Smart contracts enable automation of certain aspects of a platform’s functionality. These digital agreements self-execute predetermined actions upon receiving a digital asset or cryptocurrency. Today, smart contracts are used everywhere in the blockchain space, but this wasn’t always the case. Let’s take a second to examine how these helpful protocols first came to be, and how they function without the need for any third-party intervention.
The original smart contract concept predates cryptocurrencies by fourteen years. Ironically, the man credited with developing smart contracts is no other than well-known Bitcoinist Nick Szabo. Many people believe Nick to actually be Satoshi Nakamoto because of his previous works.
Nick famously theorized about value-storing bits utilizing a proof-of-work system five years before Bitcoin existed. He has always been a pioneer in the cryptospace. In 1994, Nick released his smart contract code to the public. He also coined the phrase “smart contract”.
What Do I Need to Create a Smart Contract?
Every smart contract contains four core principals. First, you need the subject of the contract. The subject is what gives your contract access to the goods or services that the contract governs. Second, you need digital signatures (private keys) from everyone involved in the contract. These signatures are what initiates the contract. Next, comes specification of the contract terms. This part is where you lay out the exact sequence of operations that commence when the contract executes. Finally, you need a decentralized platform. A blockchain network keeps the smart contract stored in redundancy and safe from alterations.
Smart Contract Components
- Subject of Contract
- Digital Signatures
- Contract Terms
- Decentralized Platform
How Do People Use Smart Contracts?
There are endless smart contract uses. Smart contracts help you to exchange digital and real-world assets. Smart contracts live on the blockchain and cannot be altered. This added security makes these digital agreements ideal for many business scenarios.
Smart Contracts in ICOs
Initial Coin Offerings (ICOs) utilize smart contract protocols during their crowdfunding events. The smart contracts automatically track, calculate, award, and distribute the funds sent between the company and the investor. The smart contract programming enables the automation of the entire process.
This automation allows companies to accept funding from a wider audience. The workload of the company is not increased, but the company’s fundraising exposure expands. The all-inclusive nature of this strategy helped push ICOs to record numbers this year. One report shows that ICO volume already doubled lasts year’s numbers by May.
Traditional Firms Look Towards Smart Contracts
Traditional firms continue entering the smart contract arena as blockchain integration continues. Today, platforms exist that utilize smart contracts for nearly everything including real estate, investments, royalties, elections, logistics, and much more.
Ethereum – Smart Contracts
The cryptocurrency, Ethereum, is best known for introducing the smart contract concept to the cryptospace. Ethereum’s ERC-20 protocol utilizes smart contracts to help automate token creation and distribution. ERC-20 is by far, the most widely used token issuance protocol in the market.
Vitalik Buterin, Ethereum’s developer describes smart contracts as a program that “automatically validates a condition and determines whether the asset should go to one person or back to the person who sent it or some combination.” Ethereum utilizes a second-layer protocol to accomplish smart contract capabilities without creating additional blockchain congestion.
Smart Contract Development
Since Ethereum raised smart contract awareness, more complex and advanced smart contract models entered the cryptospace. Platforms such as EOS, Steller, and NEO utilize less wasteful consensus mechanisms when compared to the Proof-of-Work system in place with Ethereum.
Say Good Bye to Lawyers
Smart contracts are removing the middleman from many of the most used business systems today. The trustless nature of these protocols allows businesses and investors the ability to increase efficiency and security simultaneously. You should expect further integration of this technology into traditional business systems as more platforms enter the market.
Utility Tokens vs Security Tokens
As a responsible crypto investor, you must understand the differences between utility tokens vs security tokens. These tokens serve different purposes in the cryptospace. Their processes differ during trading and issuance. These contrasts make security tokens unique to their utility counterparts.
Why Do We Have Security Tokens?
The ICO market continues to expand. According to a report from Business Insider, companies raised over $5.6 billion in 2017. While this number seems impressive, the ICO activity of this year already eclipsed it. By May 2018, the ICO market expanded to $6.3 billion. This record growth and the growing appeal of ICOs makes this unique crowdfunding strategy a favorite among tech startups.
The record growth of the ICO sector led to increased scrutiny from regulators such as the Securities and Exchange Commission (SEC). The task of developing regulations for the growing ICO market falls on this organization depending on how the token’s use. The SEC decided that when a token represents ownership, voting rights, or entitles the holder to share of future profits, it’s a security token.
Utility Tokens vs Security Tokens – How can I Tell the Difference
It isn’t always that easy to determine if a coin is a security or utility token. In many instances, a token starts off as a security during an ICO but later evolves into a utility token. This scenario is the case for the hugely popular cryptocurrency Ethereum (ETH). In a June ruling, the SEC determined that Ethereum operated as a security initially, but today it’s a utility token.
To make matters more complicated, a utility token such as ETH can have security tokens issued on its platform. Ethereum’s ERC-20 protocol is the most popular token launching protocol in the cryptospace. New tokens issued on the platform are security tokens if they fail the “Howey Test.”
