If you were to search the internet today, you would find a lot of complicated security token definitions; don’t worry, I have tried to explain it in the simplest terms possible in this guide.
So, what is a security token?
A security token is a device that grants the owner access to a certain network service. A token could be the value, or stake, or even a voting right and it is not limited to one particular role; it can fulfill a lot of roles in its native ecosystem.
Furthermore, security tokens are financial securities that comply with US Securities and Exchange Commission (SEC) regulations. Tokens can grant an investor various financial rights such as profit share rights, buy-back rights, rights to equity, or voting rights.
Tokens often represent a right to an underlying asset or investment; the rights are then recorded in a smart contract and the tokens are traded on an exchange powered by Blockchain.
A number of smart minds in this industry have foreseen these securities becoming very popular, to the extent of replacing the conventional stock exchanges and OTC markets within the next decade or so.
Before discussing how security tokens work, here is something you need to know.
Security tokens and crypto tokens are quite different. In relation to ICOs, tokens are only classified into two: utility tokens and security tokens.
How do Security Tokens Work?
Security tokens are considered to be a more secure way to gain access to a sensitive network system such as a financial services organization as they add an extra layer of security. These tokens may be used in addition to or instead of passwords to identify the owner.
Using the owners’ data, security tokens are able to identify the owners of respective portfolio assets. Some security token crypto contain cryptographic keys, a system used in cryptocurrency services such as Bitcoin.
However, the stored key must be kept a secret with some tokens using time-sensitive passwords, which are coordinated between the network and the token and reset at regular time intervals. Some also use biometrics such as fingerprint scanners to ensure that only the owner is granted access to the protected information.
The Importance of Security Tokens
Assets represented by security tokens physically exist acting as a bridge between the Blockchain and the legacy finance world.
So, what is the impact of security tokens?
To say the least, at the moment, the ICO space is a bit dicey. The sector lacks accountability due to unregulated utility tokens. To regain some credibility, it would make sense if the ICO would integrate with the crypto space and the legacy finance space.
Improvement in Conventional Finance
Middlemen such as banks impose fees on traditional financial transactions and this makes these conventional financial platforms a little expensive. Security tokens eliminate the need for middlemen leading to a reduction in transaction fees. In addition, smart contracts reduce the costs, paperwork, and complexities associated with traditional financial transactions.
Also, it is believed that it will soon be possible to tokenize each type of ownership, and in return, this will expose security tokens to a multi-billion dollar market.
Speedy Processing of Transactions
Conventional finance institutions have longer execution times due to having a lot of middlemen. Securities offer faster execution times for the issuance of tokens by eliminating these middlemen.
Free Market Exposure
Today, a lot of investment transactions are highly localized, and you are right to wonder what that means.
In the current economy, it is difficult for US investors to invest in private Chinese companies and vice versa. By using security tokens, creators can market their deals to anyone anywhere around the world through the internet. The internet provides a free and unregulated market, which helps increase asset valuation.
Investors will increase as a result of having a free and unregulated market. Since creators can now present their deals to a wide audience on the internet, the number of investors will increase drastically.
This is a potential area that creators can take advantage of.
Reduction in professional fees
In the days to come security tokens will use smart contracts that are going to play a big role in eliminating external service providers such as accountants and lawyers. The lesser the number of middlemen, the more affordable this investment vehicle will be.
Less Manipulation in the Financial Sector
Since brokers and middlemen will eliminated, there will be more transparency in financial institutions. Hopefully, the middlemen can be totally scraped off the investment chain to ensure it remains unmanipulated and corruption-free.
Licensed security token trading platforms will make it easy to trade secondary tokens and, in return, investors will be able to liquidate their tokens more easily.
That said, I believe that everything is not sunshine and rainbows; here is the downside of security tokens.
The Downside of Security Tokens
Organizations operating an Initial Coin Offering (ICO) always try to prevent their tokens from being categorized as securities.
This is because securities attract a lot of limitations and regulations on who can invest in their tokens and the manner in which they can be exchanged.
Security tokens may sometimes have both reduced liquidity and secondary trading since they are regulated, and as such, they cannot be freely traded .
What is the Future of Security Tokens?
These tokens have the potential of being the go-to form of funding for well-established businesses as well as start-ups that will need to tokenize their securities offering rather than having their shares listed on a traditional stock exchange.
Why the Market Seems Bullish about Security Tokens?
My market analysis showed that the bullish behavior is as a result of the effects (as mentioned above) these tokens have on the market.
Institutional investors and bankers have also elicited mixed reactions about the security tokens but what remains clear is that the financial markets are set to experience perhaps the biggest shift in over a century.
Recently, Overstock announced a plan by its subsidiary tZERO to develop the first licensed security token platform.
The tokens by tZERO will be regulated by SEC and they will feature quarterly dividends from profits generated by the company.
With such developments unfolding, we can certainly hope for even better things in the days to come.
In conclusion, it is clear that security tokens are set to cause a total disruption in the financial system as we know it. Most crusaders have likened its future impact to be similar to the one Bitcoin had on the cryptocurrency space. The tokens, we believe, will grant its owners a direct and liquid economic portfolio, offering faster and much better returns.