This document has been created to explain the use of security tokens. Many online resources are in fact wrong, so I decided to create this tell people along their path to cryptocurrency freedom. Some of the online resources or unintentionally wrong, what others are meant to mislead the reader.
In this article, we will be talking about security tokens, their value, why you would need them, and the system they operate on. To fully understand cryptocurrencies, it means you need to understand the distributed Ledger system, finances, mathematics, politics, and cryptography.
Other principles you may want to understand, are SEC regulations, local, Federal, and International laws on securities and in trading. This document isn't designed to convince you of the value of token assets, but instead to give you a look at their history, present standing, and potential future, so you can determine if they are right for you.
What has started off as a simple article to describe tokenized securities, has turned into a major project that's taking considerable time to publish.
Tokenized Earth Part One
In part one we will talk about:
- How Securities came to be, and what qualifications they require
- Why other collectibles are not considered securities
- The reason for Securities laws
- How tokenized securities are beneficial
- The reason private securities are cheaper
- Blockchain technology and its involvement in trade
- The ability of tokenization to open liquidity
- Tokenized securities real World value for private companies and public individuals
- The reason cap table management is not processed electronically
- Uses for security tokens
- Why centralization for security tokens is a must
- Common issues that arise with tokenized securities
- American enterprises that are ideal tokens
Other common, misleading pieces of information about tokenized securities we will cover, are:
- The false belief that security tokens hold no value because they operate on a centralized network and are susceptible to control.
- Mislead ways of thinking, regarding security tokens needing no blockchain because they are not technically a digital asset.
- Incorrect statements on security tokens being redundant when used on blockchain technology, because the false belief that a secure database is all that's needed.
This is a document for any crypto investor, even those who spend their full-time researching and learning about the industry. You are about to read on security tokens in the only guide you'll ever need to make intelligent investments. New people to the market will also appreciate this document for the information it provides on tokenized securities.
Anything you read in this document is strictly opinion, so please read with open mind. First, if you don't know what a security token is, that's okay, because I'm going to explain it from the beginning.
Many people have a false understanding of security tokens, a lot of them are respected individuals. Often, these people add value to the industry relating to security tokens, but the information they provide can be misleading or flat-out wrong. I know this because I was one of these people, who are misled to believe the token securities were overkill or dangerous to invest in.
What you are about to read has been researched and investigated, following some of the most influential leaders in the cryptocurrency field. Times are changing, tokenized securities are forcing the world to reevaluate how investment operate.
The first thing we will cover is how securities have been handled in the past, and how we can improve them. Second, I will explain to you what it security is, in its essence.
At its core, securities are determined by performing the Howey Test. The test was developed following the Great Depression. The Securities Act of 1933 and Exchange Act of 1934 are the foundation all securities are built on.
As for the test, it's a sequence of four parts:
- Is an investor contributing capital?
- Is the capital being contributed to a collective enterprise?
- Does that work rely on the work of others?
- Is there an expectation of profits?
Mostly, that is the Howey Test; and it is what we base our judgment Securities on.
Most Securities are privately owned; they could be real estate investments, company shares, or one of several other assets on the market. An excellent example of what security is not would be an investment made into Kickstarter. With Kickstarter, there is no expectation of a return on investment. Instead, the investor receives a product or service – and that is why it is not a security – a crowdfunding campaign on the other hand, where profits are expected, is a security.
In layman's terms, the Howey Test uses a set of rules, required by the FCC for deciding if something is a security or not. Here they are simplified:
- A financial investment.
- A common business.
- There is an expectation to collect profits.
- The work to earn profits is performed by other people.
There is an argument to this, regarding which component is seen as most important by the FCC. Many believe that is number 4; the work to earn profits, is performed by other people. It is because of this rule, that many times, direct fractional ownership of something, does not make it a security. Therefore, collectibles are not securities.
A lot a people have the notion that a token is a security. But what something is, doesn't dictate if it is a security or not, the Howey Test does that. Tokenizing something does not change its properties, it only tokenizes it. Also, a collectible that can be freely traded, without regulation, can never be labeled as a security. The fact that an item has the potential to become more valuable, does not make it a security either.
A security is made due to an agreement between two participating parties. Investors contribute money do a startup token, an expected return, turns the token into something else. When the promise of an increased ROI, is made on a token, the investment becomes a security.
