Fundraising is an area where cryptocurrency truly shines. Being able to access capital is essential for any business. Initial public offerings are popular and almost considered a rite of passage for a company’s founders—a validation that they have made it. However, security tokens offer several advantages over stocks when it comes to going public.
What are Security Tokens?
Security tokens are a form of tokenized digital security. To make sense of this definition, we must define what it means for something to tokenized and explain what a security is.
A token is something that represents something else. It can represent ownership, a vote, or a particular amount of value. Tokens differ from cryptocurrency coins in that they do not have value outside of their native ecosystem. Cryptocurrency coins like Bitcoin or Ethereum have a value that is independent of their platforms. This is sort of like the difference between U.S. dollars and a subway token. You can only use the subway token on the subway system, while you can use U.S. dollars pretty much anywhere.
A security is a financial instrument that holds some form of value. Stocks are a form of security. Certificates of Deposit (CDs) and bonds are also examples of securities. In the U.S., the U.S. Securities and Exchange Commission (SEC) regulates the sale of securities. In the EU, securities are regulated by the European Securities and Markets Authority (ESMA). Similar agencies regulate securities throughout the nations of the world.
Thus, a tokenized security is a token that holds some form of ownership, voting right or dividend. Security tokens are typically distributed in what are known as Security Token Offerings (STOs). These provide a more trusted way to raise funds than Initial Coin Offerings (ICOs), which were fertile ground for scammers.
Why Security Tokens are the Future
STOs have begun to replace ICOs and Initial exchange offerings (IEOs). During STOs, investors receive tokens in return for their contributions. These tokens are backed by securities like stocks and bonds, so they are regulated in the same way.
ICOs have fallen out of favor because they were designed to avoid certain legal frameworks and yet still managed to violate others. With that being said, they managed to accomplish some great things. They provided a very simple path for distributed application developers to raise money for their projects.
Typically, the developer in an ICO would issue a limited number of tokens. This limited supply ensured that the tokens would maintain value through scarcity. Anyone interested in purchasing the ICO tokens would simply send funds to the ICO address and a smart contract would send the corresponding amount of ICO tokens back to the contributor.
Since security tokens are regulated, STOs have a much more rigorous process than an ICO. ICOs are similar to an initial public offering (ICO) like that done by stocks going public in that they are a privately-owned entity attempting to become a publicly-owned company. STOs are essentially real-world assets being moved around on the blockchain. This means that they serve as a bridge between the traditional financial system and the blockchain-based financial system.
Advantages of Security Tokens
Security tokens have the potential to undo some of the harm done to the cryptocurrency community by ICOs. Here are some advantages that security tokens have over coins and utility tokens.
For more informative content you will be glad to read one of our most recent articles, “What is Sound Money and Why it Matters?” by Kenny Fowler
They Can Restore Accountability
The ICO scene has produced some unsavory headlines in recent years. The fact that several ICOs have turned out to be scams has led to the perception that all ICOs are scams. While this is not true at all, bringing together the cryptocurrency and traditional financial worlds together seems an easy way to restore some sense of trust.
They Can Help Traditional Finance Solve Some of Its Problems
Traditional finance tends to be slow, expensive, localized and centralized. Cryptocurrency can help with all the above. Security tokens can eliminate all the middlemen that take a cut of the action, leading to a reduction in fees. These middlemen also complicate and slow down the process. With these intercessors removed, the transactions can be completed much more efficiently.
Brokers and banks are not the only middlemen that can be eliminated. Smart contracts will automate tasks that lawyers currently do in an IPO. The traditional financial system is highly localized, separated by hundreds of national currencies. Security tokens eliminate this barrier and allow investors from all countries to take part in a fundraising effort. The increased automation involved in the process also eliminates middlemen at the institutional level, decreasing the chances of manipulation.
Security tokens bring the traditional financial system and the blockchain together in a mutually beneficial relationship. The token is backed by a regulated security, providing the public all the peace of mind that comes with buying a stock. The way the security token is transacted on the blockchain offers great potential for streamlining and automation, making buying and selling securities quicker, cheaper and more freely accessible to all.