Security tokens – understanding the basics

This is our second article in our new mini-series on asset tokenization in which we primarily discuss security tokens. To see our first article on the general principles behind asset tokenization, click here. If there is anything you’d like to discuss security tokens, get in touch with our expert analysts by subscribing here and ask away!

 

What are security tokens?

Since we defined asset tokenization in our previous article, the logical path is to first define what security tokens are. As we noted previously, tokens represent a part of something valuable – therefore, asset tokenization is, simply put, breaking the ownership of an asset into smaller pieces of equal value. But what are security tokens, then?

Security tokens are highly regulated digital assets that guarantee the ownership of an asset. Unlike its counterpart utility tokens, security tokens’ primary use is to digitally represent an investment in and ownership of a common enterprise with the expectation of profit. If any of these three criteria isn’t fulfilled: that it is seen as an investment, or that it is an investment  into a common enterprise or finally,  that one expects to profit from owning it, a token is not necessarily a security token but instead a utility token, which is issued as ‘tickets’ for renting, using or building upon an asset, but not owning it. Of course, there are more criteria that regulators use to assess whether a token is a security or not.

Regulation plays an important part in the creation and distribution of security tokens since they derive value from external sources (external assets) and if not regulated, many scams can and sometimes do occur. Also, the framework for creating and distributing the security tokens must exist and the most notable framework is seen in the issuance of SEC’s federal security regulations.

The importance of security tokens

The idea that stands behind traditional securities and security offerings is the same driving force that exists in security tokens – companies, startups, and enterprises, in order to raise capital and avoid taking out all kinds of business loans, turn to raising capital by offering ownership of the company in the form of certificates of ownership that have monetary value and can be traded. For example, owning an Apple or a Tesla equity security (or common stock as it is referred to) gives the investor a certificate that they indeed own a part of that company and are entitled to a part of the equity in the form of dividends.

However, there are major differences between traditional securities and security tokens.

 

Security tokens are important because they partially ‘erase’ the significance of a middleman, which is reduced to a minimum. For example, when you want to buy a security, you’d have to go through a brokerage house, directly from a business, from a person to another person (theoretically) or a bank – each of these ways comes with their own fees, rules, paperwork, upsides, and downsides. Security tokens shorten and simplify the whole process and a certificate of value can change ownership easily, without too much hassle.

Avoiding the middleman consequentially brings lower fees, as any change in the ownership of the security token is done either by automation through smart contracts or through a blockchain system itself, which automatically records any change in its chain.

Reducing the middleman’s importance to a minimum actually means faster execution of any change regarding security tokens – what today takes hours or days to complete due to paperwork and notifying the parties and authorizing the deal, security tokens can do in a matter of minutes.

And as we discussed in our first article in this series, asset tokenization drastically improves an asset’s liquidity, and security tokens are no exemption – as licensed token trading platforms become more widespread, we will definitely see and hear about trading security tokens more often.

We at Bullbear Analytics follow these trends daily and provide our members with an opportunity to gain early information on their development. In the next article we will discuss whether Security Token Offerings or STOs are just hype or reality and will cover their benefits, so subscribe today to receive the latest updates.

 

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