Security laws are complicated, sometimes hard to understand. Real estate security but investing into a developer who promises a return of profit is a security. The bill primarily deals with someone promising someone else more money than they initially invested. Basically, if an investor expects to make profits, that is the basis of a security.
Collectibles are based on supply and demand, whereas an investment to a company that will give profit back, is considered a security. Sometimes, depending on somebody else's work doesn't matter, the type of investment made can make it a security. If a company buys securities with investments or shares in other companies with money given to them by investors, then it is a security. Once again, the Howey test is used to determine all of this.
There is a reciprocating factor on securities and the FCC as well that should be mentioned. If an investment is regulated by the FCC, it is a security. Or, if something is a security, it is regulated by the FCC. Laws for securities are meant to protect the investor, guarantee markets are operated correctly, eliminate agent issues, build trust, and manage capital funding. They were also formed to stop fraud and protecting investors from bad decisions made by others. A principal-agent issue is when one individual can make decisions that affect another person or other persons.
It's important to note not all failures in business are scams. Sometimes, they are just bad ideas or poor execution. There is no guarantee of success in business, many times it's harder than people think to succeed. Regulations were not put in place because of failed business attempts, but rather fraud, like market manipulation and Ponzi schemes. The federal government has no problem with people losing money, just look at casinos and lotteries, for example.
Smart decisions rely on the investor's ability to make them. It's up to the person to make the right choice on where they put their money, it's up to regulations to protect them from people looking to steal it.
Securities are already complex, blockchain technology and cryptocurrency only makes it more so. A lot of people are already familiar with securities; stocks hedge funds mutual funds are all a type of security. When new technology is incorporated with them, they become unfamiliar.
Tokenized Securities are like the ones people already used to, except they are electronic. It’s not that different than regular letters being compared to emails, I.E. paper vs. electronic. Another example would be digital communication or digital photography.
Like emails, moving securities to a digital token format, means they are easier to manage, trade, cheaper, and more useful in every respect. With that light shined, hopefully, you are gaining an understanding of a what a tokenized security is.
A fundamental point to make is security tokens are ideal for publicly traded companies, but even more valuable when it comes to privately owned ones. Tokenized securities open the door for better cap table management while eliminating other issues, like shares being counted twice. Investors appreciate the doors of liquidity opened buy tokenized securities, for privately-owned companies.
Another primary benefit of a security token is it gives investors the ability to resell their investment quickly. A lot of investors will tell you, they will not invest in a company unless they have an open exit strategy they can use freely. With security tokens, a company cannot lock up their finances, making investors more comfortable.
For both private and publicly owned businesses, blockchain technology and security tokens help with administrative purposes as well. As for private companies, like a REIT, tokens can protect them in an incidence in which the company doesn't gain enough investors. A REIT is a commonly used investment pool in an industry like real estate. They allow companies certain tax privileges but require very capital-intensive investors to operate correctly. If all qualifications are not met, the company does not get the tax privileges.
Market depth is another important idea, it is the expansion of the market for a given security. With it comes more liquidity for trade that can develop even further from the use of tokenized assets. Increased Market depth can sometimes improve liquidity because there are more buyers in the pool.
When speaking of public companies now, the use of blockchain technology and tokenized securities can cut trade times down, from days to minutes. Blockchain technology also offers a secure place to store company analysis, protecting investors from Whales or other market manipulators, who want to make a quick buck. The reason tokenized securities are secure is the immutable properties of the blockchain, which were developed to protect data manipulation.
Public company investors will also benefit vs. private ones. Because trade is more natural with them, and the need for lawyers and regulators to monitor everything becomes irrelevant. Tokenized securities stored on the blockchain, also eliminates the lack of shareholder data that is accessible. As it is now, larger companies, which have gone public, have no idea who their shareholders are. With the blockchain, shareholder information is protected and stored accurately for easy access.
Crypto technologies help to cut out the middleman, whereas before, a third-party was required to complete transactions. Before blockchain & cryptocurrency, it's sometimes takes as long as three weeks to trade your shares until they are settled. Now, traded shares can be settled in a matter of minutes via tokens. Not only are trade transactions recorded accurately on the blockchain, but the data is also more secure as well.
The old way of doing things looks great on the outside, but on the infrastructure is damaged. Blockchain technology, combined with crypto, simplifies the process of trading – thereby improving it – making it better for everyday people, and business is alike.
