14. What are security tokens?
Before we move on to the main topic, let us introduce you to an interesting fact. Did you know that tokens are seen by crypto regulators as securities? All because they meet most of the criteria set out in the so-called Howey test, but we will tell you more about that later. Now we will move on to the topic of today’s lesson.
Tokens vs coins
To understand what utility tokens, or in our case security tokens, are, it is important to know the basic differences between tokens and coins. We know from experience that ‘cryptocurrencies‘, is used to refer to almost anything that is in any way related to the crypto and blockchain industry, but that is not quite how it works.
Coins or cryptocurrency assets (Bitcoin, Monero, Ether, Litecoin) represent value in their own right. They are coins because their main use is to store value and be seen as a means of exchange.
Tokens have a predetermined function. E.g. security tokens, which we will discuss today. They are used in the same way as shares, bonds, certificates, and other investment assets. We will also include utility tokens, e.g. BAT. You need to remember that these types of assets, are backed by a company or project and have a specific purpose of the operation.
Security tokens – what they are
Security tokens, often referred to as action tokens. They are representatives of a certain type of ownership. They most frequently come in the form of shares in the company that issues the token. Their concept is the same as that of shares on a traditional stock exchange. As security tokens are seen as securities, they are subject to all regulations. Just like shares and bonds. As an investor, you must remember that share tokens offer us all the legal and regulatory protections.
How do share tokens work?
To fully understand how they work, you need to know what the tokenisation process is. As you know, currently you can tokenise anything. Even your car. A security token is created similarly. A company that is interested in creating such a token selects what it is supposed to represent (property, shares) and then generates the token. It offers it to investors on an exchange or other investment platform of its choice. To become an investor, you have to go through a KYC and AML process. The entire ‘value’ of the token is, of course, stored on the blockchain. Most platforms that generate this type of token use the Ethereum ERC 2.0 or Tezos’s FA1.2 standards.
Here we also have an interesting fact for you. A security token can take different forms of identification. It can be an image displayed in a digital wallet or a number.
Where are these tokens used?
Security tokens are digital, liquid contracts of a portion of the assets you own. This is the subtle difference that sets them apart from other cryptocurrencies. This type of token can have a wide range of uses. We can start, for example, even with real estate investment trusts. The security token would then issue shares on the blockchain, which would be equivalent to owning a piece of real estate.
That is not all. Security tokens can represent other shares, placed on the blockchain. What’s interesting about them is that they combine traditional financial instruments and cryptocurrency assets. If you want to start investing in this type of asset, we recommend the STO platform. You will find a multitude of opportunities on these exchanges that will enable you to buy and sell stock tokens.
Advantages of security tokens
As they are issued on the blockchain, they have virtually all the benefits that come with blockchain. None of the delays or fees associated with traditional equity markets stand out here. As an investor, you are assured that your ownership interest will be recorded on the public ledger. The absence of market manipulation, fraud, or misunderstandings is another of the advantages of this type of asset. Security tokens also guarantee clarity on the number of shares you own and the name of their owner.
The Howey test
In the US, anything that classifies as a security is subject to oversight by the Securities and Exchange Commission (SEC). Nothing is clear, of course; there are still many securities that are also utility tokens. As a result, the SEC is unable to define them precisely. To determine whether something at least somewhat classifies as a security, the SEC uses the so-called Howey test. This consists of four basic parts.
1. The first consists of the investment of money. It examines whether someone has invested in a particular good or service.
2. “Joint venture”. The next stage of the test shows us whether the investor’s funds are tied together or, whether there is a direct correlation between the promotion of the investment and its success.
3. Expectation of profit. “Profit” can come from recurring income or from capital appreciation.
4. Effort of others. It means that if any part of the profit is due to the effort of the people who promoted the investment, the ‘asset’ meets the fourth part of the test.
If you invest money with the hope of a return that comes from the efforts of another person, the investment is considered a security.
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