Equity Tokens vs Security Tokens

Learning the differences between equity tokens vs security tokens is a smart way to better your overall crypto investment strategy. While most crypto investors are familiar with traditional utility tokens such as Ethereum, both security, and equity tokens are fairly new to the space. These tokens vary from utility tokens in many different ways.

Different tokens have different legal regulations. Currently, equity, debt, and security tokens fall under standard securities transaction laws, whereas, utility, currency, and asset tokens do not require SEC approval. Let's take a moment to examine some key differences between equity tokens vs security tokens.

What are Security Tokens?

According to the SEC, one can perform the “Howey Test” to determine if a token falls under securities regulations. The Howie test is a series of questions that include:

• Did You Invest Money?
• Do You Expect Profit?
• Did You Invest in a Common Enterprise?
• Are Profits dependent on a Third-parties Effort?

If you answer yes to these questions, you are investing in a security token. Security token holders do not have any ownership rights to the entity they invested in. Instead, they are guaranteed a percentage of the profits generated from the entity. Security tokens come in many forms:

• Securities
• Digital Mutual Funds
• Digital ETFs
• Non-equity Investments Against Capital

Additionally, security tokens cannot be transferred without meeting certain regulations. These regulations include AML and KYC requirements. This makes security tokens less liquidable than their utility token counterparts that can be traded anonymously.

There are a number of notable security token platforms operating in the cryptospace today. Polymath, Securitize, and Harbor are three of the most established platforms available today. Each offers enterprise users an easy option to issue and maintain security tokens.

Security Token Protocols

Security tokens contain their regulatory compliance directly within their protocol. By including these regulations in the tokens smart contract, security token issuers can guarantee their product remains compliant throughout all stages of its lifecycle. Below are the most popular security token protocols currently in use.

ERC-1400 / ERC-1404

The ERC-1400 entered the market in December 2018. This protocol is the brainchild of Polymath’s development team and Stephane Gosselin. Develops knew that if they could utilize a varied ERC-20 protocol that this would allow for the greatest amount of interoperability within the market. The ERC-20 protocol is by far the most widely used utility token issuance standard available.

Stephane Gosselin via SlidesLive

The team sought to create a security token standard that could function on the Ethereum blockchain. Additionally, the team wanted a protocol that contained no partitions. Today, the ERC-1400 standard is used by many firms globally.

ST-20 – Polymath

Polymath took their concept a step further when they created the ST-20 protocol. The ST-20 token standard functions similar to the ERC-1400 but with one main advantage, ST-20 tokens are able to remain compliant when traded on decentralized exchanges (DEX). Polymath proved this theory earlier in the month via a test with the DEX Loopring.

DS-Token – Securitize

The DS-token standard is the brainchild of the popular token issuance platform Securitize. Securitize utilizes a Compliance Service to ensure that their tokens are handled in a legal manner. The tokens must get approval from this on-chain registry to verify investor status before executing any trades. This means all DS-token holders have an identifying hash.

Secondary Compliance

Secondary market compliance continues to be a hot button topic in the industry. Just this month, the DTCC released a paper outlining how these secondary market concerns need to be addressed to ensure fair market practices. Currently, the DTCC is the third-party custodial exchange for traditional securities markets. The firm replaced the old paper transfer methods used in the 1970s.  Last year, the DTCC handled over four-quadrillion in securities transactions in the US alone.

What are Equity Tokens?

Equity tokens function more like a traditional stock asset. In other words, equity token holders possess some form of ownership in their investments. Their tokens represent how much ownership percentage they actually have. In most instances, equity tokens represent a third-party asset, property, or venture. Equity tokens come in many forms:

• Stocks
• Futures
• Options Contracts
• Tokenized Real Estate
• Tokenized Ventures

Equity tokens continue to see the most use in real estate crowdfunding platforms such as Atlant. These platforms allow investors to spread their funds more freely across the market. Real estate equity tokens represent a share of ownership in a particular property. This strategy enables investors to join multiple investments with less capital. Additionally, these platforms lower the entry bar for real estate investments and facilitate more market activity.

Equity Tokens vs Security Tokens Standards

Currently, equity tokens share the same protocols as security tokens, but in the near future, you can expect to see equity token specific standards emerge. For the time being, security token protocols can perform all the necessary functions required by equity tokens. Additionally, ERC-based equity tokens gain a bit more interoperability when compared to what a future equity token standard might include.

Notable Equity Token Projects

One of the most publicized equity token projects entered the market in October 2018 under the name Media Shower. The Media Shower platform enables companies to create and issue equity tokens. Speaking on the venture, Media Shower's CEO, John Hargrave explained how the concept opens the doors for new investment opportunities on all levels.

SEC vs ICO

The SEC started cracking down on the ICO market in 2017 after it revealed that it believed that most offerings were really tokenized securities. Failure to seek SEC approval when dealing with security tokens can result in hefty fines and even jail time. Since that time, there have been multiple highly publicized cases, with many currently underway.

In most instances, the SEC went after these firms for selling securities illegally. Company officials paid fines and were forced to return investors funds. In one instance, a company by the name of Gladius was able to avoid major fines by self-reporting their ICO. Consequently, the firm returned all investor funds as part of the deal.

Consider your Options

Each token type provides you with a unique investment opportunity. Be sure to consider your options fully. Also, always keep in mind that both equity and security tokens require approval prior to any transactions. These requirements can affect your ability to trade these tokens in the secondary market.

For now, the cryptospace continues to grow as the advantages of blockchain technology continue to be better understood by traditional investment firms. You can expect to see more standards and token types emerge as these trends continue.