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What Is a Security Token?

Last Updated on February 27, 2024

James Headshot
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Disclaimer: This is not a validation of cryptocurrency or any particular provider, service, or product. It should not be taken as advice to engage in trading or use any services. Please check our terms and conditions.

Quick Answer:

Security tokens are blockchain-based representations of financial assets, similar to traditional securities, offering ownership rights and potential financial gains to holders. They are subject to the Howey test to determine if they qualify as investment contracts and are thus regulated.

Companies can tokenize their shares, offering benefits like transparency, faster transaction settlement, constant market availability, and divisibility for high-value assets. There are three main types of security tokens: equity tokens (like stocks with voting rights and profit sharing), debt tokens (representing loans or bonds), and real-world asset tokens (digital representations of physical assets).

While security tokens are regulated investments, utility tokens are used within a project’s ecosystem, often with fluctuating values based on speculation. Security tokens are issued through Security Token Offerings (STOs), providing investment security and are treated as securities, unlike utility tokens which are commonly issued in ICOs and IEOs without intrinsic value.

Choosing between security and utility tokens depends on whether one seeks a regulated investment or participation in a project’s network. Security tokens offer a safer investment with legal protections, akin to IPOs, while utility tokens are more speculative and tied to the success of a project’s ecosystem.

The phrase cryptocurrency token denotes any digital currency such as Bitcoin, Ethereum, Cardano, EOS, etc. The crypto token represents an asset that can be traded or a utility that inhabits its own blockchain distributed ledger.

These tokens can be used for crowd sales fundraising, but you can also use them as a replacement for other things, such as investments and stores of value. Crypto tokens can be developed, distributed, and traded using the standard process called Initial Coin Offering (ICO), involving a crowdfunding trade in order to fund the development of the project.

The crypto tokens can be classified into two main types of tokens: utility and security tokens. In this article, we’ll focus on security tokens and their use cases. You’ll also learn about the most popular security tokens and the differences between them and the utility tokens.

Security token concept

So, What Is a Security Token?

A security token is a token developed with blockchain technology. Security tokens represent already existing assets or holdings in an external company. Investors are turning these funds into security tokens because they want the ownership of the holdings to be preserved on a public digital ledger.

Therefore, these tokens are digital representations of financial assets that can be traded, like shares of a company’s stock. When people buy these tokens they expect a future financial gain from holding onto them over a period of time.

To determine whether the token is a security token or not, you can use the most common metric, the Howey test, developed as a result of the Securities and Exchange Commission (SEC) v W.J. Howey Co. case; meaning, seeking whether an individual who invests in a common enterprise is expecting to gain some profit due to the efforts of a promoter.

Briefly explained, in our case, using the Howey test, you can determine whether a transaction can be qualified as an “investment contract”, and therefore considered as a security token.

concept of Howey Test Finance

Reasons to Use Security Tokens

The companies can use tokenization to turn their shares into tokens and distribute them digitally to potential investors. The company can assign the same advantages that shares have to these tokens, such as dividends and voting rights.

Just like digital currencies and the other types of tokens, security tokens benefit a great deal from the features of the blockchain on which they are issued. Some of these benefits are:

  • Transparency. Due to the fact that blockchain technology is open-source software, you can publicly access and audit everything without a problem. You can even see the smart contracts that run on the blockchain and maintain the security tokens, as well as keep track of the issuance of assets.
  • Quick transaction settlement. The time that takes to complete the settlement is one of the biggest problems in the assets transferring process. The trading can be made almost instantly, however, reassigning the ownership can take longer. On the blockchain, this process is automated and the settlement can be done in just a few minutes.
  • No downtime. Financial markets have an exact opening and closing time, and they are opened for fixed time periods during the weekdays but don’t work for the weekends or holidays. However, the digital asset markets are open 24/7 during the whole year.
  • Divisibility. With the use of tokenization, real estate, art, and other assets with high value can be turned into digital tokens, and these tokens will be available for investors. This process will significantly boost goods’ accessibility and provide increased levels of liquidity for investments.

