The age of tokenisation: Understanding security and utility tokens
In the age of cryptocurrencies, assets of any kind can be stored in mobile wallets in our smartphones. Such assets are then known as tokens. Much like shares, tokens are a form of digital asset issued a by a company, and there are two main token types which investors looking into crypto should be aware of.
The fundamental difference between an ICO and an IPO is that in the case of the latter, you receive stock in exchange for the your investment, while an ICO provides you with a token in exchange for your investment. However, unlike company shares, a utility token is purchased mainly to give the user access to a service or a product provided by the company.
One utility token example is Filecoin, which after raising $257million in token sales, grants its users access to its decentralised cloud storage platform. Investing in utility tokens during a company’s ICO phase — also called user tokens or app coins — represents future access to that company’s product once released.
Security tokens, on the other hand, are digital assets whose value comes from external assets, whichcan then be traded and eventually generate profit for token holders.
The main difference between the two token types lies in their functionalities. Whilst a utility token represents a product or service in itself, the security token is an investment in a project togenerate future returns.
Any token sold with the prospect of future profit qualifies as a security, so because anyone issuing any form of security must register their investment contracts with the Securities and Exchange Commission (SEC), security token holders must follow SEC regulations.
Security tokens are subject to the federal laws that govern securities, preserving consumer protection and increasing company accountability. SEC’s primary objective is to ensure that all ICOs comply with the regulations. This ensures safer practices for both companies and token-holders, and a healthier marketplace.
As the blockchain industry evolves and expands globally at a rapid pace, regulatory bodies are feeling the pressure to implement tailored frameworks to guarantee well-functioning practices and avoid fraudulent activities.
By October 2018, the cryptocurrency market cap sat at approximately 300 billion dollars, while in Q1 of the same year, ICOs had raised an estimated amount $5 billion.
Following this crypto market ICO boom, and the consequent fall-out after many ICOs turned out to be scams, the SEC set up a special task force in early 2018 to oversee cryptocurrencies. SEC-regulated ventures attract institutional investors, resulting in substantial sums to drive the projects forward.
“Our securities laws apply to the ICO space, and if people are going to raise money using initial coin offerings they either have to do so in private placement or register with the SEC,” said SEC Chairman Jay Clayton, amid the crackdown on ICO regulation.
Under SEC rules, security tokens offer holders significant advantages and rights within the company, such as equity, voting rights, dividends, buy-back rights and many others that utility tokens could not offer.
Why use tokenised securities?
There are considerable benefits in issuing and purchasing tokenised securities. Apart from being SEC-compliant and offering security to asset holders, tokens allow inexpensive and fast transactions: because there are no intermediaries between companies and token holders, transactions are quick and cost-effective, adding more value to the use of tokens.
As is typical of digital assets, tokens can be transacted on a global scale, allowing borderless transactions 24/7 anywhere in the world regardless of business hours and time zones.
“Ultimately, we can envision a world where we may even work with regulators to tokenise existing types of securities, bringing to this space the benefits of cryptocurrency-based markets — like 24/7 trading, real-time settlement, and chain-of-title,” said Coinbase COO Assiff Hiriji when the exchange was awarded SEC approval.
For the reasons above, tokens are bound to become increasingly popular and regulatory frameworks should continue addressing them more fully.
“As the blockchain revolution keeps gaining ground around the world, we see more companies embracing new ways of doing business which prioritise consumer value and enhance transparency in the relationship between company and share/ token holder,” said Stefania Barbaglio, Director at Cassiopeia Services.