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Many expect cryptocurrencies to serve as an improvement on existing financial solutions. Blockchain technology offers a wide variety of tools that can perform particular functions and may well become the base for the new financial system. In this article, we will look into security tokens, which are the digital counterpart of securities.
What are security tokens?
Morgan Creek Capital’s managing partner, Anthony Pompliano, defines security tokens as “digital assets subject to federal security regulations; they are the intersection of digital assets (tokens) with traditional financial products.” That is, security tokens are programmable ownership of a particular asset, such as real estate, stocks, dividend payments, etc.
When is a token a security?
To determine whether a certain token belongs to the category of security, the Howey test is used. The “ Howey Test” was created by the Supreme Court for determining whether certain transactions qualify as “investment contracts.” Under the Howey Test, a transaction is an investment contract if all of the criteria below are met:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
If the test gives a positive result, then under the Securities Act of 1933 and the Securities Exchange Act of 1934, financial transactions are considered securities and, therefore, subject to specific disclosure and registration requirements. This means that only accredited investors can legally buy these securities.
To become an accredited investor in the United States, you must own assets worth over one million dollars (spouse’s joint assets are also taken into account) or have an income of over 200,000 USD for each of the last two years, or joint household income of over 300,000 USD for that same period.
One of the three requirements must be fulfilled to obtain an accredited investor in Russia.
- Own a minimum of 6 million rubles in the form of securities, derivatives, funds on accounts, or deposits.
- Length of service of at least three years in an organization that concluded transactions with securities or derivatives, or at least two years in an organization, holding a qualified investor status.
- Conclude transactions with securities for a total amount of 6 million rubles or more over the past year.
Security tokens use cases
The main advantage of security tokens compared to classic financial products is the ability to eliminate the need for a third party, i.e., a bank or a broker.
Advantages of security tokens compared to classic financial products:
- Round-the-clock access to markets
- Ability to own a part of the share
- Fast execution of transactions due to the absence of intermediaries
- Simplification of exchange/trade operations
- Ability to create an ecosystem of related services.
If you want to profit from the increase in the S&P 500 index price but do not want to invest $3,000 in the asset, you can buy a security token of this index and enjoy all of the asset’s advantages.
However, it is worth mentioning that currently, the liquidity of the security tokens market is extremely low. According to the website securitytokencap.io, the daily trading volume of these tokens does not exceed $100,000. Such volumes are not able to satisfy the needs of accredited investors.
STOs are a way to raise funds similarly to ICOs, but with its own characteristics. ICOs use cryptocurrencies that are useless outside of the blockchain. The value of these cryptocurrencies lies precisely in the technology of the platform they are launched on.
STOs, in turn, offer assets similar to securities, which are either fully placed within the legal framework, or have a fixed value on predetermined conditions. Some STOs are registered with the Securities and Exchange Commission (SEC), which means that the process has followed all of the legal requirements.
There are specialized platforms that conduct STOs, with Polymath, Smartlands, Securitize, and Harbor being some of the examples. However, STOs can be held on Ethereum, EOS, Neo, and other blockchains, collecting funds on the smart contract address. However, this approach is riskier, since, by law, only accredited investors can participate in STOs.
In 2018, many believed that STOs would become a new trend, replacing ICOs. But it has been made clear that now neither accredited investors nor companies are interested in this topic.
However, some governments did show a certain level of interest, as many of them do not agree with the opinion that everything that developers call utility tokens are, in fact, what they are stated to be. Rumors have it that the SEC’s decision that Huobi Token is a security has led to the inability of the Huobi exchange to enter the US market, which hampered the emergence of a subsidiary of the American Huobi exchange.
If governments pay more attention to cryptocurrencies, perhaps we will see a new wave of popularity of security tokens as a fully legal digital tool.