Blockchain is a growing trend in fintech innovation that has gone beyond cutting-edge implementations that disrupt traditional banking. Among the blockchain trends in the recent past has been a recent rise in security tokens. There are numerous debates by financial services and crypto communities over security tokens.
While some people believe it’s just a fad with a huge risk that’s not worth worrying about, others believe it’s a legitimate investment. There is a lot of confusion about what security tokens are. This has led to a wide range of opinions. Most people also find difficulty understanding the differences between security tokens, utility tokens, and other digital assets.
What are security tokens?
There was a lot of excitement in the early days of online fundraising through initial coin offerings (ICOs). But they soon became a playground for fraudsters. As a result, many investors have become suspicious and cautious of other such initiations.
Many still dismiss blockchain without wanting to learn what it is. This can lead to investors potentially missing significant opportunities. Security Token Offering (STO) has emerged in response to the waning popularity of ICOs. STOs are a fundraising mechanism that promises more reliability and security. This blog looks at STOs, what they are, how they work, and the regulations surrounding them.
Notably, the idea of ICOs is genuinely aimed at helping startups get the funding they needed for their projects. However, due to a lack of standardized regulation and protection for investors, many fraudulent individuals corrupted the idea for their gain. This is what gave rise to STOs.
But what qualifies as security in the first place? Securities come in many forms. Options, bonds, warrants, and equities are all forms of securities that can be traded. In addition, security tokens meet the requirements of the mentioned securities. However, the United States has a test known as the Howey Test that determines whether a transaction can pass as a security or not.
This is how the Securities Exchange Commission (SEC) uses the Howey Test to qualify securities:
- The token is considered a financial investment with voting rights
- The investment does not go to an individual but to one or more companies
- The investor expects to earn a profit from the token
- The profit will come from work done by third parties
A company offering security tokens must meet all requirements for traditional securities to be considered legitimate. To determine whether a token is a security or not, the SEC can use the Howey test as one of several tools available to investors.
In addition, security tokens serve as a digital representation of ownership rights, such as stock certificates or ownership certificates for tangible commodities like real estate, precious metals, or even works of art.
Benefits of STOs
STOs have several advantages for both companies and investors, including the following:
- Enhanced trust: Storing assets on a blockchain is more secure than trusting in central systems. As long as a security token is stored on a blockchain, it can’t be altered and can always be traced back to its original issuer. It’s also helpful in improving security through tokenized payments.
- Openness and transparency: Owners can easily demonstrate their ability to exercise rights attached to security tokens by displaying the availability of the corresponding tokens in their wallets.
- Enabling fractional ownership: STO commodities can be divided into significantly small units. For example, one person may not afford a $ 500,000 investment in real estate. Since these security tokens can be fractioned, the offering company can share this opportunity with many people, each investing a small sum in return for a portion of the property.
- Lean settlement: Because transactions are carried out on a blockchain, it eliminates the need for expensive third-party involvement.
- Wide adoption: When implemented according to an open, interoperable standard, security tokens have the potential to be widely adopted and integrated into a variety of distribution channels globally very quickly. The entry of offering companies to global markets necessitates adherence to various laws and regulations, enhancing security.
The Drawbacks of Security Tokens and Possible Solutions
Naturally, security tokens have their own set of issues and challenges, just like any other technology. Here are some of the issues facing security tokens.
- Licensing and regulation: There are many regions that security tokens are still unable to operate because of a lack of or ambiguous regulation. In some places, the process of issuing and administering licenses can be complicated. However, this may change in the near future as governments and other institutions are working hard to implement new regulations.
- Lack of understanding of blockchain and STO: Many investors are still unfamiliar with blockchain and its applications. The investor holds the security tokens and does not use custodial services like those given by a bank. This lack of familiarity with the technology is a serious issue. Companies looking to launch an STO should keep in mind that the barrier to entry may rise.
- Lack of third-party support: STOs do not require third parties, and seeming lack of an oversight authority might be perceived by investors as a risk. Third-party providers frequently provide expertise and a high level of safety in situations such as these.
Blockchain and its security offerings are expected to grow over the next few years. The use of security tokens will only become more widespread as the laws governing decentralized ledger technology continue to be updated. Security tokens have a promising future ahead of them, thanks to growing investor appreciation for their regulatory ties and transparency.