Before understanding what is a security token, you need to know about the pioneering technology behind it. Well, we all know how blockchain is scaling up across the world. For those of you who are not aware of blockchain technology, here’s a glimpse of it.
Blockchain is the record-keeping technology where it stores all the information in blocks. All these blocks are connected and chained together such that they are open and available to all the participants on the network. Its decentralized model is helping industries expand far and wide. To know more in detail, read this introduction to blockchain article.
However, the first cryptocurrency, Bitcoin, sought the limelight of blockchain. Bitcoin was developed using a specific type of database called blockchain technology. Its decentralized nature made no individual or a group control Bitcoins. All the Bitcoin-related transactions are permanently recorded, making them open to everyone.
Now that it seems cryptocurrencies are outdated in the crypto world. We’ve got crypto tokens and coins with thousands of cryptocurrencies available in the market. The rise of initial coin offerings (ICOs) also popularized tokens and coins. Likely, the future will mostly have a special kind of cryptocurrency, called ‘security tokens’.
What are Security Tokens?
Security tokens act as investment contracts. The purchaser envisions the future profits from dividends, revenue share, or market appreciation. And the blockchain ledger records and preserves the ownership stake on the network.
Security tokens adhere to the SEC’s legal restrictions and follow strict guidelines. These tokens build the gaps between traditional finance and blockchain to benefit both. The ultimate aim of introducing security tokens is to utilize the blockchain-based crowdfunding system that satisfies the SEC’s current IPO requirements. Any participant taking part in the crowdfunding event will need to go through the Know Your Customer (KYC) protocols before investing. Thus this will help to know the identity of each investor.
Benefits of Security Tokens
Security tokens are a more transparent form of investment. They help investors get in-depth information about the startup, including the legal and financial aspects of it. So startups offering security tokens are bound to share the company information such as company location, finance statements, business purpose, management, etc.
Security tokens are produced according to the legal requirements. They are subject to the Securities Act of 1933 and Section 3 of the Securities Exchange Act of 1924. Large-scale investors usually look for security tokens to make the right investment decisions and prevent their investments from fraudulent activities. Security tokens offer security and safety for the transactions for both investors and businesses.
As said earlier, security tokens turn out to be beneficial for everyone involved in the chain. While investors will be able to protect their investments, corporations can confidently offer security tokens as they are free from the late legal, financial consequences resulting from the ICOs. Once the security tokens get their approval from the SEC and satisfy the SEC regulations, they can operate with higher confidence levels.
Now, what are Utility Tokens?
There is a significant difference between security and utility tokens. The main difference is that utility tokens do not pay investors any dividends or revenue shares like security tokens—for example, Ethereum. The SEC stated that the Ethereum (ETH) is not a security but a utility token. It also stated that during an ICO, ETH was a security token but not now.
The Howey Test
The Howey Test originated during the supreme court case SEC v. W.J. Howey Co. The SEC alleged that the Howey Company of Florida violated securities laws and failed to register a land investment agreement with the SEC.
Well, let’s take a quick test to determine if you are researching to know whether it is a security or a utility token.
- Are you investing money?
- Expecting profits on your investments?
- Investing in a joint enterprise?
- Will your profits come from a promoter or a third-party?
Okay, if you have answered yes, then it is a security token. But remember, the SEC could alter the language and consider a utility token as a security under the respective laws in the future.
Security tokens top the crypto market and, of course, by building the most strong base for the crypto space. They are adding additional security, transparency, and increasing scope for investors. So, soon, we might see thousands of security tokens coming in as well.