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Security Token

| June 21, 2024

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Key takeaway

  • Security tokens are digital representations of ownership rights or asset value transferred to a blockchain token. These tokens are generated through a process known as tokenization.
  • While security tokens are currently unavailable to retail investors, numerous institutions are actively pursuing regulatory approval for their issuance.
  • Approval for security tokens is subject to the Securities and Exchange Commission’s oversight.

What is a Security Token?

A security token signifies a portion of ownership or entitlement to an asset or a company. It is represented by an alphanumeric sequence generated through a hashing algorithm on a blockchain. The process of transferring asset ownership to a blockchain and assigning it a token is termed “tokenization.” When these concepts converge, they form a security token—a digital version of ownership or rights to an asset, specifically for assets that have undergone tokenization and reside on a blockchain.

Functioning as an investment asset, a security token embodies digital ownership or entitlements. It facilitates the transfer of value from an asset or a bundle of assets to the holder of the token’s private keys. Put simply, security tokens serve as the digital equivalents of conventional investments such as stocks, bonds, or other securitized assets.

The role of security tokens is centered on providing a digital representation of ownership or investment in real-world assets. Additionally, it also ensures compliance with securities regulations. Here’s a concise breakdown:

  1. Asset Tokenization: Security tokens convert real-world assets like real estate or company shares into digital tokens on a Blockchain.
  2. Legal Compliance: Security tokens adhere to securities regulations. They ensure that issuance, sale, and ownership transfer comply with the law. Thus safeguarding both issuers and investors.
  3. Ownership Representation: Holders of security tokens possess legal rights tied to the underlying asset, such as dividends, voting rights, or profit shares.
  4. Efficient Ownership Transfer: Blockchain technology facilitates efficient and transparent asset transfer. It reduces paperwork and administrative burdens associated with traditional securities transactions.
  5. Increased Liquidity: Compliant security token exchanges enable secondary trading, enhancing liquidity for traditionally illiquid assets.
  6. Global Accessibility: Security tokens allow for global trading, thanks to Blockchain’s decentralized nature, enabling cross-border transactions.
  7. Automated Compliance: Smart contracts embedded in security tokens automate compliance with contractual and legal obligations, reducing the need for intermediaries.
  8. Fractional Ownership: Security tokens enable fractional ownership of high-value assets. Thus making them accessible to a broader investor base.
  9. Innovation in Fundraising: Security tokens offer innovative fundraising avenues, such as Security Token Offerings (STOs). They provide regulated methods for companies to raise capital by offering security tokens to investors.

How do Security Tokens Differ from Cryptocurrencies?

While security tokens and cryptocurrencies share many similarities, their distinctions lie in their intended use and function. Both are created and stored on a blockchain, but they serve different purposes.

Cryptocurrencies are primarily designed to function as currency, money, or payment methods. On the other hand, security tokens are intended to represent ownership or investment in assets, such as stocks, bonds, or certificates.

Although some cryptocurrencies, like Bitcoin and Ethereum’s ether, were initially created for specific purposes—decentralized currency and payment within the Ethereum network, respectively—they have evolved to be treated as investment instruments due to their listing on exchanges and increasing value. However, this transition does not align with their original design intentions.

Bitcoin and Ethereum’s ether are not inherently designed as security tokens. Their developers do not expect profits from their usage. As a result, they do not currently meet the criteria for being classified as securities by regulatory bodies like the SEC.