Trying to understand and stay on top of the cryptocurrency market and its current trends can be challenging. Considering that during 2018 alone (as of December 18, 2018), startups using ICOs (initial coin offerings) as chosen method for fundraising managed to collect over USD 20 billion, knowledge is indeed money!
Nevertheless, the digital currency market faced a surprisingly rough period lately. With Bitcoin (BTC) as low as $3.191,30 (on December 15, 2018) and the other main cryptocurrencies losing more than 20% in the last month alone, it is quite clear why the investors started to lose their trust. With the crypto market in turmoil, it is important to follow and understand the reason behind the latest trend: tokens and projects moving out of the legal “grey area” and becoming labelled as securities or security tokens.
Previously, when startups designed their ICO, they were actively seeking to avoid that their tokens were seen as security or security tokens due to the constraint to comply with the regulations and the limitations on how the tokens were traded. Now, on the other hand, companies are choosing to issue security tokens in order to encourage regulators and investors alike to trust in their project.
But what is a security token?
To better understand what security tokens are, first you should understand what securities are. Broadly, they are tradable financial assets and can be classified in the following three broad categories:
- equity securities (such as stocks, shares, warrants etc.);
- debt securities (such as banknotes, bonds, deposits etc.);
- derivatives (such as futures, options, swaps, forwards etc.).
Governments and startups around the world use this approach to collect funds in capital markets from assorted types of investors, that are in return then guaranteed benefits in dividends, interest rates or shares from the company’s profits.
When securities are created by means of a cryptographic token, they become security tokens. In other words, security tokens are part of a certain financial security (or asset) in the form of tokens. In more details, startups that adopt ICOs as favored method to raise capital are collecting funds by emitting tokens on a blockchain and distributing them to token buyers in return for their contribution to the project.
Holders can then transfer tokens across the blockchain, trade them on a crypto exchange (for other type of cryptocurrency or fiat), use them as accepted payment for a variety of services or receive a part from the company’s profits (passive income) in proportion to their investment. According to their function, crypto tokens can be of two types: utility tokens and security tokens (also known as tokenized securities).
Utility tokens are digital “coupons” or user tokens. They guarantee their holder access to the product/service the startup will provide and, therefore, are not created as an investment. In most cases, they are nothing more than loyalty reward points.
Security tokens are a digital assets or investments backed by an external asset (like actual stocks, shares or voting rights) that can be traded. For this reason, security tokens need to respect all federal laws that govern securities.
The most significant distinction that can be made between security and utility tokens is their predisposed applicability and purpose. Security tokens are intended as investments and offer their holder not only the right of ownership over part of the company, but also decision-making rights regarding the future of the company itself. On the contrary, utility token holders have no control over the company related decisions; they can only be used to purchase in advance certain products or services.
Why the shift towards Security Token Offerings (STOs)?
The initial coin offerings dominated this year’s headlines, mostly more bad than good, due to the numerous investors that were scammed. This phenomenon also made an impact on the crypto market as a whole, being one of the reason behind the drastic fall from the last period. After the abundant number of cases in which it was linked to fraudulent practices, the entire fundraising process is being now redesigned to comply with laws and regulations and therefore comply with requirements of both regulators and investors.
The move towards security tokens has already gained momentum thanks to its pragmatism and the fact that it is a fully law-compliant method for startups to raise funds through an ICO in the current market. Security Token Offerings (STOs) seem to be the solution to the problem many organizations are facing nowadays. These digital assets have intrinsic/built-in financial worth, manifest lower risks of volatility and represent the only way of grasping the full potential of the blockchain technology in a legal manner.