Security tokens are gaining tremendous traction in the financial services industry as they offer a range of advantages over traditional securities. Security tokens are digital assets that represent a stake in some external enterprise or asset and are issued on a blockchain platform.
One of the main advantages of security tokens is that they benefit from the properties of the blockchain they are issued on. This includes transparency, rapid settlement, no downtime and divisibility. As a public ledger, the identities of participants are abstracted, but everything else can be audited. Furthermore, the process of settling a transaction is automated and can be completed within minutes. Additionally, digital asset markets are active around the clock, every day of the year and allow for greater levels of granularity over investments through token divisibility.
Security tokens are different from utility tokens, which are not intrinsically valuable. Utility tokens may offer the holder voting rights or serve as a protocol-specific currency to access products or services, but do not provide a stake in the business. By contrast, security tokens are subject to heavy regulations to protect investors and prevent fraud. They are akin to an Initial Public Offering (IPO) as opposed to an Initial Coin Offering (ICO). When investors purchase a security token, they are buying equity, bonds, or derivatives and their tokens effectively serve as investment contracts.
One of the challenges associated with security tokens is that the blockchain industry still lacks some much needed clarity on the legal front and regulators around the globe are still playing catch-up with a flood of new financial technologies. The Howey Test is the most famous metric used to determine whether a transaction amounts to an ‘investment contract’ and is used by various regulators in order to classify digital assets.
The potential of security tokens is immense and could revolutionize the traditional financial realm. Tokenized securities have the potential to reduce costs and dramatically reduce settlement times by connecting existing centralized databases to an interoperable network. Additionally, functions like KYC/AML compliance, locking up investments for set amounts of time, and many other functions can be handled by code running on the blockchain.
Overall, the use of blockchain-based tokens to replace traditional instruments may very well bridge the gap between legacy and cryptocurrency markets. This is an exciting prospect and one that will benefit many investors and institutions in the space, providing them with efficient and economical options when it comes to buying and selling assets.
