Essentially, a security token is one that “securitizes” a real-world asset. So the coin is backed by an asset that has a tangible value, unlike an ICO that involves utility coins which might accelerate in value but can also turn into ether. Security tokens enable assets to become much more liquid as they allow fractional ownership of assets. And their blockchain-based structure means the ownership rights are transparent and easily verifiable. Here’s a simplified example of security tokens at work: Your friend is starting a cat food company, but needs investors. She offers a “Meow Meow” security token for $1, with a goal of raising $250,000. Investors buy blocks of the tokens and this ownership might come with certain rights or dividends. Your friend receives the money necessary to build a business, and the investors gain ownership stakes and the potential for profits as the business succeeds.
A key benefit of security tokens is they provide liquidity to the underlying asset. They’re cryptographic tokens that pay some sort of dividend, interest, or other payment to the token holders, so they are highly liquid compared to more traditional assets such as stocks or bonds. Many in the blockchain and cryptocurrency industries see security token offerings STOs as the future vehicle for investing instead of ICOs which peaked (and often crashed) in 2017.
Intriguing Use Cases
The advent of security tokens is part of the broader ability of the blockchain and cryptocurrencies to “democratize” finance and access to money-making endeavors. Proponents of blockchain and related financial investments point to the fractionalization and transparency as ways to dramatically lower the barriers to entry. Security tokens help break down these walls further by tokenizing assets that were previously illiquid.
Consider fine art, an investment vehicle that’s dominated by the super wealthy. Until very recently it was inconceivable to picture a Van Gogh being sold in parts. Maybe some people could buy an ear, others a flower? With security tokens and smart contracts, it’s simple to offer fractions of ownership to buyers. An Andy Warhol painting was recently put up for a tokenized auction, with more than 800 bidders purchasing $1.7 million worth of a Warhol painting valued at $5.6 million. It’s considered the first and biggest auction of its kind to date, and opens up an investment type to people that likely never dreamed about owning famous artistic works.
Another use case for security tokens is the real estate market. Buyers can purchase fractionalized pieces of a property either through a sale or as part of an initial funding round. The St. Regis Aspen Resort in Aspen, Colorado raised $18 million of tokenized liquid funding through various accredited investors. Such moves allow real estate firms to access liquid cash so they can make improvements or expansions, while providing investors with an opportunity for longer-term gains.
The potential applications for security tokens are nearly limitless due to their simplicity and security. Assets such as gold and silver or even classic cars are ripe for securitization with tokens, as are many other classes of commodities. As long as an asset class has a definable value, then it has the potential to be securitized.
Regulations and Venture Capital Implications
Securitized tokens in the U.S. are subject to federal securities laws and the investments are often restricted to accredited investors. While Bitcoin and other cryptocurrencies are appealing because they’re decentralized and not beholden to too many regulations, there is some comfort for investors with securitized tokens. SEC oversight adds some legitimacy and protection to such investments. Government oversight means higher investor trust in security tokens as an investment, and more willingness for owners or artwork, real estate, companies, or other assets to employ security token sales. Sales of security tokens are more automated and transparent than traditional means and will eliminate much of the back office infrastructure that’s currently required to manage investments.
For VC’s, security tokens have the promise to transform their entire business. More VC funds will likely go to crowdsourced security token fundraising instead of more traditional IPOs or series funding rounds open to limited numbers of investors. By using a securitized token method of fundraising, venture capitalists expand their potential number of investors exponentially and can also make the funding company more liquid.
Unlike the gray area of whether or not ICOs are “securities”, investments in venture funds through security tokens are definitely considered SEC-managed securities. STOs provide investors with similar access as IPOs such as voting rights, profit sharing, and other advantages that aren’t present with ICOs. Such benefits should further drive interest in STOs among larger accredited investors and individuals. The market will need to mature over time through automated compliance platforms and other related enhancements such as disclosure tools that can send mandated information to security token owners.
The appeal and usage of security tokens and STOs will continue to spread throughout 2018 and into 2019. They represent a transformative shift for finance and for bringing liquidity and fractionalized ownership to a variety of asset classes. Sphere can help you develop a blockchain and token strategy that gets noticed. We understand the technical side and market use cases for blockchain-related tech through our end-to-end development approach. We help clients to create cryptocurrencies, leverage the Hyperledger solution, execute Ethereum smart contracts, and many other related initiatives. Our team employs a remote development model to provide clients with cost savings, and prides themselves on transparent communication throughout the project.
Visit us at www.sphereinc.com to learn about our breadth of services, including how we can craft your company’s complete blockchain strategy.