Hackernoon logoThe simpleton’s Guide to understanding Security tokens. by@naveen_saraswat

The simpleton’s Guide to understanding Security tokens.

Naveen Saraswat Hacker Noon profile picture

@naveen_saraswatNaveen Saraswat


Blockchain. ICO. Token Generation.

If you have seen any or all of these words in the past few months that you’ve spent whiling away on the internet, then congratulations, you’re a simpleton!

A simpleton, in terms of the whole blockchain scene, not general terms, don’t worry.

Blockchain is the new, latest and greatest technology that is being hailed as Internet 2.0. In other words, it has started to disrupt every industry possible, and entrepreneurs are looking to take full advantage of it. With the shift from fiat currencies to cryptocurrencies being possible because of blockchain, entrepreneurs today prefer to raise money with cryptos.

ICOs are the new venture capitalist funding, and have managed to raise billions of dollars over the past 2 years. In return for investments, ICOs usually offer ‘tokens’ which are equivalent in value to the money invested. There are usually two types of tokens, utility and security.

It is the second type that we will be covering today. Fasten your seatbelts, because it is going to be one crazy crypto ride.

The Security Token Concept

What exactly is a security token? Forget that, what is a security?

Think shares. Think equities. Think other assets of the type.

Wrap an electronic wrapper around these assets. There you have it, a security token.

More technically speaking, if a crypto token is offered by ICOs as future investment, and hope of value increase, then it qualifies as a security token. Qualifying as a security token means that it falls under federal laws and regulations governing securities. One can view security tokens as trying to find the perfect balance between ICOs and their fiat counterparts, IPOs. Now, you must be wondering, why so many regulations?

It’s pretty simple, really. Anything that can net people a fortune in the long run is bound to be halted by the State. It is the same with shares and equities, and it will certainly be the same with security tokens. We will talk about regulations a little bit later in this article.

How did security tokens come into being?

Before there were security tokens, there were the SAFT.

Simple Agreement for Future Tokens were the predecessors to the security tokens we all know today. This was formulated by US startups, basically to ensure that they stayed in compliance with the US federal laws governing securities. SAFT was basically a contract that allowed investors to be rewarded with the company’s tokens once they were able to design an efficient token model.

Since tokens were only issued when a specific trigger event took place, or when they were actively being used, there was profit to be made in these contracts. Hence, they could be classified as securities. Filecoin, a data storage platform that works on the blockchain, sold the first SAFT contracts to investors during its ICO. They were able to raise over USD 257 million, so it is safe to say that they got things right.

As the concept of SAFT became known, the Securities and Exchanges Commission of the USA cracked down on ICOs and entrepreneurs. The SEC said that tokens being issued by ICOs could be classified as security tokens and hence fall under the regulations and laws governing securities. What forced the SEC to take such a step?

It was the entrepreneurs and ICOs themselves. Many a times, they would release security tokens in the name of utility tokens, in the hopes of not being forced to comply with all rules and regulations. These utility tokens did not have a practical use in most of the cases, and resulted in investors losing money. Hence, to stop this injustice, the SEC took matters into their own hands.

Read the Security Token Thesis Here: Security Token Thesis

The Liquidity chase

Liquidity is the state of an asset which can be easily sold for cash or some other form of value. It is easy to see why everyone would be running after liquidity; a bird in hand is worth two in the bush. Illiquid assets are unwanted, basically, and people want cash in hand.

How is this relating to anything that we’ve talked about in this article?

Enter the blockchain. It allows almost any illiquid asset to be tokenized into a digital ledger, and then become liquid. It is known that private equity offers the most liquidity. Tokens represent liquidity in the blockchain and ICO world.

Fuse the two together. What do you get?

Yep. Security tokens. With billions of dollars stuck in assets that could be tokenized, it is security tokens that yield the power to bring liquidity to the people. Hold on, I think we underestimated the figure I stated in the previous line.

Well, it turns out, we were off by a huge margin. According to reports, about USD 500 trillion is stuck in illiquid assets, and what do security tokens have in them? The potential to unfreeze these assets. You now understand why these tokens are so hyped, don’t you?

Read More: Difference between Security Tokens and Utility Tokens

How Security Tokens are going to transform utility token ICOs

Although it is highly unlikely that utility tokens are going to be eradicated completely, security tokens are still going to eat into a lot of the market share. The one disadvantage to holding security token ICOs is the overhead incurred in it. Due to the various compliances and laws, it becomes difficult to get a security token offering going, but the advantages can certainly outweigh the negatives.

It is reported that either utility token offerings are going to operate in countries with more relaxed laws, or give in to the regulations and issue tokens as if they were securities, in a compliant way. Eventually, it is hoped that issuing security tokens will become easier from the monetary and legal standpoint. Whether it happens or not, is there to see.

The Regulatory overview

Wherever there’s a huge amount of money involved, the governments are certain to stick their noses. Due to the lack of regulation in the whole blockchain sector, ruling bodies have struck where they saw possible: securities. Due to the existing laws governing securities, and the similarities between real world and crypto securities, organizations (read the SEC) have stepped in and decided to take matters into their own hands. Due to the massive overhead capital that is required for ICOs to comply with these regulations, they decide to chuck them and operate under the utility ICO tag.

What they don’t realize is that they should prefer the security token tag. Granted, there is a lot of it to take in, and a lot of money to spend, but once everything is said and done, security tokens offer benefits like no other. Letting your government know that you’re doing something related to ICOs and security tokens is an important tip to help keep you out of jail. Liquidity and the other benefits have been aforementioned in this article.

So, what’s the final call?

Security tokens are here to stay, there are no two ways about that. How long they take to get into the mainstream market, and what impact do they have, well, we will have to wait and watch. The blockchain’s answer to mutual funds and equities is certainly an interesting one, and we hope we helped you simpletons to understand it better.



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