucial because it proposed a precedent by which ICOs can be deemed legal in the country, and outlined which ICOs would be illegal. Per the statement made by Division of Corporation Finance Head William Hinman, the SEC deems tokens issued by a centralized entity and with the expectation of profit from investors to be securities, which must be registered before launching.
This begs a new set of definitions, which can be used to determine the status of individual cryptocurrencies. It highlights a niche trend that was only hinted at in prior years, but one that has become inevitable: security tokens.
Security Tokens Blend Into The Status Quo
With a mixture of traditional financial concepts applied to the cryptocurrency world, security tokens were an inevitability after the ruckus created by ICOs in 2017 and the beginning of 2018.
A security token represents fractional equity of another asset, whether physical (e.g. real estate) or digital (e.g. startup stock option). They’re different from what are now termed “utility tokens”, which are essentially tokens that grant access to an application — a little like Zynga poker chips, Candy Crush gold bars, or Disney Dollars. The only difference is that utility tokens in the crypto world are not pegged to the U.S. dollar, which makes them far more volatile. There is a third addition to this short list — that of the “stable coin” (like Tether), which is pegged to the value of fiat money and doesn’t fall into either the utility nor the security category.
Many trends have led to the emergence of security tokens as a powerful financial force. One of the most obvious is that previously, ICOs were universally exempt from any kind of accountability to their investors. Tokens were printed out of thin air, without being tied to a real-world asset to give them intrinsic value.
This was an unsustainable trend which exposed investors to scam with no real intention of delivering working services. Many of these issuing companies took millions and got away scot free. This situation will not happen when the SEC will finally approve security tokens (at least not without repercussions and reimbursement).
Another impetus for security tokens started inside the traditional financial sector. Investing in securities was not easily available for investors who are either not accredited or don’t have the means to register with an exchange; however, the invention of security tokens will open an array of opportunities to these private investors as long as they comply with KYC/AML requirements.
Enabling these individuals to buy, sell, and trade fractional ownership of all kinds of real-world assets — even those not included in traditional marketplaces, such as fine art — will truly revolutionize the investing process for individual investors who will finally be able to enjoy unprecedented access and liquidity.
Worlds Collide
Security tokens bring blockchain into the non-blockchain world and vice versa, without merging the two. An off-chain asset such as a home or business can be fractionally owned by one, or many, token investors. This provides a framework for using blockchain in the traditional investing world in a compliant fashion. It also helps cryptocurrency enthusiasts gain exposure to assets backed by tangible value.
Depending on what they envision, ICOs are working to fit their token into one of these informal templates. Some are working to avoid regulations by forcing their token into a “utility” role, despite that the company engages in specifically security-adjacent activities like token buybacks. Others see security tokens as an opportunity to legitimately sell equity in a great idea or a real-world, tangible asset.
When it’s all said and done, VCs pour capital into security token exchanges and startups, and these companies make a tremendous effort to work with the SEC and regulators to legitimize security tokens exchange in order to protect private investors from bad actors.
Based on this new reality, it is safe to assume that security tokens are here for the long haul. Ultimately, the market will leave it up to investors to decide whether they want to invest in utility tokens, security tokens, or both. Whatever may be the case, many are pinning security tokens to come out on top in the coming years.