Types of Security Tokens

There are three different types of security tokens that are available on the digital asset market.

Equity Tokens

Equity tokens are rather similar to traditional stocks, with the exception of the way in which ownership is transferred and recorded. These tokens are recorded on an unchangeable ledger, updated by using numerous computer networks all around the world.

Equity token holders have a right to vote and they’re entitled to a piece of the issuers’ profits. These tokens offer the following benefits:

  • They allow the investors to invest in blockchain companies and stay in compliance with the securities law at the same time;
  • They give startups a new method of fundraising;
  • They offer a framework for regulators, so they can estimate the fundraising project.

Debt Tokens

These types of tokens represent short-term credits with an interest rate, in the amount that investors give as a credit to a company, such as corporate bonds, real estate mortgages, or other kinds of structured debt. The price of the debt tokens depends on the “dividend” and “risk”. When we speak about a blockchain this means that here the debt security is represented by smart contracts which inhabit the blockchain network.

Real World Asset Tokens

Using tokenization, we can convert physical assets, commodities, carbon credits, art, or real estate into digital tokens. Due to the security, immutability, and transparency of the blockchain, the transactions are recorded trustfully. This lowers the number of frauds and upgrades the settlement time, thus becoming a suitable way for commodity trading.

Tokenized real-world assets are virtual assets that have similar features with any commodity, like precious metals, or oil, and this brings value to the tokens that you want to trade.

real world assets app on smartphone

Security Token vs Utility Token

Security tokens and utility tokens have many resemblances. Technically, they both have identical offerings. The offerings are maintained by smart contracts, the tokens can be sent to blockchain addresses, and can be sold or bought on crypto exchanges or using peer-to-peer transactions.

The main difference between them lies in the rules and economics that support them.

Utility tokens are often issued in Initial Coin Offerings (ICOs), or Initial Exchange Offerings (IEOs) in order for the setup projects or startups to develop crypto token ecosystems using crowdfunding. The user is allowed to receive these crypto tokens with an investment of assets after the ICO is finished, and this allows the user to participate in the project’s network.

Unlike utility tokens, security tokens are issued in Security Token Offerings (STO).

Utility tokens don’t have intrinsic value, as is the case with some traditional securities. The value of the utility tokens can fluctuate under the impact of the speculations. Some investors buy utility tokens because they hope that the tokens’ price will rise with the development of the ecosystem. If the project fails, the asset holders aren’t secured enough.

Just like utility tokens, security tokens are issued using a distribution event called Security Token Offering (STO). However, the utility tokens and the security tokens present very different mechanisms.

Despite the fact that security tokens are created on a blockchain, they remain treated as a security.

Tokens are highly regulated, which means your investments will be secure and protected from fraud. Because of this, STO is similar to an Initial Public Offering, aka IPO, rather than to an Initial Coin Offering.

By buying a security token the investors are purchasing bonds, stocks, or equity. These tokens represent the investment contracts and they secure the rights for ownership over the funds that are not on the blockchain.

Illustration of Security Token Offering (STO) is replacing Initial Coin Offering (ICO)

A Few Words Before You Go…

Hopefully, we’ve managed to give you an insight into security tokens and the benefits that you can enjoy by using them.

Now you have basic knowledge about the different types of security tokens and if you decide to use any one of them it would be easy for you to choose the right one.

Finally, you’ve learned the main differences and similarities between the two types of tokens: security tokens and utility tokens.

About The Author

James Headshot
Written by

Crypto Technical Writer

James Page, previously the lead writer at Crypto Head and a registered psychologist, brings a unique perspective to the world of blockchain and cryptocurrency.

His extensive experience in the industry and ability to present complex concepts in an understandable manner make his articles a valuable resource for readers seeking to navigate the ever-evolving crypto landscape.

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