Blockchain is no longer a new concept… The technology has grown, and we can see its applications in every field — e-commerce, supply chain, management, finance, etc — , it is an available tech and ready to be massive. The widespread publicity and the appearance of new token economies, the rage of creators producing NFTs and the ownership economy emergence have positioned the technology as the new standard. Security tokens have been around for a while, but given the several constraints in terms of regulations or lack of them, the strict ties to jurisdictions, and the high costs for setup, have slowed down its permeation.
This year, the market has surpassed the 1 Billion dollars and marked more than 2.8x growth since the beginning of the year. Many exchanges are investing in the issuance and frameworks for these types of tokens to work. Many traders are now turning their attention to investing in security tokens, but what are them and why are they receiving such attention?
Here are the basics that can help you understand what a security token is and how it works.
What are security tokens?
In essence, a security token is a form of “fractional ownership” of an asset that already has value, like real estate or shares in a company. The information about this asset is encrypted in the form of a token and stored on a blockchain. Therefore, security tokens must comply with the provisions of certain securities laws depending on the jurisdiction they are issued.
Security Tokens are usually generated with the sole purpose of raising capital, giving a digital certificate of ownership to the different stakeholders of the project. Based on the amount of security tokens held, investors will receive dividends (dividends), profits (from the company’s activities), shares, or any activity that generates profits for the company. Said this, is becoming a type of legally binding investment contract that allows the owner to have decision-making power in the business decision-making process of the business. Ownership of shares in the form of security tokens by investors will be stored on the blockchain ledger. Likewise, businesses issue shares in the form of security tokens and give voting rights through the blockchain.
Security Tokens can also represent ownership over off-chain assets, such as real estate, equipment, bills payable, or businesses. Similar to stocks, the value of a security token is directly linked to the value of the asset. Typically, the value of a security token will be proportional to the business performance, the value of the respective underlying security. If the price of the underlying security asset increases, the price of the security token should also increase, and vice versa, if the price of the underlying security asset decreases, the price of the security token is expected to decrease accordingly, however, the price is always regulated by the market.
A token is called a security token when the following conditions are satisfied:
- That token must be a financial investment product
- Investments must be made to the company or organization
- Investors have the expectation of owning that token to make a profit
- Expected profit is generated by the third party
Security token offering
Security Token is issued through the Security token offering (STO), also known as the form of fundraising through the sale of tokens to investors. This form is somewhat similar to ICO (Initial Coin Offering) but with the difference that, in ICO, the coins/tokens do not represent any (tangible) assets or shares of the project. In STO, the tokens are security tokens that can represent stocks, bonds, funds, real estate… of that project or company.
However, this form of fundraising with security tokens is not always suitable for all projects. Young startups without working products and no revenue will find it difficult to satisfy the conditions to issue STOs due to the requirement for assets of the company to tokenize. That asset can be physical facilities, or revenue and profits from that company’s operations. The usual start-ups started operating, or even just started to have an idea to raise capital have not yet realized a profit and do not have a substantial amount of assets available to price the security token against that return. STO form is suitable for companies and businesses that have been put into operation and have revenue. Also because of this feature, STO is considered to be an advantage over ICO, which has a lot of scam projects, scams…
Why security tokens?
More and more organizations and businesses (for example: Apple, Microsoft, Tesla…) are tokenizing their assets into security tokens due to the benefits this token brings:
Risk reductions for investors
The projects and companies that issue security tokens through STO must comply with the provisions of the law which can eliminate scams and frauds in investing. If the STO process is not completed, the business may be punished according to the law. Besides, blockchain technology minimizes the role of intermediaries involved in financial transactions, thereby, reducing the risk of market manipulation and destruction. If the STO process is not completed, the business may be fined according to the law. Blockchain technology makes the ownership of security tokens more transparent. Moreover, it brings peace of mind to investors because owning a security token is owning the assets of the project or company in real life.
Transparency
Blockchain technology storing the owning information of securities tokens in the ledger makes the ownership of security tokens more transparent. Moreover, it provides peace of mind to investors since holding a security token means owning the assets of the project or business in real life.
Rights of security token owners
Similar to stocks, investors who own security tokens will have the right to give their opinion on the decisions of the company or organization. The more security tokens they have, the more influence an investor has.
Remove geographical barriers
Security tokens completely remove the barriers of geographical distance, helping business owners to reach investors around the world easily through the Internet. Investors in any country can participate with a minimum capital as well as can participate in many different STO projects.
Cost reduction
Since security tokens are issued on the blockchain and use smart contracts to manage, they have the ability to significantly eliminate intermediaries such as brokers, banking services and legal consulting services… The organizations and companies can reduce the cost of operating. Besides, the transaction process becomes a bit simpler for investors. Therefore, the transaction cost of security tokens is also significantly reduced.
High liquidity
Liquidity represents one of the most important concepts – beyond market capitalization – that everyone needs to understand when trading or investing in cryptocurrencies. Liquidity is the degree to which a particular asset can be bought or sold quickly without affecting the overall stability of its price. In simple terms, liquidity refers to the ability of assets to be converted into cash easily.
The promise of global liquidity is perhaps the most valuable point of security tokens. Security tokens have the ability to represent fractional ownership of assets and can be traded on global stock markets and exchanges – two things that are virtually impossible for traditional securities. Due to the elimination of distance and investment conditions, many investors can access and trade security tokens which create high liquidity for this market.
Potential of security tokens’ penetration
The traditional stock market has limitations in terms of accessibility, country-specific legal procedures, intermediary services, etc., making it difficult for foreign investors to access and invest. In contrast, the security token markets are somewhat more active as investors are allowed to trade, buy and sell cross-border through digital tokens, and are reflected in the traditional market through private equity. The entire process is immediately stored and authenticated through the system. This gives investors of security tokens access to the traditional stock market and benefits traditional investors with greater liquidity. Ownership and price transparency are also guaranteed. With only a digital wallet without a complicated authentication process, investors can easily invest in the blockchain world while still being assured of safety and security.
In general, Blockchain is still considered a new and potential technology. The STO form of fundraising with security tokens associated with this technology is also very new. However, the security token market is still not clear, and many leading organizations that have dominated the STO market such as Polymath, Swarm, Harbor, Own Market, etc. have not really exploded. Many investors are still cautious about investing in security tokens. But that does not mean that they miss a good opportunity to learn and catch the new trend at this rekindling stage.
About Dandelion Labs
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