By Aaron Kaplan
Chances are you’ve heard the term “security token” circulating the crypto space, and chances are your reaction was to furrow your brows in confusion.
The industry’s reliance on incomprehensible buzzwords has earned it a reputation for thoroughly baffling the uninitiated. Part of that phenomenon can be attributed to the fact that crypto and blockchain are, in their nature, new and complex subjects that are tremendously difficult to explain in simple terms. But the intricacy of the space is exactly why semantics are so crucial.
“Security token,” in particular, is an oft-used but scarcely explained term that anyone who follows crypto needs to understand in order to digest the exciting developments shaping the industry today. The time has come to properly define it for all the brow-furrowers and the naysayers, and all others who are interested.
First things first
Let’s start with a basic definition of the term “security token.” A security token is a compliant digital asset represented by a cryptographic token that trades via a blockchain. Not to be confused with cryptocurrencies (coins), tokens aren’t limited to one role in their crypto ecosystem. They can serve as anything between a value and a stake -- even a voting right.
The difference between a “crypto” security token and a cryptocurrency (like Bitcoin and Ethereum) is that cryptocurrencies represent stores of value used to purchase goods or items outside of their native platforms and are regulated under the Money Service Bureau (MSB) rules and regulations. Tokens, on the other hand, are value-transfer instruments that can represent different asset classes or sets of rights. That means they can have just as much tangible value as stocks in a company or a valuable piece of art.
Tokenized securities vs. securitized tokens
In the securities context, security tokens can be subdivided into two main categories: tokenized securities and securitized tokens. Tokenized securities are the same as traditional securities, such as equities or debt. The difference is they trade via a cryptographic token over a blockchain.
Tokenized securities won’t bring as much short-term innovation to the financial industry, but as the use of blockchain becomes prevalent in financial services and markets, new issuances of traditional securities will migrate to blockchain ecosystems to enjoy the efficiencies and cost benefits associated with blockchain-based platforms.
Securitized tokens, on the other hand, are a brand new asset class. They combine the benefits of distributed ledger technology with the innovative utility features of the new token asset class. Here’s what makes securitized tokens so novel: They are compliant financial assets (securities) that must be issued, transacted, and processed compliantly under U.S. federal securities laws, but also have utilities in the distributed economy.
A perfect example of a securitized token is the Filecoin token.
Filecoin’s token was the first to be issued compliantly via an exempt Reg D security offering in 2017. While the token is a security, the Filecoin token also has a utility in that owning the token gives you a right to store data on the Filecoin blockchain. Securitized tokens take the best from both worlds, representing an innovative new asset class whose value isn’t only tied to the profit and loss of the underlying issuer, but rather the user interest in the underlying protocol or ecosystem to which that specific securitized token is tied.
As such, securitized tokens themselves embody the evolution of markets brought about by a new, digitized asset class.
What advantages do security tokens offer?
The blockchain nature of security tokens and their inherent ability to interact with smart contracts introduces efficiencies that disrupt the traditional methodologies of the 20th century securities model. The security token is the 21st century security, offering new and cost-efficient methods of capital formation whereby issuers will be able to customize their cryptographic tokens to meet the specific needs of their investors and/or industry.
Securitized tokens are dual natured in that they are compliant financial assets that also have a utility in the distributed economy. As such, they represent a new era in the evolution of securities. Financial instruments can now have speculative value while also giving the holder access to a set of rights (a utility).
A stride toward mainstream adoption
As the crypto space slowly begins to creep out of the sidelines and into the sights of government regulators, it’s crucial that the language used to describe industry concepts is clear and concise -- the same way it is for other regulated industries. Though crypto is itself an inherently financial sector, the advent of security tokens marks a major stride toward its mainstream adoption.
About Aaron
Aaron Kaplan is the founder and co-CEO of Prometheum, Inc., a New York City-based fintech company building a federal securities law-compliant, blockchain-native ecosystem for the entire security token lifecycle. Aaron is also of counsel at Gusrae Kaplan Nusbaum, where he has focused his practice on the applications of distributed ledger technology in the securities industry since 2013. Aaron previously held Series 7, 63, 55, 4, 24, 27, and 53 securities licenses.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.