What is a Security Token? =

Lately there has been a lot of talk about the security token, but what is a security token? How do they work? And why should you look at it? In this blog we give detailed answers to these questions. We will first start with an explanation of what a security and what a token exactly mean.

What is a security?

A security is a piece of paper that represents a certain value. This can be the value of an asset or the value of a debt. When we look at assets, we quickly think of stocks. When we look at debt, a bond is a well-known example. In English, a security that represents a value is called an equity security and a security that represents a debt is called a debt security.

Equity security = An equity security represents an asset such as a stock in a company. Other examples of possessions are paintings, apartments and pieces of land.

Debt security = A debt security represents borrowed money that needs to be paid back. This is similar to a bond, where one party lends money to the other party.

What is a token?

A token is a digital representation of something within a given ecosystem. This ‘something’ can be a value, a right to vote, a debt and so on. The token has a role within this ecosystem and this need not be limited to one role. It can fulfill multiple roles such as facilitating transactions, casting a vote and paying dividends.

The words token and coin are often used interchangeably, while there is a real difference between them. A token is used within an ecosystem and a coin can work independently of a platform. To learn more about this, I would like to refer you to the article about the difference between a coin and a token.

What is a security token?

A security token is a digital currency on the blockchain that represents the value of an asset or a debt. You can also say that the asset or debt is ‘tokenized’.

What are the benefits of a security token?

The security token brings several benefits.

1. Investment becomes more liquid

The advantage of a security token is that it makes the underlying value liquid. Something is considered liquid when it is easy to trade. A stock or bond as we know it is easy to trade online, but an apartment is a lot trickier.

Example real estate

When you invest in the real estate market, one asset can already cost € 200,000. This money is in bricks and if you want to have this money in a week’s time, this is almost impossible. Hardly anyone will be able to complete the sale within a week and hand you over 2 tons. This is one of the reasons that many people do not invest in real estate.

Nowadays there are also companies that offer real estate funds. They then buy an apartment for € 200,000, for example, and investors can register to invest. A minimum amount of around 10,000 euros is often used. The advantage is that you do not have to deposit the entire amount of 200,000 euros, but you still have an investment that is not liquid. Your money is invested in the apartment and you can only get it back when the apartment is sold.

Thanks to the security token, the companies that offer these real estate funds can make it possible for investors to trade with each other. For every 10 thousand invested, the investor receives a token. When someone wants to convert his investment to euros, he can easily sell the token to another investor. The blockchain then notes who the new owner is and the former investor has euros in his pocket again.

2. Global trade

Another big advantage is that a security token can be traded all over the world, unless a country has explicitly indicated that it does not want to support it. Due to global trade, you could, for example, invest in real estate from other countries. This makes it just as easy to invest in a country like Africa as in your own country.

3. No chance of theft

A third advantage is that a security token cannot be stolen. This is possible with many other cryptocurrencies, including Bitcoin. When someone has your private key in their hands, they can take your Bitcoins from the wallet and transfer them to their own address. The same also applies to fiat money such as the euro. If you drop a 50 note and someone else picks it up, they can just spend your 50 euros at the local supermarket.

This is different with security tokens. The token is not the security itself. It’s not the bond, it’s not the stock, and it’s not the apartment. The only thing the security token is is the digital representation of the security. No one can send this token to their wallet as it is not whitelisted. If he is on this, it is immediately clear who he is since he has done KYC and AML. You know exactly who he is. You can read about KYC and AML in the upcoming article about programming rules.

Programming rules in the security token

You can program rules in the security token that everyone must adhere to. For example, you can say that the token can only be traded when all rules are met. An example of a rule is that the investor must do KYC. KYC stands for Know Your Customer. They must then send their personal details, including proof of identity, to the company so that the identity of the investor can be verified.

Companies can use the token to raise money

The security token is interesting for investors as they can easily invest money in a liquid token. Conversely, it is also interesting for the company as they can easily attract investors from all over the world.

As a result, they get the necessary capital filled faster and they spend less time and money looking for investors. They often use this capital to further develop the company. Startups in particular need seed capital at the start. Attracting seed capital via security tokens is also called a Security Token Offering.

What is a Security Token Offering?

A Security Token Offering, also abbreviated as STO, is a crowdfunding campaign in which companies raise money through the sale of security tokens in order to further develop their product or service. Investors can use the STO to buy the tokens as cheaply as possible, with the aim of selling them again at a profit in the future.

