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.
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.
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.
Stablecoins within Digital Securities
A Brief Look at Stablecoins
We focus primarily on digital securities, here at Securities.io. However, there is another notable trend in the world of blockchain, which is often intertwined with this new asset class. This would be the rapidly growing world of ‘stablecoins’.
These stablecoins have inherent qualities that appeal to participants involved with digital securities. This makes them attractive to both issuers, and investors alike.
So what exactly is it about stablecoins that makes them attractive to investors? The reasons vary in every case, but the following traits are the most obvious benefits these tokens afford.
- As these assets are blockchain based, anyone can view transactional history, since this data is stored on public ledgers. These inside looks can be obtained through use of various ‘block explorers’.
- While FIAT transfers are at the mercy of banks, and often take a lengthy amount of time to be approved, stablecoins benefit from a lack of middle-men. Large and small denominations alike are able to be transferred directly between two parties. There are no holding periods.
- Building on the point made above, the lack of middle-men in a transaction is a good thing. This is one less mouth that needs to be fed. The result of this is lower transaction fees, as there is no need to pay a cut to a bank.
- This is undoubtedly the largest draw for many towards stablecoins. The entire foundation of the idea they are built upon, is to provide their holder with financial stability. This is afforded to the hold by ‘pegging’ the stablecoin to a traditionally non-volatile asset. This most often means national currencies, such as USD, CAD, FRANC, EUR, etc. Although, there are various instances of stablecoins being pegged to commodities such as maple syrup, gold, and more.
These qualities also just happen to appeal to those involved in digital securities, leading investors to see the appeal of both. Digital securities are a means of taking part in the world of blockchain, while ensuring compliance with regulations. The results are investment opportunities that are more predictable, and backed by real world assets- both traits offered by stablecoins.
While the points noted above may sound fantastic when applied to a financial asset, they are not givens. These point are strived for, but not always attained. For example, it was recently verified that industry leading stablecoin, ‘Tether’, does not maintain 1:1 reserves of USD in their accounts.
While this has long been suspected by many involved in the world of cryptocurrencies, it has only now been verified in an affidavit signed by a lawyer working with Tether. The following is a brief excerpt from this recent statement.
“Tether has cash and cash equivalents (short term securities) on hand totaling approximately $2.1 billion, representing approximately 74 percent of the current outstanding tethers.”
The Story Thus Far
To elaborate on the sticky situation in which Tether finds themselves, the New York General Attorney recently issued a statement condemning the company’s practices. In these statements, it was said that Tether reserves were used by sister company, BitFinex, to cover losses of investor funds – coming in to the tune of roughly $900 million. It is believed that, not only did these actions take place, but they were intentionally hid from the public.
In the days following these statements, BitFinex has denied any wrong-doing, and indicates that they have not lost any funds. They were, rather, locked-up by their payment processer, Panama based, Crypto Capital, due to an inability to prove ownership.
The point in raising awareness to this story, is that the status as the ‘go-to’ stable coin, held by Tether, is tenuous at best. Now is the time for any contenders to step up and usurp Tether in their bid for dominance; a dominance that may be achieved by cozying up with the world of digital securities.
The situation continues to unfold as the investigation continues.
Some have noted that there is a common denominator seen in, both the unfolding Tether situation, and that of embattled Canadian exchange, QuadrigaCX; this would be payment processer Crypto Capital.
Much of the woes experienced by both Tether and QuadrigaCX stem from each having significant sums of money ‘locked-up’. In time, investigators hope to shed more light on how each of these companies found themselves in their respective situations, and whether Crypto Capital has played a role in the demise of each.
Despite the recent woes of industry leading, Tether, stablecoins appear to have as bright a future as ever. Various companies have, both, recognized this, and contributed towards it being true. While options are plentiful, a few offerings stand out from the pack as viable replacements for Tether.
Each of these four stablecoins are products of mother company, TrustToken. All of these tokens are backed 1:1 by each’s respective FIAT currency. TrueUSD, in particular, has seen high levels of adoption, and can actively be traded on a variety exchanges, such as Bittrex, Binance, UpBit, and more.
TrustToken is a promising company which specializes in the tokenization of real-world assets. While TrustToken can be used to tokenize assets such as real-estate, art, and more, it is their implementation, with regards to stablecoins pegged to various FIAT currencies, which has caught the attention of many.
A product of Gemini exchange, Gemini Dollar (GUSD), is another token backed on a 1:1 ratio by USD. The purpose of this stablecoin is to provide investors with an asset that behaves in a predictable manner like USD, but benefits form the inherent qualities of blockchain. This stablecoin is based on the ERC-20 standard, meaning that it functions on the Ethereum blockchain.
This particular stablecoin touts itself as the first of its kind to be regulated. This regulation comes in the form of monthly audits by accounting firms, custody provided by State Street Bank and Trust Company, and through licensing granted to Gemini by the State of New York.
Adoption, thus far, has resulted in GUSD being traded on a variety of exchanges, in addition to establishing partnerships with tokenizing platforms such as Harbor.
Circle is a United States based company which has made headlines over the past two years through their purchase of Poloniex, and public statements indicating an eventual foray into digital securities. Along the way, Circle has noted both digital securities and stablecoins as growing trends, and sought to take part. This resulted in the creation of USD Coin (USDC).
As its name implies, this Ethereum based asset is pegged to the US dollar at a 1:1 ratio. The goal is to provide its holders with a means for maintaining consistent buying power, in an industry known for its volatility.
Recent adoption has seen Securitize announce their support of USDC through their industry leading tokenization services.
It is important to remember that these are only three of the most viable alternatives to Tether. More offerings are popping up every day, and none have attained #1 status, or any semblance of dominance. As the situation with Tether unfolds, watch closely as the markets react and begin turning to rival stablecoins.
With development of digital securities booming, and a sky-high ceiling for the sector, perhaps the best indicator of which stablecoin stands to inherit Tether’s crown, is the one which sees the most adoption in the burgeoning sector.
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.
Protect Your Investment
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.
Know the Difference – 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:
- 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.
Notable Security Token Platforms
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.
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 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.
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:
- 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.
Equity vs Security Tokens – Brothers from Another Mother
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.
More to Come
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.