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How do Security Token Transactions Work?

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Security Token transactions

Security token transactions require you to meet certain regulatory standards prior to engaging in your transaction. The regulations are what makes security tokens different than traditional tokens. Understanding the lifecycle of these tokens will help you to better grasp the concept, including the current requirements, of a security token transaction.

Security Token Transactions – Issuance

Issuance is the first security coin transaction to take place. Security tokens are issued in a couple of different ways. In most instances, Investors acquire these tokens during a Security Token Offering (STO). The complex nature of the process led to alternatives forming in the crypto space. Recently, multiple security token launch firms steeped into the crypto space. These platforms integrate the SEC’s security requirements right into your token development. Platforms such as Polymath utilize their own protocol. This ensures compliance requirements remain intact throughout the entire process.

Polymath via Homepage

Polymath via Homepage

KYC / AML

Security tokens meet both, Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements. This legislation requires companies and investors to provide all relevant information regarding the transaction. These standards are common practice in the banking world. During an STO, Companies provide investors with information such as their company’s name, corporate address, the identities of the executives, and financial records.

This information gives investors more security. Unlike an ICO, an STO requires validation of every investor’s identity. This regulation also means that security tokens can’t be transferred to random or anonymous individuals. These requirements led to the development of security coin only exchanges.

Exchanges / Custodial Wallets

Exchange transfers are another form of security token transaction. Security coin exchanges differ from their counterparts in the fact that all participants follow the above-mentioned SEC guidelines. There are no anonymous accounts or privacy coins permitted on security exchanges. As a result, one of the main concerns regarding security tokens is how they are handled when on exchanges.

Since exchanges hold their users crypto, it creates a unique challenge for regulators and developers alike. Security exchanges use special formatted custodial wallets that adhere to the regulations regarding holding securities for clients in their attempt to integrate into the current legislation.

Security Token Transactions Agents

The complex nature of the securities legislation created the perfect opportunity for transfer agents. These professionals help investors transfer their security tokens properly. Recently, the transferring firm V Stock partnered with Polymath. The partnership provides Polymath users with more liquidity and security. The firm specializes in security token transfer compliance.

Polymath V Stock Partnership via Twitter

Polymath V Stock Partnership via Twitter

 

Security Token ProtocolsThere are many different emerging security token platforms. Of these platforms, Ethereum and Polymath are the most popular. Ethereum utilizes the ERC-725 and ERC-735 protocols. Polymath utilizes the T-20 protocol. These platforms integrate the necessary security token requirements directly into the protocol via smart contracts.

These smart contracts require compliance before full-filling any token transfer. By internalizing the security token requirements, these platforms protect both the consumer and their own interests. These protocols incorporate the benefits of blockchain technology flawlessly, through the use of smart contracts.

Security Token Transactions – A Work in Progress

There is still much to be decided in the coming months as the SEC mulls further integration of the cryptomarket. On the flip side, developers continue to host meetups to increase development in the security token sector. You should expect to see both parties stepping up their efforts in the coming months considering the growing popularity of security tokens. 

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David Hamilton is a full-time journalist and a long-time bitcoinist. He specializes in writing articles on the blockchain. His articles have been published in multiple bitcoin publications including Bitcoinlightning.com

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What are Digital Securities?

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Digital Securities

Digital securities continue to see further adoption by traditional investment firms for many reasons. These tokens remove many of the barriers encountered by investors and streamline the entire security process from issuance to oversight. Additionally, they provide new market opportunities to nonliquidable investments. For all these reasons and many more, security tokens are here to stay.

Digital securities, or security tokens, come in many forms. All of these forms share one thing in common, they are digital representations of securities, and therefore, subject to traditional securities laws. Importantly, not all digital assets are security tokens.

Security tokens emerged at the tail end of the 2017 bull market run in response to the rising amount of fraud in the space. Investors lost billions on Ponzi schemes such as Bitconnect. Real projects needed a way to distinguish their tokens from the scamsters and traditional investment firms needed to utilize blockchain technology in a regulated manner.

Digital Securities are Born

Digital securities can represent all types of assets including investment contracts, shares of a corporation, a portion of a note, debt security, or even a fractionalized interest. Basically, any electronically registered and transferable debt, equity, or asset that issues or trades using blockchain technology is a security token.

Digital Securities Statistics

Digital Securities Statistics

Benefits of Digital Securities

The benefits blockchain technology brings to the sector are immense. For one, ownership is verified and recorded on a distributed ledger. This provides a more secure alternative than traditional methods. Additionally, blockchain technology allows for the transfer of private and non-listed alternative assets. Consequently, security tokens provide more opportunity, efficiency, and liquidity in the market.

