Blockchain is a disruptive technology that is not only used for the decentralized financial sector alone. It is adopted by governments and private enterprises for the creation of centralized financial networks that are upgraded versions of the existing traditional financial instruments. One such product is a security token.
What is a Security Token?
Security tokens are cryptocurrencies that come with a stake or ownership claim for an external entity or enterprise. They are usually issued by private blockchains that are under the use of commercial enterprises or government departments. They can serve as a digitized counterpart for stocks and bonds etc.
Creation of a Security Token
At present there is a lack of technical and legal description concerning the qualification of cryptocurrencies as a security. The Securities and Exchange Commission (SEC) has adopted the Howey Test as the scale to determine whether a particular cryptocurrency project qualifies as a security or not.
However, this test was devised by the US legal system before the invention of decentralized and distributed ledger technology. Therefore, there is still much work to be done to use the Howey test as the technical basis for nominating cryptocurrencies as securities.
Utility of Security Tokens
Security tokens work much like stocks but they are issued by companies or states on a private blockchain network. Here are some of the important use cases of security tokens listed below:
In most cases, companies or states may choose to issue their security tokens on a public blockchain. In this manner, they will be able to maintain better transparency. Every user on the network will be able to perform an audit at any time.
Additionally, everyone can view and access the smart contracts that are used to run and issue the tokens.
One of the most important benefits of digitized securities is that they ensure a rapid transfer. All transactions taking place on the blockchain network are completed within seconds.
On the current digital system stock trades can happen quickly by ownership reassignment takes more time. However, the issue is fixed using blockchain that is fully automated and performs new use verification without delay.
In most cases, brokers and investors can only perform trading on the traditional stock markets during business hours. However, with the availability of token securities on blockchains, traders can access their holdings and the market at any hour. It means a 24/7 trading day session that continues 365 days a year without any breaks or downtime.
Token securities have enabled fractional trading options that can increase the flow a lot more consumers in the financial sector. Investors can now sell their assets such as artwork, real estate, and other intellectual property by dividing them into very small and affordable parts.
In this manner, the small-scale investors can get a chance to purchase them and trade to make profits.
Difference Between Security and Utility Tokens
Utility tokens are cryptocurrencies that can be used to perform a particular function such as sales and purchase of goods or services. However, they do not contain any ownership claim like security tokens. Here are some of the most important differences between both types of crypto tokens:
ICOs and IEOs
Security tokens can be issued as part of Initial Coin Offerings (ICOs) or Initial Exchange Offerings (IEOs). They offer ownership of a share in profits for the investors and help startups to crowdfund.
Sometimes, security tokens are also issued during an event called Security Token Offering or STOs. Utility tokens are usually not part of the ICO or IEO offerings.
Voting and Governance
Security tokens can grant governance rights to the holders by way of ownership. It means that the users who hold them may be able to cast a vote for new proposals and changes in the protocol.
They can also serve as native currency within a particular protocol. On the other hand, utility tokens can sometimes offer voting rights to the holders for community voting but they are not representative of ownership stake.
Programmable Finance and Security Tokens
Programmable finance is a feature that is akin to security tokens and CBDCs. It means that businesses and individuals can outsource the native ledger or on-chain data available on the blockchains that issue these security tokens.
It can pave the way for greater transparency, instant transaction settlement, and global scalability. At the same time, it may also automate lengthy processes such as KYC/AML processing.
Security tokens can be seen as the next evolutionary step for the existing financial networks and instruments. However, regulators, the business community, and other stakeholders still have a lot of work to do to adopt the new technology while circumventing associated risks.