The past two years have seen an increase in the number of companies applying for funding through a Security Token Offerings (STO). However, if the concept has grown, the fact remains that many do not really master the basics. The fault with the very understanding of what a security token is and how it works. But before we get there, it’s important to start by differentiating between utility token and security token.
Utility vs security token
Utility tokens are tokens that have a function in the activity of a decentralized ecosystem based on a blockchain. In general, when a user invests in a utility token, he receives in return a definable advantage. It can be access to a particular system or to any service. On the other hand, the Security token does not need to be useful.
Rather than access to a service, it represents for the investor a virtualized action from the company that issued it. This is why security tokens are also sometimes called “action tokens”. This compares to buying shares on the stock market, which gives you partial ownership of a business. They therefore allow pay dividends, of share profits, or to invest in other tokens or assets in order to generate profits for their holders.
The different functions to which a utility token gives access are quite varied and sometimes confusing. The major difference between the two types of token comes down to one fact: the fairly strict regulations that revolve around security tokens, considered by financial authorities to be close to a traditional asset.
This test is a legal tool used in the USA by the DRY (Securities and Exchange Commission) to determine if a transaction will be classified as a security. Security tokens being assimilated to securities, some have seen fit to use this test to better distinguish with utility tokens. Thus, according to Howey’s test, a transaction will be classified in the “security” category if the following four conditions are met:
- There is an investment in money.
- There is an expectation of profits.
- The money is invested in a joint venture.
- All profit comes from the efforts of a promoter or a third party.
If the issuance of a token involves the previous conditions, it will be classified in the category of security token. It will therefore be subject to the same transparency and registration requirements as all other financial assets in the country. In the French case, there are independent regimes that govern both types of tokens and which appear within the scope of the PACTE Law.
The concept of security token being defined and the difference with utility tokens made, now gives way to the opportunities they represent for the financial market.
The STO or security token funding
The STO is unquestionably the phenomenon that popularized the use of security tokens. This is’a fundraiser carried out by a company by pre-selling tokens: security tokens.
The principle is nothing new, it is also modeled on the ICO (Initial Coin Offering) from which it differs with regard to the type of token used. ICOs were the heyday of the 2017 crypto explosion, allowing thousands of startups to find funding. However, this had led to complaints from many investors, who realized a little late that they had no say whatsoever over the finished product (when there was one). Things got worse when we became aware of the number of scams who used this method of funding. STOs have therefore become an alternative to ICOs due to the regulations governing the sale of tokens.
Indeed, the exchanges and entities proposing the listing of Security Tokens must comply with the various prescriptions of the law. These are, for example,in-depth investigations into token listing, data sharing and investor integration procedures. In addition, participation in an STO is subject to KYC identification procedures (know your customer) and fight against money laundering (Anti-Money Laundering). So, Security Tokens offer more credibility to funding. They allow holders to have rights to dividends or other predefined sources of income. This form of funding also brings other benefits in addition to credibility.
There is also the issue of liquidity which has improved in every way. Unlike traditional securities issued on the stock exchange, security tokens are not subject to market closing hours.
Since Security Tokens are traded on specialized exchange platforms, investors have a convenient way to liquidate their assets. This is all the more true since there is a possibility of opening up capital to world markets. The other advantage over traditional titles is the programmability of security tokens. In fact, the title’s compliance with the various existing regulations can be entered in the token. This saves a lot of time when trading securities.
In the crypto-bath since 2017, both much too late but quite soon from the point of view of my future grandchildren ????
Writer, Amateur Trader, Ethereum and NEO-compatible