By Larry Wright
The financial system of the world is changing at a much more rapid rate than we are willing to give it any credit for. It sounded almost like magic when someone talked about having your money transacted from one place to another in a completely digital manner, but we have achieved that feat and are consistently moving on towards this interaction. Our financial system has been revolutionized multiple times in the past, and the introduction of decentralization and cryptocurrencies have really furthered the fact of how forward we can go with this digital approach.
Blockchain technology really opens up the available opportunities to the users with which they can interact; some of them only are limited to sending and receiving money, such as the case with traditional crypto tokens. Some have to do with the idea of making smart contracts so that multiple business exclusive tasks could be completed in a much more decisive manner, and of course, there is the prospect of security tokens.
The security tokens are a better recent concept within the realm of decentralization, and it is a domain that has not yet been tapped or explored to its ultimate reach. To be able to understand the concept a little bit better, you have to take into account the very definition of what security is.
In the financial world, the term ‘security’ refers to a financial instrument that has some kind of value attached to it, and it can be traded in an open market. Some of the financial instruments that we see today or interact with, such as stocks, bonds, and other such financial options, could be taken up as securities.
Stock is a security given to investors against the investment that they have made into the company or firm the stock represents; the same concept can be applied to bonds and so on soon. Apply the definition of what a security is in a legal context; you would find the definition to be much more narrow and vary from concept to concept and jurisdiction to jurisdiction. The subject of what we can call security is already subjected to extreme regulatory scrutiny. What we will be discussing here is the prospect of blockchain technology and how it can help in streamlining our financial markets by powering these with security tokens.
What are Security Tokens?
A security token is merely a digital entity that is issued on a blockchain system, and it represents a certain stake in some dedicated financial enterprise or asset. It could belong to an already established and circulating cryptocurrency, or it could be from a completely different and unique domain of decentralization.
Private businesses and governments can offer or issue these entities, and these are going to serve an identical purpose to their counterparts, such as stocks and or bonds. The only difference between a security token and a stock is that one is created on the Internet while the other one is being traded in a much more elegant and separate marketplace while both are traded publicly.
Why Should You Consider Investing in Security Tokens?
If you are wise enough to understand what a security token is, then a question that might have jumped to your head is, why bother using security tokens at all when you have access to stocks and bonds? While it is an extremely important question to ask, the answer might not surprise you at all. To understand more about this, let’s take an example into account.
Suppose there is a company out there that simply wishes to distribute some of its shares to the investors on a blockchain system; they would have to come up with a tokenized form of the shares so that these could be proposed to the blockchain environment. All these tokens would be designed to have almost identical benefits that come with having shares of a financial entity and or company, such as having voting rights, receiving dividends, and providing yourself with a decent stake within the concerned company or financial firm.
The company could have distributed its shares in the form of stocks or bonds, but then the essence of decentralization would have been lost. Security tokens allow people to communicate with each other in a much more rigorous and compact environment; the security of this infrastructure is just over the top, and to have a cherry on top, these security tokens are immutable, which means that the guidelines that were drafted during the production and development of these tokens would remain unchanged down many years.
This way, you have a security token whose value is only going to increase, and surely you would not get a negative push in terms of the overall money that you did spend on it in the first place. Your return on investment would remain secure and intact. Moreover, these security tokens draw extensive benefits from the blockchain they are present on, and some of these benefits include rapid settlement, zero downtime, transparency, and divisibility. Following is a brief assortment of these benefits so you can understand better why it is much more rewarding to have security tokens at hand rather than going for stocks or bonds as securities.
Transparency
A blockchain system works in an anonymous manner, all the transactions that are taking place are being validated in real-time by the network validators or miners, and the data is incorporated into the blocks with a proper hash number to identify certain transactions or categorize them for easier looking up. The information regarding the personnel involved in a transaction, such as the private data of a sender or receiver, remains completely anonymous, but everything else is made public, which means that it could be audited easily. Smart contracts that are managing the tokens in the first place are public data which means that anyone can view these and drive insights from them.
Rapid Settlement
According to many critics of decentralization and blockchain technology, being able to liquidate the tokens that you carry is a real blessing because most of the time, according to these people, there isn’t a chance to do so. This is just a made-up assumption and not based on real-life facts; such delays or interruptions are only encountered when there is something seriously wrong with the blockchain of a dedicated cryptocurrency; other than that, there is absolutely no bottleneck whatsoever.
The type of blockchains that house these smart tokens are extremely powerful and automated, which means the reassigning of ownership from one person to another only takes a couple of seconds, and the process is done. You can liquidate your smart tokens right then and there and move on to a better prospect or investment idea if you want to.
Consistent Uptime
The traditional financial markets are not 100% consistent with keeping their uptime score near to perfection, there are a few loopholes in there, and more often than not, people are seriously troubled with having multiple downtimes with their conventional banking systems.
Some financial institutions are only open for a fixed duration of time during the week and most probably are going to be closed on the weekends. This is not, however, the case with blockchain technology; as long as you have access to the Internet connection and a mobile device, you can access your funds and, therefore, the smart tokens that you carry around the clock.