Regulations Enforcement

Security tokens wouldn’t exist if smart contracts never entered the scene. These preprogrammed protocols can be developed directly into the token. This strategy allows for the automatic enforcement of all regulations. Basically, smart contracts help eliminate much of the redundant paper-based processes currently in use.

Types of Digital Securities

Today, there are more types of security tokens than ever before. The market continues to develop as more advantageous tokenization concepts emerge. You should expect to see this trend continue as security tokens lend themselves perfectly to many markets. Below are the most common types of digital securities in use today.

Real Estate

The real estate sector experienced an explosion of tokenization strategies over the last year.  Both developers and tokenization platforms went all-in on tokenizing property. Tokenized real estate has some clear advantages. For one, it allows for the sale to be fractionalized. This strategy lowers the entry-level for investors and provides more opportunities for diversification.

The tokenization platform Polymath made headlines in September 2018 after inking a partnership with the real estate development firm BlockEstate. As part of the strategy, the Block Estate Alpha Token, or BEAT was born. This token utilized Polymaths unique Ethereum token standard ST-20 to ensure that the project remained compliant. Each token represented a share in the ownership of the fund.

Venture Capital

Perhaps one of the most popular ways in which digital securities see use is venture capital. Security token offerings (STOs) provide business with all the benefits of blockchain technology such as global reach, added security, and instant trackability. Additionally, STOs allow companies to stay within the regulatory guidelines of their industry and region when hosting a crowdfunding event.

Swarm Fund - Digital Securities

Swarm Fund – Digital Securities

A perfect example of this strategy in use is the 2017 STO hosted by the Swarm Fund. This tokenization platform secured $5,500,000 to further develop its security token and exchange ecosystem.

Private Equity

Private equity is another type of security token that continues to see more adoption in the space. These security tokens can also go by the name equity tokens. Equity token offerings (ETO) are more popular than ever before because tokenized equity provides more liquidity in the market.

Real Assets

One of the best features of tokenization is that it can be applied to so many types of assets. Real assets such as gold or diamonds already live on the blockchain. Not surprisingly, these tokens were among the first type of security tokens to emerge.

While the concept of tokenizing assets like gold isn’t anything new to the market per se, the ramifications of these maneuvers are evident. For one, tokenization platforms now seek to not just tokenize gold but to utilize the gold tethered token as a new form of stablecoin.

Stablecoins are coin tethered to real-world assets such as the USD, or in this scenario, gold. These tokens allow users to get the benefits of cryptocurrency but avoid all of the volatility found in the market today.

Hedge Funds

Tokenized hedge funds are another perfect example of digital securities. Hedge funds are a great way to diversify your portfolio. Traditional hedge funds are restricted in their trading times and the methods used to transfer these assets are outdated. Tokenized hedge funds create a frictionless experience for investors.

The Protos Hedge Fund includes a number of the top cryptocurrencies in existence. The fund sold $6.5 million during its primary issuance. Notably, Protos was the first licensed tokenized hedge fund to trade on an Alternative Trading System (ATS) in the US.

Digital Securities – A Bright Future

Now that you understand what digital securities are, its easy to see why they continue to see adoption in the market. These new-age financial tools provide more investment opportunities and reduce the workload and costs usually associated with these transactions. You can expect to see security tokens become more popular as these advantages become common investment knowledge.

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Titles and Designations Among Industry Participants

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Titles and Designations Among Industry Participants

Those that follow developments within the digital securities sector may have come across a variety of titles/designations given to industry participants. While a select few companies have set their sights on attaining a full scope of designations, most specialize in one area or another. This necessitates a high level of cooperation among companies, as issuing digital securities requires utilizing various services.

With Securitize recently attaining the title of ‘transfer agent’, now is as good a time as any to take a brief look at what positions, such as this, entail. Here are a few designations typically associated with digital securities, and a superficial look at the roles which they play.

Placement Agent

Companies tasked with completing the roles of a placement agent typically function as a conduit for raising capital. A placement agent is usually hired by a company looking to raise capital through an STO/DSO or some other means of fundraising. Throughout this process, the placement agent will attempt to connect appropriate, and interested, parties (issuers & investors). In doing so, investors gain access to pre-vetted opportunities in their ‘wheelhouse’, while issuers benefit from access to a larger pool of investors.

Beyond simply providing token issuers access to their contact book, placement agents are able to provide certain levels of clout to relatively unknown companies through mere affiliation. In addition, they are often tasked with helping develop marketing strategies for token issuers, to more efficiently connect appropriate parties.

The following companies are examples of participants within the digital securities sector which hold the title of a placement agent.

