What are Security Tokens?

Securities can represent an ownership position in a publicly-traded corporation, a creditor relationship with a governmental body/corporation, or rights to ownership as represented by an option. A security token is a tokenized, digital form of these traditional securities.

What is a security token:

The said transaction will be called an investment contract if it fulfills the following criteria:

• It is an investment of money
• The investment is in a common enterprise
• There is an expectation of profit from the work of the promoters or the third party.

The term “common enterprise” is open to interpretation. However, many federal courts have defined a common enterprise as a horizontal enterprise where the investors pool in their money and assets to invest in a project.

Plus, there is another important thing to consider while determining securities. The profits that come from the investment, is it in the investor’s control or is it completely out of it? If it is not in the investor’s control, then the asset has usually declared a security.

In 1990, the Supreme Court developed a family resemblance test which provided a way for contract creators to show that their contract has a “family resemblance” to other investments and hence cannot be called securities.Certain states have their own securities registration requirements which are sometimes called “Blue Sky” laws.

DAO -: The DAO is an organization that was designed to be automated and decentralized. It acted as a form of venture capital fund, based on open-source code and without a typical management structure or board of directors

SEC-:The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation's stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States.

How SEC and DAO works together

We’re going to write code and sell a token and, in exchange, people who buy the token will get whatever profits are made from those projects.We’ll work the code. They’ll pick the projects. The projects will flourish and everyone will profit.

The SEC said: “That’s a security.”

The DAO developers said: “No, no. That’s just selling tokens.”

Ultimately, the SEC said: “That’s a security” – because of the application of the Howey Test: There was an investment of money. And a common enterprise. With the expectation of profit, primarily from the efforts of others.”

So, why was this investigation and ruling done in the first place?

Well, it was because of the infamous DAO hack. just to give you an overview:

• There was a flaw in the Dao smart contract
• The hacker exploited that flaw to execute a re-entrancy attack.
• Over $!50 million worth of ether was siphoned away.

Because a lot of people invested and got back nothing in return, the SEC intervened to “protect” the interest of the investors and deemed the tokens a security.

Security Tokens Crypto

A crypto token that passes the Howey Test is deemed a security token. These usually derive their value from an external, tradable asset. Because the tokens are deemed a security, they are subject to federal securities and regulations. If the ICO doesn’t follow the regulations, then they could be subject to penalties.

What Regulations Are Security Tokens Subjected to?

Security tokens need to follow these regulations:

• Regulation D
• Regulation A+
• Regulation S

Regulation D

Regulation D will allow a particular offering to avoid being registered by the SEC provided “Form D” has been filled by the creators after the securities have been sold. The individual who is offering this security may solicit offerings from investors in compliance with Section 506C.

So what does Section 506C require?

It requires a verification that the investors are indeed accredited and the information which has been providing during the solicitation is “free from false or misleading statements.

Regulation A+

This exemption will allow the creator to offer SEC-approved security to non-accredited investors through a general solicitation for up to $50 million in investment.

In order for the requirement to register the security, the issuance of Regulation A+ can take a lot more time compared to other options. For the same reason, Regulation A+ issuance will be more expensive than any other option.

Regulation S

This happens when a security offering is executed in a country apart from the US and is therefore not subjected to the registration requirement under section 5 of the 1993 Act. The creators are still required to follow the security regulations of the country where they are supposed to be executed.

Why are Security Tokens Important?

Since the assets which are represented by the security tokens already exist in the “real world”, they act like a bridge between legacy finance and the blockchain world. So what are the exact changes that security tokens are bringing along with them?

#1 Bringing Credibility Back

#2 Improving Traditional Finance

#3 Speeding up Execution

#4 Exposure to Free Market

#5 Huge Number of Investors

#6 Reducing Lawyer Service

#7 Lack of Institution Manipulation

#8 Easier Liquidation

Conclusion

Security tokens have a far less share of the market as compared to utility tokens, however, security tokens are something which can become huge in 2018 and needs to be embraced by everyone soon. It is believed that tons of capital is going to flow from Wall Street to security tokens instead of utility tokens.This shift is happening because security tokens are considered to be safer because of the strict regulations.

“It’s inevitable that security tokens will transform equity just as bitcoin has transformed currency, because they afford the owner a direct, liquid economic interest and the expedited delivery of proceeds. Every type of ownership can be tokenized, which is a massive multi-trillion dollar addressable market.”

About Author -:

Adarsh Naidu is a Enterprise Architect with Fourteen years of experience in IT Strategy, Dev-Ops, Service Oriented Architecture (SOA),Microservices Architecture, Enterprise Application Integration, Enterprise Standards, Governance, Process Modelling, Architectural Transformation, Capability building, Portfolio Management. Has been working in Enterprise Blockchain project/products since last 5 years.

Reference -: blockgeeks.com, Google.com ,Wikipedia