Cryptocurrency is a word on everyone’s lips these days. Whether it’s the rise in the value of Bitcoin or the ways that firms are now able to raise cash through ICOs (initial coin offerings), there are all sorts of dimensions to cryptocurrencies that can be explored.
However, the term “security token” is a more complex one: what exactly is one of these interesting assets, and how can they be used for maximum benefit?
What is a token?
Generally speaking, a “token” is simply something that offers you the right to do something else. It may confer a financial benefit when cashed in, for example, or it may grant you entry to a location or the right to use a machine. In the cryptocurrency world, though, the word “token” has a specific meaning. It is used to distinguish between a cryptocurrency itself – which can, at least in theory, be spent elsewhere and have value as a whole – and an internal piece of value that is relevant to just that cryptocurrency in particular, like a share.
Bitcoin is a cryptocurrency, and it would usually be referred to as a “coin” rather than a token. That’s because it can be spent in certain stores, and as a value exchange tool for certain transactions. A token, though, would be something else. Often, a token is used as part of an ICO: when a company decides that it will use the cryptocurrency world in order to raise funds, it will sell off some tokens as a product.
There are a whole host of token types out there, even within the cryptocurrency sphere. Utility tokens, for example, provide the holder with the right to access a particular service or product. Other types of token, meanwhile, may confer voting rights, which gives the holder the chance to contribute to the performance of the wider network.
Security tokens, though, are different. In real-world finance, the term “security” simply means an item with either current or potential financial value, which can be listed on some sort of exchange in order to be traded. In the crypto world, it’s similar: the value of a security token is derived from an asset and can be bought and sold. In the context of an ICO, then, a person may buy a token in order to get involved in a particular crypto community, or contribute to the development of whatever project the ICO is funding. However, if they buy a security token, it’s likely to be because they want to sell it on at a profit.
The legal significance of security tokens
When a token is designated as a security, its nature changes. In the US, this puts it under the jurisdiction of the Securities and Exchange Commission (SEC). This organization is, alongside the Commodity Futures Trading Commission (CFTC), one of the country’s main financial instrument regulators – and it places a whole host of regulations on security tokens and ensures that they are traded in a way that encourages fair and transparent financial markets.
In theory, all securities need to be registered with the SEC before they can be properly traded. However, there are some exemptions. One of the main themes of the exemptions lies in whether or not investors are accredited: if you have non-accredited investors but the security has been SEC-validated, then it may be possible to get a form that allows you to sell it up to the value of $50m.
Usually, it’s advised that those running an ICO or planning to buy a security token get some independent advice in order to be certain that what they’re doing is fully legitimate and above board. It can sometimes be tempting to think that because cryptocurrencies and the blockchain exist mainly in the online space, this exempts them from real-world laws. In fact, the opposite is true: the authorities in the US and around the world regularly police cryptocurrency fraud and other legal issues, so don’t get caught out.
In sum, then, security tokens are some of the most innovative financial instruments out there these days. Not only do they provide the holders with the chance to benefit financially, but they can also allow them to access a community or – in some circumstances – voting rights. They mimic shares in the real world, but offer so much more as a result of their dynamic, blockchain-powered nature. While these assets do fall under the auspices of all kinds of securities legislation, they are still considered by many to be worth investing in providing the context and financial potential is right.