What are Security Tokens and Security Token Offering (STO)?

Security tokens-digital analogues of securities (English. – Securities) that certify property and give the owners the right to realize their investment interests (the right to shares, dividends, a share of profit, etc.P.). These rights are recorded in a smart contract, and the tokens themselves are traded on exchanges. The turnover of security tokens occurs in accordance with the legal norms of financial regulators of various countries, for example, the US Securities and Exchange Commission (SEC) or the Swiss service for supervision of financial markets (FINMA).

Morgan Creek Capital Managing Partner Anthony Pliano in his article “The official guide for tokenized securities” is defined by Security Tokens as “digital assets obeying federal laws on securities, something between tokens and traditional financial products”. He also characterizes security tokens as “programmable ownership”, which can apply to any asset-public or private capital, monetary obligation, real estate, etc. D.

Why are security tokens needed?

Due to the features of security-tokens, from the point of view of a legal prospect, they are completely different than the so-called utilitarian tokens (Utility tokens). The latter are popular among the organizers of the ICO, representing a means of obtaining access to the product or service of the company. Unlike UTILITY-TOKENS, security tokens are tied to real securities, that is, they are considered financial investment, and additional regulatory requirements are imposed on the companies that produce them, including reporting.

Security Tokens also solve one of the biggest problems of ICO-the lack of compensation guarantees in the event of a project or fraud by the organizers. In addition, they serve as a risk hedging tool with such an investment strategy as a simple agreement on future tokens (Simple Agreement for Future Tokens – SAFT). This model is considered safer, as it gives accredited investors the opportunity to purchase tokens after the launch of the project, but it is still associated with certain risks: investments are not sent to tokens, but in fact to the promise to get them in the future.

What are the advantages of secret-tokens give?

One of the main advantages of Security Tokens compared to traditional financial products is to eliminate mediation in the person of banks and other organizations. This determines the creation of a completely different environment for investing and concluding transactions.

In his article by The Security Token byesis, a professor of finance of Oregon University and the Harbor project editer (attracted $ 28 million investments to create a protocol for the release and trade of secret-tokens), Stephen McCeon transfers the following key advantages of this class of assets:

  • Access to markets 24/7
  • Shared ownership
  • Fast execution of transactions
  • Reduced transaction costs
    Increasing market liquidity
  • The possibility of automation of Compliance process
  • Simplification of exchange/trade operations of such assets
  • The ability to create an ecosystem of related services

How to determine that the asset belongs to the category of security tokens?

The position of the American SEC regarding the fact that it should be considered a security is traditionally important. To understand the approach that the US financial regulator adheres to, it is necessary to return to Florida in 1946, where the company owned by orange plantations called Howey Company offered investors an unusual decision. The scheme suggested that investors acquire a plot of land with plantation, and Howey Company gives a clearly written obligation to conduct work there and pay them part of the income.

The transaction, however, was prevented by the SEC – the commission decided that this scheme is an investment contract and the participants should have been properly protected. Howe Company challenged this decision, saying as an argument that we are talking only about the sale of land. The case eventually turned out to be the consideration of the US Supreme Court, which took the side of the commission, thereby laying the beginning of the determination of what was considered a securities.

In honor of the company that entered into a legal dispute with the authorities, the so -called Howey Test (Haui test), According to which the transaction is classified as a security if the investor answers in the affirmative to all the next four questions:

  1. There is a fact of investing cash.
  2. There is a expectation of profit.
  3. Money is invested in an ordinary enterprise.
  4. Any profit and its size depend not on the efforts of the investor, but on the efforts of the counterparty or third party (promoter).

It is this test SEC that applies today to ICO and tokens, and if an affirmative answer is given to all the questions, then the investor is going to invest in investment (security) tokens.

What is Security Token Offering (STO)?

According to widespread opinion, Security Token Offering (STO) is the following evolutionary step after the INITIAL COIN OFFERING (ICO), which determines the industry development vector towards a more regulated and transparent market. However, STO and ICO are two different mechanisms for attracting investments intended for different situations.

First of all, STO involves the release of digital assets in full accordance with the requirements of the legislation on securities. This should provide a higher degree of protection of investors and reducing regulatory risks for tokens issuers. In addition, STO focus on another target audience – exclusively professional (accredited) investors can participate in such placement.