Tokenized securities solve many issues with analytics for the issuing party. They also improve the infrastructure spoken of earlier, while providing solutions to unlock liquidity. It genuinely enhances the system with clarified data for all investors. The technology also helps to organize the messy methods traditionally used to store equity or stocks by some of the largest publicly traded companies in the world.
Lastly, using tokenized securities and blockchain technology, gives investors control of their money. There is less delay when trading, making people more comfortable to trade or invest in both public and private companies. More freedom is better for all involved parties.
Now, token holders can even sell their tokens off to each other on a peer-to-peer based system. However, with traditional securities selling person to person has been deemed illegal in all cases. The cheaper, faster, more natural way of trading associated with security tokens is what makes them accessible and desirable. More and more people want to get involved now that they are in control, it's the main reason tokenized securities are vital for trade.
Tokenized Earth Part Two
Part two will be a little different than part one. Part one was structured more to help you understand how tokenized securities work. Part two, will be more of a summarized story of two of the largest participants in the security token sector, Polymath and Harbor.
To start, let's talk about Polymath and Harbor – two of the largest tokenized security systems in the world. Both companies were launched to meet the needs of the market, as seen by their creators who wanted to make their own security tokens. After doing so, the founders of both companies realized intricate knowledge needed to create a security token was far beyond that of Everyday People.
So, they decided to create their own platforms to help mainstream users automate the process, facilitating it until completion. Polymath coined the phrase security token. They needed to do so, as there used to be no difference between one and a utility token. To complete the building of their own tokenized security, the company, had to create their own products, environments, and systems to launch their new coin. Polymath knew right away that most people wouldn't be able to complete the process.
As for Harbor, they had a similar story – with their token, constructed out of need as well – both companies, able to raise more than 15 million dollars to create their security tokens. Each of them understood, no regular person had that kind of money laying around or the technical knowledge to generate their own token. Hence came Polymath, then Harbor, each built to help other companies create their individual security tokens.
Harbor, along with Polymath, handle the needs of their clients, creating security tokens, while also setting up legal protection, compliance layers, and the needed infrastructure to keep new tokens secure. They can even set up a token for exchanges, or peer-to-peer based networks. Separately, these companies have become two of the world’s most sought-after to use teams for providing guidance in creating tokenized securities.
Tokenized Earth Part Three
The purpose of part three is to give you insights into the future of the industry. I’ll give some explanation on how exchanges change with the market’s maturity. Also, how security tokens affect the blockchain, are handled from a legal standpoint.
Lastly, you’ll learn a little about the potential mass use of tokenized securities by government institutions. The SEC may in time set regulations in place to prepare for mainstream use of security tokens in the United States.
For those who are interested in starting their own security token, it is vital to have an accredited attorney. Every transaction made, needs to be done through an adviser who understands securities, cryptocurrency, blockchain and the laws that surround them. Failing to use legal counsel, could result in extra costs, more time, and launch that isn't effective as it could be.
The point of launching, it's to do so successfully, distributing the token to as many people as possible. Those people, however, should have used for the token in some way, whether it be for purpose or to gain profit. Anyone who reads this document, and who would like to represent a new security token or support it, better get familiar with smart contracts.
There are plenty of events, conferences and seminars, that teach about blockchain technology, cryptocurrency, and smart contracts. Anyone can attend these events in most cases and learn how to utilize them properly. Thanks to blockchain technology, combined with modern communications, a team can serve a company or individual anywhere on the globe via satellite.
Emerging technology is giving people all over the globe the potential to become the next investment superstar. And with blockchain technology, you can verify that someone is who they say they are, with the results they claim to have. This means if some guy in Eastern Europe has been crushing it by picking the right investments, you can track his record via the blockchain.
New tokenized securities are improving the way businesses operate, creating more jobs and making it easier to perform transactions on a worldwide scale. As time goes on, there's a good chance that custodial services for security tokens and investments will become more decentralized. It will be an open-world investment environment, in which the investors control their own stock or currency.
Another benefit the world is already seeing thanks to cryptocurrency, is the improved exchange of cross-border foreign currencies. Once again, security tokens and new technology like blockchain, are making these transactions cheaper, faster and easier to perform for everyday people.
The last the last question people have asked, which is still unknown and hard to predict – is when or if the United States government and others around the world will require securities to be tokenized. They would do so to better enforce the benefits that come with them and regulate them to protect the people who use them.
Thank you for reading this guide, please leave your comments and insights or questions in the section below.