US Capital Global

Entoro

BlockPass

Issuance Platform

The entire process of selling and distributing digital securities is contingent on finding a competent issuance platform. Digital securities require specific traits to be built into their coding, as they are required to be compliant with securities laws imposed by regulatory bodies, such as the SEC. This is done when they are created, using issuance protocols based on blockchain technologies, such as Polymath’s well known ST-20.

The following companies are examples of participants within the digital securities sector which act as issuance platforms.

Harbor

Fintelum

Swarm

Broker-Dealer

A broker-dealer refers to a licenced company which buys and sells securities. A broker-dealer has the ability to act on behalf of, either, themselves or a client. This is a fluctuating designation which is broken down as follows:

  • When securities are traded on behalf of a client, the company is assuming the role of a broker.
  • When securities are traded on behalf of the company, itself, the company is assuming the role of a dealer.

The following companies are examples of participants within the digital securities sector which hold the title of a broker-dealer.

StartEngine

Gemini

Dinosaur Financial Group

Custodian

In a world which is becoming increasingly connected, new challenges regarding security measures are arising every day. This places increased importance on companies assuming the roles of custodians.

Custodians within the digital securities sector are tasked with safely storing digital assets. While their means for achieving this may vary, their presence within the sector is extremely important.

Warranted or not, blockchain based assets are often viewed together. This means that when an unregulated exchange with poor security measures is hacked, it paints a bleak picture of similar assets. To continue the upwards trajectory of blockchain based assets (digital securities), regulated custodians are of key importance. Through stringent security measures, they are able to provide a safe home for valuable assets, as well as piece of mind for their holders.

The following companies are examples of participants within the digital securities sector which provide custodial services.

PrimeTrust

Copper

TokenSoft

Marketplace Provider

For participating parties to benefit from the oft-touted liquidity associated with digital securities, these assets need a place to call home. Marketplace providers offer this, as they facilitate secondary market trading of digital securities. By facilitating the buying/selling of digital securities, investors can now easily enter and exit their positions.

The following companies are examples of participants within the digital securities sector which act as Marketplace Providers.

Archax

OpenFinance

TokenMarket

Transfer Agent

For companies which undergo the tokenization process and distribute tokens, a transfer agent is vital. Companies which assume this role are typically tasked with accurately tracking the activity and ownership of distributed assets. This means providing token issuers with an accurate picture of who is in possession of their digital assets, and in some instances doling out dividends to holders.

The SEC breaks down the roles of a transfer agent into the following 3 main categories.

  • Issue and cancel certificates to reflect changes in ownership.
  • Act as an intermediary for the company.
  • Handle lost, destroyed, or stolen certificates

The following companies are examples of participants, within the digital securities sector, which hold the title of a transfer agent.

Securitize

VStock Transfer

Horizon Globex

Jockeying for Position

While there are many roles and designations within the sector, these are a few of the most prominent and important found in digital securities. With the digital securities sector still in a nascent stage of growth, there are various companies jockeying for position as the ‘go-to’ entity for their specialities.

In time, we will eventually see the cream rise to the top, as select companies stand out from the pack with the services they offer.

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Security Tokens vs Tokenized Securities – Thought Leaders

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Security Tokens vs Tokenized Securities - Thought Leaders

Since crypto is a growing industry, there still are a lot of words and concepts that are unclear to a large audience. In fact, many users struggle due to the presence of confusing jargon.

Most people still do not know what blockchain is or why it is called a blockchain. While it can be a confusing term to understand, there’s no denying the fact that blockchain is massive.

It’s important that you are well aware of all the terms used in the industry if you want to be the master of cryptos. Today, we are going to talk about security tokens and tokenized securities.

Introduction To Security Tokens and Tokenized Securities

As confusing as may sound, both the terms refer to two very different concepts. I have read a lot of articles and news pieces regarding security tokens. From my understanding, the term refers to a wide variety of assets based on blockchain.

A consultation paper published by the Financial Conduct Authority in the UK verified the meaning of the term. The paper mainly discussed the regulation and classification of crypto assets defined ‘security token’ as a recognized investment or asset concept.

Now that the meaning of security token is clear, we need to move to tokenized securities. A lot of people believe these terms are interchangeable when in reality they are not.

They refer to two different concepts and using one in place of another can lead to confusion. They imply different regulations, investors, and constructs. Hence, it is important to be aware of the difference between the two so you make no mistakes in using the right term.

Security Token and Tokenized Security – The Difference

The difference doesn’t lie in grammar. It may look like a shift from active to passive but there’s more here.

Security Token: In this phrase, “security” is the adjective and “token” is the noun. It refers to a new technology that shares some qualities with traditional securities.