Easy Divisibility
You would be amazed to know that any entity out there may, it be real estate, art, or other high-value assets, could be tokenized in real-time in a blockchain environment and be made available to the investors. A specific something could be tokenized into thousands of pieces, and each of them could amount to a certain value. This way, thousands of investors could chip into owning multiple parts and or tokenized segments of that specific asset which really makes divisibility less of an issue.
What Makes a Token A Security?
Blockchain technology in itself is pretty straightforward, and you would find the definition along with the working mechanism to be exact and fit the description of what the technology is capable of. It is the legal front where the blockchain industry lacks the clarity that can help in making the definition and or purpose of various associated terms and assets clearer. Financial regulators around the globe are still trying to do their very best to define blockchain technology and multiple varieties of it that are present out there and working in a synchronized manner.
There are multiple scenarios where the issuers of security tokens believed that they were issuing utility tokens but later on were determined to be securities by the Securities and Exchange Commission. One such case that has been lingering for too much time now is SEC versus Ripple. Ripple is a crypto token that found its reputation in the form of getting entrenched in a legal dispute with the Securities and Exchange Commission.
Earlier presumed to be a crypto token Securities and Exchange Commission, later on, changed the status of Ripple from crypto token to security which Ripple strongly contested, and a lawsuit is still open and going in the United States to determine which description best fit Ripple and if there has been a misunderstanding by the Securities and Exchange Commission.
Howey test is the most elementary way of finding if a transaction could be termed as an investment contract or not. The test is in place to ensure that an individual who has invested in a particular enterprise can expect to have some kind of profit at their hand as a result of the promoter’s efforts. This test was developed long ago by the US courts when blockchain technology wasn’t around.
That is why it is a bit difficult to apply this test to the new tokens and to determine if these could be termed securities or not. But still, to this date, this test remains a valid tool for regulators around the globe for the classification of digital assets and determining whether or not these could be termed or classified under the umbrella of security. The logic behind this whole thing remains the same, but the framework used to determine if a digital asset in itself is a security or not could be a little bit different.
There is a desperate need to strike a union between smart contracts and security tokens because if both could work with each other, the final outcome could be thrilling. Think of a business deal where the two parties don’t rely on each other; one party is offering their services while the other has to pay for these services. Now a smart contract could be generated between the two have a full list of all potential objectives that need to be completed for the payment to get released to the intended party.
Blockchain technology is already going to take care of the whole thing; when the party who was in charge of providing the service has actually done the deed, the funds that are locked within the blockchain would get released and paid directly to them. This is how smart contracts work; now throw in security tokens there, and you have got yourself a great modern financial cocktail that is seamless and accurate.
Now the money that was supposed to be wired or provided to the party who was offering its service could be converted into security tokens that could be shifted one by one depending on the degree of work done by the party or service provided. This way, even if the agreement needs to be broken halfway, both parties would have gotten something out of the deal. The party who was to provide a certain service would have received the payment to the extent of work done, and the party who was supposed to pay would have only paid the amount to which the service was provided to them. Everybody wins, and the matter is solved without any dispute.
Programmable Finance and Security Tokens
Given the present size of financial markets in today’s world, tokenization could be of immense value as it could immensely transform the conventional financial systems. Both the investors and institutions that are in charge of housing and aggregating transactions on a daily basis could benefit greatly from the fully digital approach that these new financial instruments have to offer. A sustained ecosystem of centralized databases around the world has offered great friction to the world of finance, and this is something that needs to be smoothed out if we all are to move further and farther in the world of modern finance.
Financial enterprises really need to implement certain resources to administrative processes for the sake of managing external data that might or might not be incompatible with their own practical systems. There is a serious lack of industry-wide standardization, which is adding consistently to the overall cost of the businesses and how effectively and significantly transactions could take place.
A blockchain is, without any doubt, a shared database that any business or user out there can conveniently interact with. A variety of functions pertaining to the transactions that are taking place over the Internet and or the transfer of finances along with digital assets which were previously handled by centralized institutions could now be outsourced to a digital Ledger that would automate the progression of transactions and their effective recording within the blocks.
Now, this is a digital ledger that could be used by the rest of the industry. By tokenizing these securities, an interoperable networking system could be manufactured, which would enable increased speed for offering rapid settlement times and global compatibility of the system, hindering any and all excuses pertaining to the compatibility of the conventional financial systems with each other.
All the other time-consuming processes could now be handled effectively by blockchain technology. Know your customer and anti-money laundering compliance could help in making sure that only transactions that are legit and surface from a potential source are processed over the blockchain technology, and all the illegitimate and shadowy transactions are nullified right then and there. This put the control back into the hands of governments and people who are trying their best to make the world of digital finance as secure and pleasant for everyone as it possibly can be.
Despite the fact that these security tokens are managed and operated in a blockchain environment, their operation and or working mechanism is extremely similar to those of traditional securities rather than cryptocurrencies and another decentralized manner of conducting business. As it has been explained multiple times before, some serious work needs to be done on the regulatory front, but that is something world governments are already working on.
Authorities must make sure that all these digital assets could be easily transferred from one place to another without posing any threat to their issuance and flow. According to some professionals out there, this very speculation could also be automated with the help of smart contracts. If smart security tokens are adopted wildly within the financial realm, then the operation of financial institutions could get immensely streamlined. This will bring conventional and digital markets on a rather agreeable front where interoperability is not as much a concern as it used to be.