Editors note. This post is written by Sheldon Freedman, a fintech and funds lawyer at Hassans in Gibraltar. Security Tokens is a big, complex subject that requires legal, technical and commercial knowledge. We found that rare combination in Sheldon Freedman, member of the Bars of New York, Ontario (Canada) and Israel, former FINRA-registered representative, and asked him to write a 4 part series, because Daily Fintech’s job is to explain complex subjects in an engaging way. This is the first post. Tune in (subscribe by email) to get the the rest of the series over the next 3 weeks.
A blockchain token is a unique digital token created on a blockchain as part of a decentralized software protocol. Some tokens function as digital currencies, like Bitcoin.
A utility token is digital coupon or ticket redeemable by the holder for a good or service. A utility token, or user token or app coin as it is sometimes called, can entitle the holder upon redemption to a cup of coffee, an advanced medical device or admission to the World Cup championship game. A utility token functions in a closed system according to the token economics designed for the system. For more on utility tokens, please see this chapter in The Blockchain Economy.
Though utility token prices may fluctuate in value as demand for the redeemable goods or services fluctuates, utility tokens do not provide holders with, or relate to, ownership or assets relating to the entity issuing the tokens other than the redeemable goods or services. Security tokens, also known as securitized tokens or tokenized securities, are a digital investment asset with security aspects that do relate to ownership or other assets. For more on security tokens, please see this chapter in The Blockchain Economy.
Security tokens are blockchain-based value tokens that provide holders with value relating to investment assets, which may include rights in the issuing entity such as rights to voting, equity ownership, debt, derivatives, real estate, dividends, profit sharing, buy-back options, cash flow – anything related to assets or performance of the issuing entity, or any real-word asset. The spectacular promise of blockchain and related decentralizing technologies to support the reliable recording, trading and mass adoption of security tokens will undoubtedly lead to the digitization of securities becoming adopted on a massive global scale that will revolutionize finance – limited only by the imagination and daring of financial engineers. Security tokens will have the advantages over conventional securities markets of:
- functioning 24/7 at low transaction cost
- high liquidity
- rapid settlement
- great market depth
- automated compliance
- asset interoperability (different types of assets in same wallet)
- continuous expansion of design space for security contracts and unlimited varieties of features.
Security tokens are programmable by sophisticated architectures deploying rapidly-developing mechanics, employing dramatic efficiencies to process large capital pools.
The versatility and seemingly limitless varieties of deployment of security tokens suddenly presents the world’s regulators with a new digital security asset that they are only beginning to understand. Securities regulators, in their perceived role to protect the investing public (and economies in general), establish regimes of disclosure, registration and reporting to regulate the viable issuance and exchange of securities. Understanding how security tokens markets and smart contracts function – and the complex ramifications elicited thereby- is obviously requisite to regulating them. Some notable small, nimble jurisdictions in Europe, Asia and the Caribbean have been vigorously investing since 2015 in studying and establishing early regulatory blockchain finance-related frameworks to capture early leading industry activity, while the major national jurisdiction are in the committee stages in the process of deciding what to do about the coming golden age of security token innovation, which will be no less revolutionary than the invention of the railroad.
The United States Securities & Exchange Commission has taken the view that security tokens are securities fully subject securities regulation. Thus, the issuance and exchange of security tokens in the United States is subject to registration or must come under an exemption from registration (typically, exemptions pertaining to investors deemed sufficiently sophisticated to analyze the risks and merits of an investment, or of sufficient means capable of sustaining losses). Other major jurisdictions are taking note of the United States position, some following, others embarking on their own regulatory reforms to address regulating of security tokens. Since blockchain infrastructure is trans-jurisdictional and anonymous, there is an added dimension of the need for global cooperation, and for the involvement of agencies that regulate much more than securities: banking, taxation, anti-money laundering, anti-terrorist and other crime financing, tariffs and trade finance. There is not an industry that will be left unaffected by the advent of security tokens. From mining to pharmaceuticals to retailing to aerospace – security tokens will play a role. The ability of small investors to participate globally will democratize investor bases. Tokenized funds and other collective investment schemes will emerge to attract passive investors.
Over the next three articles we will examine how the global security token “rails” are being laid to provide for the imminent securities token global express train. Dozens of fabulous companies are building rails of scalable, standardized, interoperable token solutions ushering in a Golden Age of securities innovation. We will survey the many platforms available and being built for the launching and trading of security tokens. We will also analyze the regulatory approaches major jurisdictions are taking to the challenges of regulating security tokens, taking notice of existing laws and trends.
The schedule of the other 3 posts in this series is as follows:
- 3rd November: Platforms for launching Security Tokens.
- 10th November: Jurisdictional and Legal issues related to Security Tokens.
- 17th November: The current state of the art in Security Tokens and where the puck is headed.
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