Security Tokens In Crypto: What Is It, How Does It Work?

Web 3 services and their applications have gained wide popularity in the 21st century. The contemporary world is transforming into a decentralized system that exploits the active services of blockchain technology. The cryptocurrency ecosystem is a sphere that is filled with complex terminologies and jargon. Mastery of these complex terminologies and their respective concepts can only create a better understanding of the crypto world. This article aims to give extensive knowledge about security tokens which are a significant component in the blockchain technology and crypto sphere.

Tokens are an integral part of the cryptocurrency system and blockchain technology. It is the representational digital asset in the blockchain system. A security token is a token that represents the piece of ownership of or an asset of the company. Tokenization is the process of creating security tokens. This article will go through each detail regarding security tokens.

What is tokenization?

Tokenization is the process of creating and attributing the digital representation of an asset. In simple words, the tokenization process issues a unique digital representation of a real thing. Tokenization can enable the provision for transforming intangible assets into token forms. All the tokens including security tokens are created using this process.

What is a Security Token?

A security token in crypto is a digital asset tokenized to represent ownership or assets of a company or project. Tokens on the blockchain are long strands of letters and numbers that are generated by the hashing algorithm in the blockchain. The value and ownership representation are attributed to security tokens and stored on the blockchain after it. After attributing certain values to the cryptocurrency tokens, they become the digital representation of the rudimentary asset.

How do Security tokens work?

Security tokens are an investment mode in the cryptocurrency. Getting security tokens is similar to buying a corporate ownership stake. Users who possess the security tokens will gain the ownership slice of the company. The privileges that come along with the ownership dividends are voting rights and interest payments. 

The working principle of security tokens is almost the same in all companies and projects. A corporation will issue a security token and attribute a certain percentage or share of the company’s ownership to the token holder. The team creates a whitelist with the crypto wallet details of eligible investors for purchasing security tokens.

Retail investors cannot invest in security tokens without regulatory approval, as the approval process is required to make security token investments available to Accredited investors and institutional players are the only ones allowed to invest in the option until regulatory compliances are approved or made available.

Regulatory Compliances of Security Tokens

Security tokens need to follow the regulatory requirements suggested by financial authorities to manage the protection of investment programs and market integrity. In the United States of America, the Securities and Exchange Commission (SEC) is the responsible authority to oversee the security tokens in the market. The Securities and Exchange Commission determines that a token is a security token if it meets the criteria specified in the Howey Test.

There are four Criteria to meet consider a token as a security token as per the Howey Test.

1. Money investment: the transaction involves money investment.
2. Profit expectation: the investors expect an amount of profit from the investment.
3. Common enterprise: The investment has to be in a common enterprise.
4. Efforts of others: the profit needs to come from the attempts of a third-party agency or individual promoter.

Advantages and Benefits of Security Tokens

Security tokens have a great impact on the blockchain technology and cryptocurrency ecosystem. This is one of the most preferred investment options because of the numerous benefits of it.

1. Eradicates the presence of intermediaries: This can reduce transaction costs by disabling the presence of third-party authorities. It will further lead to faster transactions.
2. Increased liquidity: Security tokens can increase the liquidity of liquid assets. This is possible via the trade of the security token in the decentralized exchanges.
3. Segmented ownership: Investors across the world can purchase shares of the projects and companies. They can sell their shares as well. 

Disadvantages of Security Tokens

Advantages and disadvantages are complementary factors. Security tokens too have some disadvantages. 

1. Regulatory issues: Sticking up to the recommended regulatory compliances is a complex task and difficult for users. This can be expensive all the time. Expensive is one of the major disadvantages of security tokens
2. Market volatility: The market for security tokens is volatile because it is still in its embryonic stage.
3. Issues related to scalability: Security tokens are sometimes vulnerable to scalability issues. Challenges related to scalability issues of security tokens are not a new thing in the cryptocurrency ecosystem.

Types of security tokens

Security tokens can be classified or categorized into different types. They all differ in their nature and functionality. The important types of security tokens are equity tokens, debt tokens, asset-backed tokens, utility tokens 

Equity Tokens

It is a type of token that is similar to the traditional stock share concept. It represents the ownership share in the company. Equity token holders can vote on business issues and are eligible to receive dividends.

Asset-Backed Tokens

These types of coins are powered and supported by tangible assets. These tangible assets consist of commodities, fine arts, and real estate.

Debt Tokens

Debt token has a slight difference from the rest. It stands for a debt that an issuer owes to the individuals who possess the token. It is a tokenized version of bonds and loans.

Utility tokens

It is not a cent percent security token, but some tokens can be placed in between the utility and security. This type of token can offer access to a product and a stake in an asset. These are utility tokens.

The Bottom Line

Security tokens and their importance in the cryptocurrency sphere are visible from the unmatched demand and significance that has in the entire ecosystem. The digital asset in the form of security tokens can offer enhanced efficiency, transparency, improvement in liquidity, market access, and automation. The ultimate role of a Security token is to represent the ownership share of the underlying assets.

The security compliances regarding the security token will enable all the retail investors to possess the tokens from the market. These digital assets will be the future economy-determining factors and financial alternatives. Equipping ourselves with the technical knowledge of Web 3 and decentralized finance will only be helpful in the future. Use this article to learn more about security tokens and how they work in the crypto sphere.