Will security tokens alter the way investors hold and transfer investments? Because these tokens act as financial securities in the form of digital assets, their value relies not on the utility of a token itself, but rather on the value of an external asset. The downfall of Initial Coin Offerings (ICOs) led to the rise of Security Token Offerings (STOs) out of respect for the regulatory demands impacting compliant securitization of assets.

The security token industry is barely two years old, yet major companies such as Overstock.com’s tZero are now focused on tokenized securities. Many new platforms provide security token services including Polymath, BlockEx, TokenMarket, BlockSafe, Blockport, Securitize, STOMarket, GSX Group, and many others have sprung into existence to service the secondary trading of STOs, as well as related tokenization services.

Will Security Tokens Will Be the Next Big Thing?

Security tokens have captured the imagination of U.S. investors. The majority of ICOs have failed, causing a massive slump within the crypto industry generally. STOs better align with the required regulatory norms laid down by the SEC, FinCEN, FINRA, and other government agencies.

Additionally, STOs are tokens backed by real collateral. STOs allow fractional ownership of true assets that can be valued using traditional models. The promise to investors involves diversification of their portfolio with lower costs than traditional securities.

Below are some key features of security tokens that have aided in the accelerating adoption of STOs and solidified their position as a legitimate subsector of the cryptoverse.

Credibility

Because security tokens operate within better established legal frameworks — regulations which ICOs have largely failed to respect, per commentary from the SEC — STOs tend to score higher in terms of credibility. The stringent regulations decried by proponents of utility tokens, conversely benefit the positioning of STOs, at least in terms of credibility.

Investors should feel safer participating in a STO compared to an ICO. An investor can expect a token to reflect the value and legal framework of an asset, versus the more nebulous utility value of a network.

STO as Micro-Investment

With the help of security token offerings, investors may find it easier to pursue micro-investment strategies. Because STOs function similarly to stocks or bonds, albeit in the form of a digital token, it has given a greater opportunity to non-accredited investors to participate in a potential startup venture and become security holders who are entitled to the profit shares, dividends, or buy-back rights.

Imminent Success Rate

Unlike 2018’s ICO investors who suffered from one of crypto’s worst bear markets on a global stage, STO investors are starting anew with a difference experience. There is less negativity about STOs, and most commentators cast them in a better light than ICOs, optimistic regarding the future of security tokens as a more sustainable and credible secular trend. There is a chance that STOs may perform even better in the upcoming years. The increasing success of various STOs is helping to counteract the ICO fad.

Programmable Ownership

As we know, security tokens can be programmed as per their technical requirements, such as in a smart contract. While programming a security token, one may embed as many compliance protocols as desired, meaning that altering cash flow rights as per the ownership characteristics can improve the original asset with time. In short, programmable securities will unlock many such innovations which are required by corporate governance.

Segregated Value

One of the most prominent features of tokenized securities is that it offers investors with an unbundling value of either share, dividends, bonds, all backed by a securitized asset. This framework can be integrated by companies to unbundle revenue streams and enable them to finance it independently. This act of decoupling of value can be explored for many variable categories that exist in the current financial system.

About Security Tokens and Their Features

Launching a security token requires new understandings and new technical approaches to solving crypto’s problems. Although the concepts behind asset tokenization may seem more complicated due to regulatory norms, this is precisely why STO platforms give enterprises assistance related to these new issues:

Regulatory Compliance

Token Issuance

Business Plan and Disclosure Documents

Custodianship

Secondary Trading

The Significance of a Security Token’s Structure

The regulations surrounding security tokens are more robust than those for utility tokens, yet there remains significant work to be done. Traditional regulations are incomplete except in cases where the STO issuance is executed under regulatory frameworks such as Regulation D, Regulation S, Regulation A+, and Regulation Crowdfunding. These frameworks are faster and more cost-efficient when compared to launching an IPO or private equity acquisition.

Tokenized securities must comply with securities laws, which have been refined across years of regulation to keep investors and contributors safe from undue losses. In particular, the SEC’s stringent law enforcement program enforces the structure of asset-backed tokens and security token offerings and protects the token buyer rights. Furthermore, it also duly clarifies certain obligations and duties which are associated with the issuer of a digital asset.

The organization of security tokens and its offerings is more transparent and reliable than utility tokens, which is why premier financial institutions and even sovereign wealth funds are expressing interest in STOs. The economics of digital assets sheds light on the economics of the asset class, and how the issuer intends to utilize the liquidity for the benefit of marketplace participants.

The demand for ICOs and STOs is impossible to avoid, yet investors and especially issuers need to take great care when soliciting investment. Secondary trading for digital securities is often subject to exchange regulations, the same as any other securities exchange such as the NYSE and NASDAQ. Issuers may be required to issue an investment memorandum, business plan, risk disclosures, and other continuous disclosure protocols. STOs may not be freely transferable or legally traded on a secondary exchange, and may be subjected to various restrictions, both by the issuer, marketplace participants, and the government agencies.

The Need for Security Tokens Wallets

It is also worth noting that there are few official security token wallets, and even fewer custodians, that support storing an asset-backed token in compliance with government regulations. Investors in digital securities need a reliable wallet storage option, not only to store security tokens, but also to transfer tokens securely while limiting the possibility of hacks or illicit activities. Such a security token storage wallet system, complete with custodians and insurance providers, would require regulatory compliance as well as multi-signature wallet functionalities.

On May 6, 2019, Smartlands (SLT) launched a Stellar (XLM) wallet which supports on-chain trading of security tokens. Smartlands operates a platform that crowdfunds investments through security token issuance. The wallet functions within a regulated fraction of Stellar’s network, users of which are required to pass Know Your Customer (KYC) and abide by regulatory laws to transact their assets. It is also equipped with an AI-based compliance engine for Anti-Money Laundering (AML) monitoring to limit illegal activities. Many more wallets and initiatives like this are needed to advance the STO industry.

Final Thoughts

Tokenizing assets is an exciting opportunity, and more companies are investigating STOs day by day. There will undoubtedly be a plethora of use-cases where digital securities can be implemented to facilitate transparency. Asset-backed tokens have the potential to solve many of the problems of the first iteration of cryptocurrencies, ICOs, and advance the industry forward. To read more about the legal considerations for STO issuers, continue reading our previous article on that topic.