In this second article on cryptocurrencies, I’ll try to explain a bit about so-called security tokens – what exactly are these tokens, what are they used for, and how are they different from for example Bitcoin. The world of cryptocurrency/tokens can be divided into three types:
- Utility tokens
- Security tokens
Cryptocurrencies are virtual coins used for the very rapid transfer of money/value to any place in the world, such as for example Bitcoin. Each Bitcoin (BTC) has a specified value at a given moment, and when we send Bitcoins, we simply transfer this value from one account to another. No Bitcoin has any other additional functionality – they cannot be used for anything other than the transfer of value. More information on the topic of cryptocurrencies and blockchain technology can be found in my previous article – Blockchain, Bitcoin, cryptocurrencies – introduction for beginners.
So-called utility tokens combine features of cryptocurrencies with some other kind of functionality. Each token can be treated strictly as a means for transferring value (as in the case of Bitcoin), however, depending on the platform, they may be able to provide some additional functionality – usually access to a service or product. Examples are:
- Golem – Golem is a network for making computing power available for demanding tasks in which each participant can decide how many GNT tokens he or she would like to receive in exchange for making the computing power of his or her device available, or conversely how much he or she would be willing to pay to the rental of such power from other users.
- Civic – Civic is a platform which provides services for the identity management and verification; the CVC token is used for payment on this platform.
- Basic Attention Token – the BAT is a token used on the Brave marketing platform for buying/selling different kinds of services and advertisements.
- Ethereum – Also Ethers can be treated as utility tokens which make it possible to take part in all so-called ICOs (Initial Coin Offerings of tokens or coins at the moment they are created, the equivalent of an IPO for stocks) as well as execute so-called smart contracts (the topic of smart contracts is so broad that it deserves another separate article in the future).
- And many others (many of the items in Coin Market Cap are precisely this, utility tokens).
A general definition of so-called security tokens can be given as a blockchain representation of value, which is to some degree regulated by the state.
Security tokens are still a little-known issue, but one with a financial potential many times greater than cryptocurrencies and utility tokens. Put simply, they are a kind of reflection of different kinds of assets and values in the form of tokens. The value represented by security tokens can be linked to securities, real estate, or shares in a company – with any legally regulated model of ownership.
One can say that security tokens are a new form of the concept of ownership rights. Until now, real estate has always had a clearly defined owner (or owners) and shares have always been bought and sold as single, indivisible units (it is not possible to buy a half a share, thus leading to the phenomenon of stock split). Nowadays, the idea is to reflect ownership through a given number of tokens (if the share is divided into 100 tokens, then each token represents 1/100 of the value of the share). This form of ownership has a wide range of properties and advantages over traditional forms:
- 24/7 Access to the market
The majority of stock markets operate from Monday through Friday between 9 or 10 a.m. and 4 or 5 p.m.. In the evening, at night, and at weekends trading cannot be carried out. Cryptocurrency markets operate 24 hours a day.
- Partial ownership
This is not a new concept, but until now it has been poorly implemented. Splitting of stocks or, for example, commercial real estate into tokens makes it possible for a much larger group of people to have partial ownership.
- Instant settlement
In classical investing, it is important to differentiate between the conduct of the transaction and its settlement. Shares markets and investment funds most often operate according to a T+2 rule, that is if in a given day a transaction is conducted (the main element of which is the agreement between the seller and the buyer regarding the price), then settlement for the transaction (that is, the creation of full documentation associated with the transaction and the actual transfer of ownership from the seller to the buyer) only takes place 2 days later.
This image comes from a very good article explaining the process of how transactions are conducted – Simple explanation of how shares move around the securities settlement system. Currently, the so-called financial markets can conduct transactions very quickly, but the settlement of these transaction always takes several days; in the case of cryptocurrencies, this problem simply does not exist.
The representation of something quite expensive (such as commercial real estate) by tokens gives new possibilities to both parties on the market. If the owner of a building has a problem with selling it, it is often easier to sell to a group of small investors who buy a determined number of tokens than to find a single investor who is capable of buying the whole building. On the other hand, if someone is looking to participate in the profits of renting a building but can’t afford to purchase an entire building, now such a person can take part despite having limited financial resources.
Regardless of whether my tokens represent stock, real estate, or something completely different, I can still keep them in one portfolio, as all security tokens by definition are meant to use the same standard of recording and storing information. At this time, it is impossible to imagine sales of stock and real estate using the same system.
Regulators – or potential problems
It is easy to lose oneself in the fantasy that security tokens are a new technology sector that will soon be worth billions. It is possible that this will happen, yet much will depend on the actions of regulators (to get back to our initial definition, security tokens are a blockchain representation of a value which is subject to regulation). Two potential problems which I see coming up on the horizon are:
- permissibility – certain defined classes of value (such as stocks or commercial real estate) may not be permitted for representation in tokens, for any of a number of reasons indicated by regulators
- limitations on trading – shares most often can be bought and sold in one country in one stock market (although there are companies which are traded on several trading floors simultaneously). If then for example, we represent the value of a Polish company traded on the Warsaw Stock Exchange in tokens, how can we be sure that the Polish regulatory agency will allow these tokens to be traded in other countries? And if they can only be traded in one country, will they be permitted to be traded in more than one cryptocurrency exchange? We cannot be certain.
As an interesting example, take the USA and the current regulatory environment, in which companies can decide which regulations to apply depending on how they plan to sell/distribute shares:
- Regulation D
A company may raise an unlimited amount of money, though in most cases only from so-called accredited investors. These can be located in any place in the world, but must demonstrate accreditation in compliance with American norms. It is not necessary for the company to get SEC (Securities and Exchange Commission) consent, but after sales of shares, a summary must be sent to the SEC. More information can be found here – Regulation D: Everything You Need to Know.
- Regulation S
A company can raise any amount of money, but only from international investors (accredited or otherwise). The company does not need to seek SEC approval for conducting transactions.
- Regulation A+
A company may raise up to 20 million, or in another option up to 50 million, dollars from any investors (accredited or otherwise) around the world, but must previously obtain the consent of the SEC for sales transactions conducted under this regulation. The limit of funds determines the scope of the audit which will be conducted by the SEC in the company before issuing consent.
As you can see, the concept of accredited investors is interwoven throughout all of this. Unfortunately, in the USA, in compliance with regulations on access to offers on the non-public market (that is, all initial tokenisations, ICOs or even purchase of simple shares during IPOs) is restricted to individuals who are able to demonstrate accreditation. Others must wait until a given asset is available for sale on a public market.
The current landscape
When it comes to the platforms and protocols associated with security tokens available at the moment, the following are worth note:
- Polymath – Polymath is meant to be for security tokens what Ethereum is for utility tokens, that is a protocol on which a given item is reflected in the form of tokens. It is promoting the ST-20 standard for security tokens as the equivalent of the ERC-20 for Ethereum-based tokens.
- Harbor – Another protocol for security tokens, currently at a very early stage of development.
- Securitize.io – A company offering comprehensive services associated with tokenisation.
Two other platforms positioning themselves for trading in and only in security tokens are worth note: