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What are Security Tokens?

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What are security tokens

Security tokens function as investment contracts wherein the purchaser anticipates future profits from dividends, revenue share, or market appreciation. Security tokens differ from utility coins in a couple of ways.  The main difference between these tokens is that security coins follow strict guidelines regarding who can purchase these coins and their transference.

Security vs. Utility Token

There are currently two types of tokens in the cryptospace – security tokens and utility tokens. It’s important to learn the differences between these two types of tokens. You should also understand that some tokens start off as security tokens during their ICO, but later develop into utility tokens following the development of the platform.

Many investors prefer security tokens because the coins adhere to the SEC’s legal restrictions. Security tokens are the direct result of a desire by investors and businesses to utilize a blockchain-based crowdfunding system that conforms to the SEC’s current IPO requirements. These regulations include the implementation of Know Your Customer (KYC) protocols. KYC laws require all investors to reveal their identity before they can participate in the crowdfunding event.

Secure Investments

Security tokens provide participants with a more transparent investment experience. Startups offering security tokens must provide investors with a plethora of legally required information such as the company location, financial statements, business purposes, and management. All valuable pieces of data to be sure about before making any investment. While utility token investments can provide this information, they are not legally required to currently.

Additionally, there are few examples of ramifications for utility token providers who falsified information provided. These laws offer valuable protection to all parties involved, and many in the crypto space believe them to be critical in curbing fraud and spurring wide-scale crypto adoption.

Fraud in the Cryptospace via Bloomberg

Fraud in the Cryptospace via Bloomberg

Due to the unregulated nature of the cryptomarket, there are a significant amount of fraudsters in the space. These individuals prey on new investor’s doubts and misgivings to make a profit. One study put the number of fraudulent ICOs in 2017 at eighty percent. Given the amount of fraudulent activity in the cryptomarket, it’s no surprise that investors seek a more secure alternative to the status quo.

Large Scale Investors

Security tokens attract more large-scale investments because they are subject to legislation that protects investors such as the Securities Act of 1933 and the Section 3 of the Securities Exchange Act of 1924. These protections are necessary to prevent fraudulent activity from occurring in the market. This added security provides a safer transaction for both investors and corporations looking to utilize blockchain fundraising strategies.

More Security for Your Corporation

Users aren’t the only one benefiting from security tokens. A business that chooses to offer security tokens gains the confidence of knowing that they will not be subject to later legal, or financial, ramifications resulting from their ICO. Their tokens are in line with the SEC regulations and, therefore, the company can operate with greater confidence.

Utility Tokens

Utility tokens serve a specific purpose within the platform. Additionally, they do not pay investors any dividends or revenue share for holding the coin. A perfect example of a well-known utility coin is Ethereum. In July, the SEC ruled that Ethereum (ETH) is not a security. One senior SEC official stated that Ethereum was a security during its initial coin offering (ICO), but that in its current status it’s a utility token.

The Howie Test

It isn’t always easy to determine if a coin is a security or utility token. Also, it’s important to remember that the SEC could alter their language and consider even utility tokens as falling under security laws in the future. Despite the uncertainty of the market, you can employ the Howie Test to self-verify a token’s standing in most scenarios.

  • Are You Investing Money?
  • Do You Expect Profits in Return for Your Investment?
  • Are You Investing in a Common Enterprise?
  • Will Your Profits come from the Efforts of a Promoter or Third-party?

The token you are researching is a security token if you answered yes to these questions. Additionally, if the profit received from the investment is entirely outside of your control, the chances are good that the token in question falls under security laws. The Howie Test originated during the Supreme Court case SEC v. W.J. Howey Co.  The SEC alleged that the Howie Company of Florida violated Securities Laws when it failed to register a land investment agreement with the SEC. The deal involved an investor purchasing half of the company’s unused land so that they could develop the rest of their land into more citrus fields.

SEC Head Jay Clayton via The Wallstreet Journal

SEC Head Jay Clayton via The Wallstreet Journal

The Supreme Court determined that because the investors had no “knowledge, skill, and equipment necessary for the care and cultivation of citrus trees” that they were acting as speculators. In other words, they invested in the land with the hopes of making a profit from the efforts of someone else.

The SEC determined that the investments made were not for the land, but instead, for the opportunity to share in the future profits of the large citrus fruit enterprise. The Howie test works when applied to cryptocurrencies, but given the shifting nature of tokens, not all coins can be precisely defined using this technique.

Disadvantages of Security Tokens

There are also some disadvantages provided by security tokens. The main obstacle to this type of token is the reduced liquidity. You can’t send a security token to just anyone without complying with KYC protocols. These restrictions add another level of operations to your fundraising requirements.

Companies need full transparency to host a Securities Coin Offering (SCO). The SEC requires a treasure trove of information from companies looking to host SCOs including complete financial statements. The organization only approves companies that meet these stringent guidelines one-hundred percent.

A More Secure Option

Security tokens fill a much-needed niche in the cryptomarket. The added transparency provided by these tokens should help to spur increased investment. While many love the anonymity provided by many platforms in the decentralized economy, large investors seek the stability required by the current financial systems in place. Security tokens accomplish this task perfectly.

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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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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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Stablecoins within Digital Securities

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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.

The Allure

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.

  • Transparency
    • 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’.
  • Efficiency
    • 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.
  • Affordability
    • 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.
  • Volatility
    • 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.

Flexible Pegging

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.

Coincidence?

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.

Viable alternatives

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.

TrueUSD (TUSD) | TrueGBP (TGBP) | TrueAUD (TAUD) | TrueCAD (TCAD)

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.

TrueUSD saw its exclusive use in a recent STO, hosted by Blockport.

 

Gemini Dollar (GUSD)

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.

 

USD Coin (USDC)

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.

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