Such a Security Token Offering is facilitated by the blockchain. This decentralized database ensures that the crowdfunding is safe and correct.

STOs bring confidence

With the advent of the STOs, confidence is returning to the crypto world. For this, crowdfunding campaigns were done through Initial Coin Offerings (ICOs) and there are few rules attached to these promotions. This allows any company to set up an ICO and raise money. It has therefore often happened that a company with a nice promise has collected thousands of euros, and then left with a happy smile. The investors could whistle at their invested money.

In addition to STOs, IEOs are also very much in demand these days. IEO stands for Initial Exchange Offering and if you want to learn more about this, you can check out the blog about IEOs.

How do security tokens work?

Security tokens almost all work the same. You have a company that issues the token and this token will then represent a certain value. The company will create a whitelist containing all wallet addresses of investors who are allowed to take a share in the company.

The investors will have to prove that they comply with the rules of the security token and that they are accredited investors.

The whitelist can be shared with other parties, such as exchanges, so that everyone on this list can trade tokens with each other. The makers of the security token often have other parties also do the KYC and AML checks. When new investors meet the verification requirements, they are whitelisted and can also participate in trading this security token. This increases the liquidity of this token and the issuing party does not have to screen all new investors itself.

Where can you trade security tokens?

Well-known exchanges where you can trade security tokens are tZero, Open Finance and Blocktrade. Both individuals and institutions trade in the tokens there.

When is a token labeled as a security token?

A token is labeled as a security token when it is seen as an investment. And we talk about an investment when people invest money with the aim of making a profit.

To label a token as security, a test is done in the United States, the so-called Howey Test. The financial watchdog of the United States, the SEC, uses this test to determine whether it is an investment or not. If this is the case, the token will have to comply with strict laws and regulations. They count a token as an investment when:

  1. it is an investment of money or other form of value;
  2. the investment is made in a company; and
  3. there is an expectation of making a profit by investing money in this company.

The Howey Test is not the only test that America uses to assess investment properties. In 1990, the Supreme Court created a ‘Family Resemblance Test’. This allows the creators of the token to show that their token is very similar to another type of investment that is not seen as a security. If the assessors agree with them on this, the company will escape and will not be labeled as security. Many companies do not want their token to be seen as security since they then have to comply with additional laws and regulations.

Examples of tokens that are seen as security are BCap (Blockchain Capital), 22X Fund, Slice, SPICE VC and Siafunds. It is good to know that Bitcoin and Ethereum are not seen as security.

What the United States labels as security, we in Europe do not necessarily have to see as security. We have our own laws and regulations and this will determine to what extent a token is seen as an investment object or not.

Different kind of tokens

The security token is divided into equity tokens and debt tokens. In addition to these tokens, there are also tokens that have to comply with less legislation and regulations, because they are not regarded as security. These are the utility token and the reward / reputation token. In the article “different types of crypto tokens” you can learn more about these types of tokens.

You have read a lot of information about security tokens in the last few minutes and to make sure you remember it well, it is useful to hear the same thing again in a video. It only takes 11 minutes and after that you are sure that you fully understand the concept.

Why are security tokens important?

Security tokens are important because they form the connecting bridge between the existing investment objects and the blockchain world. An investment object is, for example, an apartment, a painting, a share or a bond.

1. Lower costs

Because these investment objects are offered via the blockchain, considerable cost savings can be made. Traditional investments have to go through intermediaries such as the bank and these intermediaries all charge costs. Thanks to blockchain, the middleman can be removed from the process and costs can be reduced.

The operation of smart contracts allows the entire process to run smoothly. These smart contracts ensure that the process is less complex, costs less and less administrative work is required. For example, you need fewer lawyers and paper contracts are exchanged for code contracts.

2. Speed

Because the middleman is removed from the process, the entire process can be accelerated. The security tokens can be offered quickly and the investment in them is done at the touch of a button. As a result, many people see the security token as the investment method of the future.

3. Less manipulation

Because fewer intermediaries interfere with the investment, you also have less chance of manipulation. Everything is written down in code in advance and the process will proceed exactly as stated in this code.

Because security tokens make the transition from traditional investment objects to digital tokens, this is seen as the investment way of the future.

Finally

If you still have questions based on this blog, feel free to ask them at the bottom of this article, with us on the Crypto Forum or in the AllesOverCrypto Facebook group.

 

Source: Blockgeeks, Hackernoon

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