What Are Security Tokens & Why Is The Market Bullish About It?

Security Tokens can well be the next big megatrend of the blockchain revolution.

Before the security tokens, we have seen the emergence of these trends in the blockchain revolution:

• Cryptocurrencies
• Smart Contracts
• Utility Tokens
• And now Security Tokens

Had you put forth a question related to security tokens to somebody a couple of years ago, I bet there would have been no answer.

That is because no such thing existed then, but if you dig now, you will find a plethora of information on security tokens.

In this article, let’s see what security tokens are and what the buzz is all about.

What Are Security Tokens?

To understand what security tokens are, it is crucial to understand securities.

Securities are tradable financial assets such as bonds, debentures, notes, options, shares (stocks), and warrants. And if we take the example of stocks, you might understand that it is a way to own a part in a company without taking actual possession of it.

Companies and governments use this method to raise money from capital markets from various investors. And then these investors are promised a return back programme in the form of dividends or interest rates or share of company’s profit in some form or other.

When these things are done through a cryptographic token, it is called a ‘Security Token’.

In simpler terms, security tokens are cryptographic tokens that pay dividends, share profits, pay interest or invest in other tokens or assets to generate profits for the token holders. This takes care of the liquidity issues.

Previously, with traditional paper backed assets like company’s shares or bonds or real estate, liquidity was a problem, but the cryptographic representation of all these things in a token form can take care of that issue.

Imagine, your dividends being paid to you on a specific date upon meeting a certain condition via a smart contract!

All these programmabilities can bring in a lot of automation and swiftness to the whole process because after all, you are creating programmable security. And this type of security can do all things that a traditional form can and more.

Moreover, there is sufficient demand for such type of security tokens because security’s regulations in the respective jurisdictions govern them.

For example, in the US, a litmus test called the ‘Howey Test‘, is employed to judge whether or not the crypto is a security token. Here is what a ‘Howey Test’ is:

The “Howey Test” is a test created by the Supreme Court for determining whether certain transactions qualify as “investment contracts.” If so, then under the Securities Act of 1933 and the Securities Exchange Act of 1934, those transactions are considered securities and therefore subject to certain disclosure and registration requirements.

A security is found to exist when all four of these elements exist:

1. Investment of money
2. In a common enterprise
3. With an expectation of profits
4. From the efforts of others

Why Is Market Bullish About It?

In my opinion, the market is bullish due to the unlimited use cases that these tokens bring with them. Of course, it is an unchartered territory, but big bankers and institutional investors are betting high on its prospects.

• It brings in the much-needed regulation in the market required for cryptographic tokens.

• As a result, such projects will have more support from the investors and will have their trust.

• This will bring more liquidity to the securities market.

• Will be more cost-effective, secure, & fast in trading.

• Will bring more automation to the securities market where an entire back office can be removed or minimized.

• Lastly, more and more companies want to leverage the power of blockchains, smart contracts in their business which they can surely do through such programmable security tokens

Moreover, this will require the development of a whole new infrastructure for security tokens because the old model is too old now. Securities token will need:

• Marketplaces/exchanges
• STOs (Security Token Offerings)
• Custodians
• Wallets, etc.

Also, the reason why everyone is bullish is that they can see tremendous opportunity in this space.

Example of some of the SEC regulated ‘security tokens’ that are developing the base infrastructure for the securitization of real-world assets and their liquidity are:

• tZERO
• Polymath
• Open Finance Network

Conclusion

Beware of security tokens that try to act like utility tokens and are unregulated by the SEC.