This category, according to the US legislation, includes persons who meet at least one of the requirements listed below:

  • An annual income of more than $ 200,000 per person or $ 300,000 for a married couple, supported over the past two years and predicted in the current year, in which the person plans to carry out investments;
  • Net assets in the amount of over $ 1 million, which does not include the value of real estate in which the person lives on an ongoing basis;
  • An organization that has assets in the amount of over $ 5 million, for example, a venture or target fund;
  • A company whose members are accredited investors.

In addition, there are a lot of technical details that the investor needs to know for proper participation in Sto, and the organizers to attract funds. In particular, when conducting STO in the United States, issuers should take into account the law on securities from 1933, namely several of its provisions: position D, position A+ and position S. They describe various scenarios in which companies can offer investors securities (security tokens).

What disadvantages do Security Tokens have?

The cryptocurrency industry, first of all, concerns the ICO sphere, is often perceived as a kind of reincarnation of the “Wild West”, where the right is strong and the ability to crank up a particular scheme. STO, as already mentioned, largely removes this whole process from the gray zone, but it also means that the sector loses previously the usual advantages.

High threshold of the entrance. Since investment in Security Tokens involves the participation of only accredited investors, this automatically cuts off a significant part of the cryptocurrency community, including quite law-abiding participants.

Higher expenses for issuers. Despite the decrease in transaction costs, the launch of Sto is associated with significant bureaucratic red tape. This means increased expenses for lawyers and other specialists who contribute to the smooth launch of the project. Consequently, due to high Sto costs are more suitable for companies at later stages of development (round A and above).

The above-mentioned Anthony Pliano in his work on Security Tokens also suggests that the “reverse side of the coin” is that when the intermediary is eliminated, his functions go to the buyer and seller. In particular, he draws attention to the fact that the parties that are traditionally responsible for the preparation of marketing materials, the attraction of investors, ensure a high level of compliance with regulatory requirements and the successful conclusion of the transaction are excluded from the transaction. However, one can safely argue with this statement – many companies successfully develop their own marketing departments without giving such issues to outsources.

Where are the sekURITY-tokens are traded?

Despite the fact that this direction is considered promising, the capabilities of investors are still quite limited. Already existing large cryptocurrency platforms, for example, Binance, as well as large stock exchanges like NASDAQ, are also declared to work in this area. Nevertheless, at the beginning of 2019 there was a very small number of licensed trading platforms offering such tools.

Among them, the Tzero platform can be noted, which officially launched in January. The first token to bargain http://coin-graph.website/?p=616 on Tzero was Kodakcoin designed to serve the digital images of Kodakone. This token allows professional photographers and amateur photographers to pay for licensing their work, a share of the common income of the platform and sell ownership of their work using the safe Kodakone platform.

At the end of 2018, the Harbor startup launched a platform for the distribution of security tokens, offering investors to register for the purchase of shares in the residential complex of The Hub in South Carolina. 955 shares in the form of security tokens were put up for $ 21,000 per unit.

It should also be noted other startups specializing in technological and financial solutions for this sphere. So, among the creators of the SRC-20 protocol, which is considered the cryptographic standard of Security Tokens, liquidity suppliers and other solutions for this area, you can distinguish Blockchain Capital Brock Pierce, Polymath, Securitize, Securrency, Openfinance andords.

During 2019, the situation, however, may change significantly, and it is assumed that competition in this market will significantly grow.

What future is security-tokens awaits?

Despite the fact that a number of projects are still desperately trying to avoid the situation in which the tokens they produce are classified as securities, the general tendency is in this direction. Good or bad is a question that is not a definite answer.

On the one hand, the arrival of institutional investors, namely, accredited investors are understood as they can radically change the entire landscape of the industry and give it an important impulse to development. On the other hand, it must be remembered that in nature, security-tokens are fundamentally different from cryptocurrencies in their usual sense. There is a large layer of the community that categorically refuses to adopt new rules of the game, offering its own solutions based on the Bitcoin blockchain and not without reason to believe that the future is precisely for a truly distributed network with its powerful security mechanism in the form of a Proof-OF-WORK algorithm.

At the same time, you should not throw off the accounts of players who will continue to adhere to the principles of traditional ICOs. They can go to other jurisdictions, somewhere to change the rules of the game, but in general will continue to offer investment opportunities for a wider circle of users.

The trend, however, is obvious, although the transition to it will not be simple. In addition to the need to comply with the rules of financial regulators, the development of this industry also requires the creation of the necessary infrastructure. And this may turn out to be an even more difficult task than a simple purchase of bitcoin.