New waves of technology are gaining momentum, and one, in particular, is the security token movement. If you are even remotely familiar with the blockchain industry, then you’ve most likely heard of ICOs (initial coin offerings), which were all the rage throughout 2017 and 2018, raising over $10 billion dollars in those two years. Unfortunately, the ICO movement was also filled with a large amount of hype, which resulted in unfinished projects, scammers, and disappointed investors. Some project owners even ran off with funds, causing investors to be at a total loss, with little legal ramifications. But, it seems we have a solution now – security token offerings (STOs), which are expected to be a hit throughout 2019.
By the end of this article, you will:
- Understand the difference between utility tokens and security tokens from technical, economic, and regulatory standpoints
- Get to know my opinion on the future of cryptocurrency’s offerings
- Know how you can stay up to date with the latest STOs
Let’s dive in.
Utility Tokens Explained Simply
A utility token is a token issued through initial coin offerings. In short, initial coin offerings are a fundraising mechanism used by projects to fund their business and development efforts by selling tokens.
Utility tokens are meant to provide utility, which means that from a legal and business standpoint, utility tokens are not sold with the expectation of profits. Uses of utility tokens can be for purchase discounts, priority on support, priority on gaining access to new features, and others.
The Issues with ICOs
What history has shown, is that in many cases, these utility tokens sold by ICOs didn’t provide much utility at all.
So, why did investors buy into ICOs? Well, investors purchased tokens with the expectation that the tokens will be listed on an exchange, increase in price, and as a result, they hoped to profit.
This is where things get ugly; investors and regulators are not on the same page. Companies are (officially) not selling profitable assets, while people are buying them for potential profits. The reason for this is because, oddly enough, some people did make lots of money from investing in these tokens. But, unless you understand some fundamental cryptocurrency investment strategies, it’s mostly luck of the draw.
To reiterate, although the token should have inherent utility within the application, most utility tokens did not have any obvious use case (utility) for the business, which left investors stuck with useless tokens.
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These tokens are purely speculative, and should only be purchased if you plan to use the project’s software or product. Otherwise, you are gambling on the token’s price increasing, which is completely separated from the success of the business. Utility tokens do not grant any ownership in the company to holders, do not pay dividends to investors, and are not legally considered a security, which brings us to our next point.
What Exactly is a Security?
A security is a fungible financial instrument (such as stock) which is sold to investors. Investors purchase this security with the expectation to receive a return on their investment from the company’s success, such as investing in a company and receiving stock. Securities are bound to regulatory rules and obligations to their investors, whereas utility tokens from ICOs are exempt from these rules.
There is a famous test called the Howey Test developed in the 1940s to define if an investment contract is a security or not. There are many blurry lines defining what makes an asset a security, and even today, some things are up to debate, especially in the cryptocurrency market. Overall, if investors invest to make profits, then it may very well be a security.
Then, What is a Security Token?
A security token is a tokenized security. Seems obvious, but what does that really mean?
Well, unlike a utility token, you are investing directly in the company or company assets. This means that just like investing in public stocks, you may be eligible to receive dividends, revenue share on profits, or part ownership in the company which can include voting rights.
Additionally, projects looking to issue their own security tokens must regulate with governments just like any traditional company would have to. This means they may not be able to accept investments from all investors, might have a minimum requirement for amounts to invest, and will require all investors to go through a KYC/AML process.
The goal of STOs is to give investors the peace of mind that, unlike ICO projects, these projects are conscious of regulations and are obligated to update their clients on revenue and pay dividends accordingly.
The beauty of blockchain technology is that we can automate certain functions, to offer a more fluid ecosystem for trading. These security tokens are tokenized assets which have confirmed ownership by investors on the blockchain. All token ownership, KYC/AML rules, and more are typically programmed into the token and/or related smart contracts. It’s pretty crazy.
This means that while any two individuals can trade utility tokens between one another, a security token between two parties may fail if one of the investors fails the KYC/AML or other rules, which are programmatically entered into the system. There may also be a whitelist of permitted addresses which a smart contract checks against to be sure that the token can be sent to the recipient.
Examples of STOs can be any company like you see on the stock market, in addition to real-estate backed companies, gold and commodity-based companies, and more. Some projects are launching an STO with the security being backed by masternode or staking services done by the firm. As they profit from securely staking for investors, you get a share of their pie!
Will STOs make ICOs obsolete?
In my opinion, no. There are some valid use-cases for utility tokens, especially if people are comfortable investing in the token for its utility. Loyalty programs, discounts on purchases, and priority for support are all valid use-cases for utility tokens.
Surprisingly, I believe that utility tokens and security tokens can complement each other very well. For example, a project can issue security tokens, in addition to giving free utility tokens to all security token holders. If a real-estate backed STO issues security tokens, then perhaps they can also give free utility tokens to all holders giving them priority support or access to certain features of their platform. The point here is that utility tokens can further incentivize and add to the overall experience that companies can offer.
Where Can I Keep Up to Date on the Latest STOs?
This stuff is new, so there are not that many resources yet, but I recommend checking out the Security Token Network. They have an awesome list of STOs upcoming and active STOs, in addition to educational articles and current events on the industry. I highly recommend checking them out to familiarize yourself with the types of companies launching STOs, and to become acquainted with the industry.