Technology is the main focus in this case. Not all tokens are referred to as securities. In fact, regulators appear to be confused about the classification of some new tokens due to their novel concepts.

If it pays dividend then it’s considered a security. A security token does not necessarily have a utility. It offers tangible benefits and represents a share in the company behind the token. This is why security tokens are also known as equity tokens.

Moreover, security tokens are different from utility tokens. They are either filed under an exemption or registered with an authority. Due to this, security tokens can be used outside of blockchain projects.

Tokenized Security: In this phrase, “token” is an adjective, whereas “security” is the noun. It refers to a traditional security or asset that comes wrapped in the latest technology.

All tokens are considered securities in this case. They work quite like off-blockchain assets but use a different set of technology to work.

Here, the main focus is on ‘use case’ and not the technology used. This is why such tokens are easy to regulate.

After all, it is easy to understand and categorize a traditional security that’s traded differently.

Given the huge difference between the two, it would not be fair to confuse the names.

The Authorities Involved

The Security and Exchange Commission (SEC) regulates security tokens. However, the relationship between the SEC and digital coins seems to be a bit confusing.

A transaction will be considered a security if:

  • Money is invested.
  • Profit is expected.
  • Efforts are required.
  • A common enterprise is involved.

The situation became clear in 2016 when Ethereum lost about half its value due to a major hack. This caused a sit in the industry, forcing the SEC to think about the future of digital tokens.

Last year, the SEC sent a letter to Ted Budd talking about digital assets and how they should be dealt with. While the response to the letter cleared a few things, most experts agree that the position of digital securities is still not fully clear.

Many organizations are also jumping the bandwagon. The Swiss Exchange recently announced plans to build an exchange for tokenized securities. According to FINMA, the exchange will be properly regulated.

Most experts believe that the involvement of such big names is a good sign for the industry but we’re not yet sure of how this will play out.

Take a Step Ahead

Tokenized securities are designed to broaden the market while also enhancing liquidity. It’s the same as using a known asset and putting a digital wrapper around it.

It’s not a new product from the perspective of regulators. It’s merely a new distribution channel, which makes approval easier.

On the other hand, it’s a different ballgame when it comes to security tokens. They present a new challenge for investors and regulators as it is hard to figure out the risks and ramifications involved in dealing with them.

Tokenized securities are highly innovative and have their own place in the industry. We may see more such securities hit the market in the near future. It’s actually good for the industry as the huge supply will enable traders to get a grasp of things and understand how it works.

Advantages of Security Tokens and Tokenized Securities

You will realize that a lot of the benefits are similar in nature.

Security tokens offer more liquidity by enabling fractional ownership and lowering minimum investments. More people will be able to invest due to lower requirements. Businesses are also taking advantages. A good example would be Mayfair Gallery, which put its art collection for sale on the blockchain.

Similarly, tokenized securities are more efficient and scalable. Security tokens help reduce cost, simplify auditing, reduce paperwork, lower issuance fees, etc.

Other benefits include transparency and ease.

The Legal Aspect of  Things

Since security tokens are subject to federal regulations, they are compliant. You need to be aware of three regulations:

Regulation A+: This allows investors to offer an SEC-qualified security to non-accredited investors (max $50,000,000). Due to registration requirements, such issuance can take longer and also cost more than other options. Plus, it requires qualification of a Form A-1. Moreover, the amount of money you raise is also considered revenue and hence is taxed unless it represents equity in the company.

Regulation D: This requires an electronic filing of “Form D” without needing registration with the SEC. The seller may solicit investors for offerings that meet the requirements found in Section 506c. This part of the law requires the offerer to be true and accredited.

Regulation S: This comes into play when a security is executed outside of the US and hence is not subjected to the 1993 Act. However, issuers are still required to follow the laws of the country where the security is offered.

What It Really Means

You can draw some analogies when it comes to tokenized securities. Think of print magazines and how they’re now available online. The format is the same but the reach has increased due to more access.

Security tokens work similarly. It’s a concept that nobody saw coming. At the end of the day, both concepts will change capital markets and improve access. However, only one will have a lasting impact and change how we look at capital markets.

Conclusion

Security tokens need space and support to stay strong. It’s important to be clear about what the term means. We’ll, however, not be able to enjoy the benefits of these concepts if we are not able to differentiate between the two. Beyond linguistic differences, what’s more important is vital aspects as liquidity and more institutional grade Reg A+ offerings which will bring more confidence to the market. 

Education and investor protection are vital elements of the ecosystem, hence at ABOTMI we work a lot on providing more solutions to increase transparency in digital asset industry. Investors who risk with their time and money deserve a seamless discovery process connecting to the most reliable and trustworthy digital asset advisors across the globe.  

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