This article has been contributed by journalist Andrew Fenton from Nauticus Exchange.
It’s the next big thing in blockchain, following on from the utility token boom that was spawned by the creation of generic ERC-20 tokens that anyone with a laptop can knock up in 20 minutes.
The global market for assets is expected to be worth $900 trillion by 2020. If just one per cent of it is tokenised, then security tokens will account for $9 trillion of value. No wonder investors are getting excited.
So what is a security token and how does it differ to a utility token?
What are utility tokens?
Utility Tokens provide the user with some tangible benefit – usually access to a blockchain based network or service or product.
The Nauticus Coin is a good example, providing users with 50 percent off transaction fees when trading crypto on Nauticus Exchange.
Binance has tremendous success with its Binance coin (BNB), which at one stage gave users a 22,000% profit, and is forecast by many to continue growing. Binance sells the token on its exchange and enables users to pay for trading fees, exchange fees and listing fees.
VeChain Thor is another example, providing payment to the node holders on a decentralised blockchain network, allowing a company to record a product’s journey along the supply chain.
Although many crypto “investors’ think they’re buying a slice of the company, utility tokens are more analogous to buying prepaid credit for your phone that allows you to make calls on the network infrastructure. No one thinks they own the phone company after they’ve topped up their credit.
What are security tokens?
Security tokens, however, DO provide ownership of a slice of the company, or of real assets like gold or silver, debts/loans. As such, they fall under existing security laws.
They can provide dividends and shareholder voting rights and they are bought in the expectation of future returns.
In the US they use the Howey Test to determine if a token is really a security:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Security tokens: How are they different?
Muddying the waters is the fact an awful lot of ‘utility’ tokens are really security tokens in disguise. The SEC in the US has clearly stated its belief that many existing tokens are actually securities. Here in Australia, lawyer John Bassilios, from Hall and Wilcox has laid out a convincing case that the vast majority of utility tokens are actually disguised Managed Investment Schemes. Managed Investment Schemes require the operator to hold an Australian Financial Services (AFS) licenceand to register the scheme with ASIC – meaning many coin projects could well be breaking the law.
Why masquerade as a utility token?
Utility tokens are by and large unregulated. You can raise a bunch of money by selling them with little to no oversight. Security tokens on the other hand, are regulated by large, intimidating organisations such as the SEC in America and ASIC in Australia. They require prospective issuers to get a bunch of licenses and jump through regulatory hoops. In short, they come with a bunch of regulations designed to prevent the exact kind of scams and sharp practices that have infected every aspect of crypto fund raising.
Why tokenise your company or assets?
While they are more difficult to set up than a utility token, Security Tokens are considerably easier and cheaper than trying to float a company on the stock market. They enable smaller companies to raise funds quickly, while maintaining a much greater level of control than if they were a publicly listed company.
Types of security tokens
An STO where each token represents stock in the company. Holders have the voting and dividend rights of stock holders.
Reserve Assets Token
Companies that trade commodities such as gold or real estate can launch tokens which are backed by a reserve of real world assets.
Companies that don’t wish to tokenize stock or assets can raise funds by issuing debt tokens with a promise to payback with interest to attract debt investors.
Benefits of security tokens
Unlike utility tokens, security tokens actually represent real world value – whether that’s a slice of a company or an asset. Investors don’t need to wait years for ‘adoption’ because the value already exists. This makes them easier to value too and less prone to volatility.
Non stop / international
Trading in Security Tokens goes on 24/7 right around the world.
As they are fully regulated, the chances are much lower investors will fall victim to an exit scam. Regulations should also help combat the rampant market manipulation that exists in the crypto market
Floating a company on the stock market is ludicrously difficult and is only really suitable for large companies targeted tens of millions of funding. It requires enormous amounts of very expensive middlemen. Security Tokens by contrast are relatively easily to set up and are affordable for smaller, early stage businesses who need to raise capital quickly.
Listing a business on the Stock Exchange means ongoing compliance work Security Tokens provide greater flexibility in running a business, comparable to a private company.
Compared to shares they don’t require intermediaries like share registries and the admin costs for buying and selling is virtually zero
You can create a security token for a wide range of assets, from real estate to venture capital and even artworks.
Many companies looking to raise funds through an ICO don’t actually offer a service that lends itself to a utility token (despite many amusingly tortured attempts to do so). A security token is often much more suitable as the value of the token is based on the value of the underlying asset or company and not on demand for the platform.
Disadvatanges of security tokens
You can sell utility tokens to pretty much anyone with an internet connection. But there are many more limitations with security tokens in terms of who can invest in them and where and how they can be traded.
The liquidity isn’t as great – though this will change as the market matures.
Compared to utility tokens, it costs a lot more in compliance costs to set up and sell a security token.
They fall under existing security regulations so it’s a lot more complicated to set them up than an ICO.
Despite all the talk about security tokens, they have only been around for a little over two years and there aren’t a lot of them in the market just yet. This means there are uncertainties over how they will perform and what regulatory hurdles they could face in future.
This article first appeared on the Nauticus Exchange website as How To Make Millions from Security Tokens (Part One) and How to make millions from Security Tokens (Part Two). To register for the exchange and participate in their latest airdrop click here.
Content on the Micky website is not intended as investment advice. Readers are urged to conduct their own research before making any investment decisions. The cryptocurrency market is volatile and there is a chance you could lose some or all of your money.