Utility. Currency. Commodity. Security. It may seem academic which box a particular cryptocurrency or token falls into, but for investors it really makes a huge difference that can drastically affect both the potential revenue available and also what responsibilities the issuer owes.

A security token is essentially a crypto token which meets the legal definition of a security: that is, it is backed by a real underlying asset along with a promise of future increase in value.

To be an “investment contract,” and therefore fall under the definition of a security, a commodity like a crypto token must be accompanied by this promise from the issuer that it will be developed in the future or that its value will increase.

Security = Future value increase

How does this work in the traditional finance world? When buying shares, an investor is not just buying a static slice of a company. They are buying a promise that the company has ‘something’ of value behind it, whether that’s a piece of smartphone technology the company manufactures, a Californian orange grove, 1,000 grocery stores in Russia or a fleet of gold-plated helicopters.

Whatever it is that the company owns, they are buying a little piece of that, on the proviso that with the company’s expertise in managing it, that particular thing will increase in value in the future.

Similarly, when an investor puts money into a security token, he has not just a few hundred dollars worth of a cryptocurrency, but a piece of a company that includes a promise that that particular token will appreciate in value.

A security is a tradable financial asset. It’s tradable, because it can be bought and sold without its value changing. It is a financial asset, because it is backed by a underlying store of value in something, like a fleet of gold helicopters, an orange grove, or those Russian grocery stores.

The main types of securities are:

  • Equity securities

    , like shares, where investors buy a piece of a company.

  • Debt securities

    , like bonds, where investors effectively loan a company money along with the promise that it will be paid back with interest, and

  • Derivative securities

    , like futures or options, where investor bet on whether they think the value of a company or commodity will go up or down.

All of these are backed by assets: helicopters, oranges, grocery stores, etc...

Security tokens - this new kind of asset class we’re looking at - are wading headlong into these very traditional and very established definitions so there is bound to be some confusion along the way.

What are STOs?

A security token offering or STO is when a company or set of developers issues a set amount of tokens, which themselves meet the legal definition of a security.  

STOs include offerings of tokens which have these features. That is, they can fit into the boxes we outlined above: they are equities, they are debt or they are derivatives.

What the judges rule

Judges in the US have very different standards for what does and does not meet the current law, and this is changing all the time.

For example, in September 2018, a federal judge ruled that cryptocurrencies are commodities, and should be policed by the Commodity Futures Trading Commission, while a second ruled that cryptocurrency fraud comes under existing securities law and should therefore fall under the purview of the Securities and Exchange Commission.

Crypto issuers - that’s the developers or company behind a particular token - are very happy to comply with the rules. In fact, newly formed pro-blockchain and pro-crypto lobbying groups are begging lawmakers for clearer rules so they can, in fact, comply with them. But there is still vast uncertainty as to whether a token will be classified as a security token.

Regulators also tend to work in an incremental, case-by-case way to constantly define and redefine what does and doesn’t fit into their laws. In the US, the SEC has only said that Bitcoin and Ether are NOT security tokens. The other 2,045 tokens listed on coinmarketcap.com are up in the air.

How security tokens will change crypto

Security tokens give the impression of being more secure than cryptocurrencies, because they are:

  • Asset-backed - so the price is reflected not just by sentiment but by an actual thing

  • Regulated - so (in the US at least) it won’t get sued by the SEC, CFTC or disappear overnight

In September 2018, Binance signed a deal to set up a security token trading platform in partnership with the Malta Stock Exchange. That’s the world’s largest cryptocurrency exchange by volume working hand in glove with one of the world’s friendliest crypto jurisdictions. This by itself should be enough to pique investors’ interest.

Security tokens will likely bring more retail and institutional investment into the crypto space.

As we mentioned above: the likelihood that a token can fall under existing regulation means there is less uncertainty for issuers, investors and regulators. As a whole, this means better protection for investors. Better protection for investors will lead to greater amounts of traditionally risk-averse money coming in.

The equation we come to is this: regulation equals recognition. Recognition equals mainstream attention. Mainstream attention equals liquidity - new investor money entering the space so if you want to trade, the interest and ability for you to do so is there.

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