cryptocurrency, bitcoin, ethereum, crypto
Right now most ICOs are for currencies or utility tokens. But there’s a third category that many believe will be more widespread and useful: security tokens.
What Is A Security Token?
A "security token" is a blockchain-based asset that functions like a traditional security. Instead of owning stock in a company, you would own a security token. That token would come with voting rights, distribution rights, and/or liquidation rights.
Security tokens are a way to bring blockchain efficiencies to traditional equity. Companies can issue tokens instead of stock, and have an up-to-date blockchain ledger of its shareholders at all times.
Compared to Utility Tokens
Utility tokens are built to be used by a blockchain ecosystem; you would use Filecoin to access a decentralized cloud. But security tokens don’t have much utility, just like owning a share of Disney stock doesn’t give you any benefit outside of voting, distribution and/or liquidation rights.
Utility tokens may generally not be considered securities (though many are, and the standards are still unclear and developing). But security tokens will be issued in compliance with all relevant securities laws.
What Are The Benefits Of Using A Security Token?
First, the SEC is increasingly going after ICOs (see, for example, Munchee) because a lot of them are securities disguised as utility tokens. Issuing securities tokens in compliance with securities laws would protect a company from the risk of regulatory agencies shutting them down.
Note that this isn’t a bad thing; the SEC could have shut down Bitconnect. Or Prodeum. And if it had, crypto wouldn’t have lost the credibility it did as a result of those frauds (and maybe we wouldn't be entering a crypto-dip winter as I write this...).
Second, a company won’t have to vigilantly track who owns its securities. This matters because there may be restrictions on who can own certain securities, and how frequently they can be sold.
For example, “restricted” and “control” securities are securities bought or sold in private sales from the company issuing the securities. Rule 144 limits the sale of these by imposing a holding period, during which they can’t be sold (six months to one year, depending on who the issuer of the securities is).
But how can a company know? The owner could privately resell the stock without the company’s knowledge.
But if those securities are blockchained, the company could have full view of such a sale. Even better: the company could program the security tokens as smart contracts so that a restricted owner couldn’t even transfer them for the first six months.
Or, as another example, securities issued under Regulation D Rule 506(b) must only be bought by accredited investors. A security token could require verification of accredited investor status by a company before it can be transferred.
Securities tokens are currently just an idea. But it may be one of the most widespread blockchain uses once it comes to fruition, and there are already a few companies working on it. Overstock’s tZERO is probably the best example.
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