The “Howey Test” is a brief questionnaire created by the Supreme Court for determining whether a transaction qualifies as an investment contract. The test became famous during the 1946 Supreme Court case SEC V. Howey. The case revolved around a Howey, Florida-based orange juice company that offered large parts of its land for sale to investors with the intent of having the new owners lease the property back to the citrus developer, who would continue developing the area with the newly acquired funds.
The SEC sued the defendants in this transaction for violating the Securities regulations. The SEC determined that because the investors put forth funds in the hopes of making a profit from the efforts of the citrus farm, the deal was an investment contract. Therefore, the agreement falls under securities regulations.
The Supreme Court developed a simple test to prove the theory. The Howey Test asks investors four critical questions. These questions can be applied to tokens to determine if they are security tokens:
- Are You are Investing Money?
- Do You Expect Profits from Your Investment?
- Are You Investing in A Common Enterprise?
- Will You Profit from the Efforts of a Promoter or Third Party?
Utility tokens serve a use within a platform. In most cases, companies host ICOs to issue utility tokens. These tokens are essential to the functionality of their platforms. Additionally, they do not give token holders rights to the company’s future development or profits. These tokens transfer without regulations, and any company can offer utility tokens without meeting SEC regulations. The open nature of these tokens made them a favorite amongst investors and startups.
Security tokens operate in a much different manner, and under different requirements. A company cannot just host a security token offering (STO) without fulfilling specific conditions. Companies must provide investors with a plethora of information including the company’s actual address, the names of all board members, and open financial records. These requirements protect investors from fraudulent activity.
On top of the company regulations, investors meet stringent security regulations as well. Companies cannot sell security tokens to anonymous individuals. You will need to provide and prove your identity when investing in these tokens. Know Your Customer (KYC), and Anti-Money Laundering (AML) laws must be adhered to when moving security tokens between owners.
Added Security – Added Investment Funds
While some early crypto investors undoubtedly see security tokens as a burden on the cryptospace, many believe these tokens to provide an essential bridge between traditional investment funds and the cryptomarket. Analysts have predicted a rise in traditional investment firms entering the cryptospace.
These firms require added protection due to the substantial nature of their investments. Security tokens provide them with the protections they need to avoid future financial and legal problems.
Utility Tokens vs Security Tokens
Now that you better understand the differences between these tokens, you are ready to comprehend STOs and what makes them different than their ICO counterparts. Security tokens play an important, and ever-growing, role in the cryptospace. You should expect more platforms entering the cryptomarket using this type of token over the coming months.
How do Security Token Transactions Work?
What are Security Token Offerings (STO)?
Security token offerings (STO) share similarities with both initial coin offerings and traditional securities. This unique crowdfunding strategy combines the efficiency of blockchain technology, with the legal protections found in standard securities offerings. This form of crowdfunding creates a safer investment climate for potential investors.
In most places in the world, there are no legal requirements for hosting an initial coin offering (ICO). Anyone can purchase these tokens without having to reveal their true identity and companies don’t need to provide any information. These tokens do not have any transference requirements, and there is little recourse for investors who lose funds due to fraudulent activity.
Unfortunately, this lack of regulations led to increased fraud in the crypto sector. According to one report, as much as eighty percent of ICOs launched in 2017 turned out to be frauds. This fraudulent activity created an outcry from burned investors and a real demand for more secure options.
The Birth of the Security Token Offerings Concept
Recognizing the Wild West nature of the cryptomarket, developers started developing tokens that fall in line with the Securities and Exchange Commission’s (SEC) current requirements. People that investing in an STO gain added customer protections. These companies must comply with ATS registration and meet proper broker-dealer requirements. These protections include the company’s legal name, address, members, and financial information.
Additionally, information provided by the potential investment undergoes an approval process. This process confirms that the information provided is true and accurate. When compared to the complete lack of checks found in the ICO sector, it’s easy to see why some investors look towards security token offerings for a better investment opportunity.
In March 2018, US-based Praetorian Group became the first firm to offer an STO. The platform lists as a cryptocurrency real estate investment platform. On March 6, the platform registered its seventy million dollar ICO with the SEC. The move was deemed as necessary by the platform’s developers because they were working within the real estate sector.
The platform utilizes PAX tokens to represent real estate. This strategy facilitates more accessible and more secure transactions. This strategy is known as tokenization, and it is becoming one of the fastest growing sectors in the cryptomarket.
Security tokens comply with both Know Your Customer (KYC) and Anti Money Laundering (AML) laws. This compliance means that both individuals and businesses must reveal they’re true identity before investing. KYC and AML laws are standard practice when dealing with financial institutions. Many analysts predict the same scenario for crypto services in the future.
STO investors receive direct benefits for holding a platform’s tokens. Depending on the platform, users gain voting rights, dividends, and even revenue shares. If you are investing in an ICO that offers these features, there is an excellent chance that you are investing in a security token. If this is the case, you should ensure that the token is registered with the SEC to avoid future consequences.
Security Token Offerings – A Bright Future
STOs continue gaining traction in the cryptospace. This flood of new tokenization platforms creates the perfect environment for strategies such as security token offerings to flourish. You can expect to see this trend continue as traditional financial institutions look towards the cryptomarket for future revenue.
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