5 Advantages of Security Tokens

Stefan Perlebach
Stefan Perlebach

Sep 3, 2018

Security Tokens are coming to disrupt the financial world!

Traditional financial products  will be digitized and put onto the blockchain. By tokenizing securities we will see many improvements for investors and issuers in the market. But even regulators will benefit from this new technology.

The following text will guide you through the biggest advantages Security Tokens will bring to us.

1. More Compliance

Are regulators such as the SEC (in the U.S.) or Bafin (in Germany) happy about tokenized securities?

The answer is: Not yet, but soon they will be.

At the moment regulators from many countries are trying to handle all kinds of crypto projects out there - figuring out how existing law applies to them and what identifies them being a security or not.

What seems to be a Wild West authorities currently need to deal with, soon will make their lives much easier. Tokenized securities will give regulators the opportunity to apply more compliance and control, rather than less. When we look at regulators today, they are mostly reactive. They spend a lot of time and money on identifying organisations that break the rules. Once identified, it takes years and millions for prosecutions and trials.

The tokenization of securities can completely change this status quo, putting regulators back into the driving seat and let them govern proactively. Since blockchain technology and smart contracts make it possible to write ownership and law directly into a token, the token will be able to execute, regulate and govern itself. For example, a Security Token can be programmed to verify who can buy and sell it and therefore restrict Security Token holders from trading it to any address that has not passed the required verifications, assuring the issuer that their tokens will only be held by authorized investors. Another use case includes restrictions on the token transfer. For example, under SEC Reg D investors are not allowed to sell their ownership stake for at least 12 months after their initial purchase - this can be encoded into the token, preventing it from being traded before that time period ends.

In addition to that, the whole audit trail and data from the Security Token creation and compliance processes are uploaded to the transparent and fully auditable blockchain. Therefore, regulators will be able to drastically reduce their compliance cost, saving energy and resources which might be worth millions taking SEC`s annual budget of $1.6 billion in consideration.

2. Inclusion of New Investors

Due to these regulatory benefits, sooner or later authorities will understand the advantages of global Security Token standards and support its implementation. This will provide huge opportunities for issuers to access an international pool of capital and reach out to a larger potential investor base.

Once Security Tokens will be tradable globally, theoretically they will be accessible by anyone with an internet connection (within regulatory limits) and therefore democratize access to capital markets for companies and investors alike.

The regulatory framework that governs Security Tokens will be another good reason for the crypto community to invest without worrying about being scammed (as happened to many putting their money into ICOs). When buying Security Tokens, they “just” have to be concerned with the economic success of the company.

The fractionalization of larger assets will be another door opener for new investors to a formerly exclusive market. The tokenization of assets makes it possible to own just a small fraction of a stock, real estate or piece of art. Formerly, these were just accessible to those investors which much capital and the ability to take on longer-term investments.

3. Liquidity

With Security Tokens enabling fractional ownership and thereby lowering minimum investments, more liquidity will come into the market. As more people will be able to purchase smaller stakes, many assets that are considered to be illiquid, or not easily to (re)sell can increase their liquidity on the blockchain. For example, if an owner of an expensive piece of property or a rare piece of art wants to turn it into cash, it will be much more likely to find investors who want to lay claim to just a fraction of it, rather than the entire asset.

One of the first known prominent examples of tokenizing art is the Mayfair Gallery, putting their entire collection on the blockchain including a work of art by Andy Warhol, the “14 Small Electric Chairs”, valued at more than $5 million. Also within the Real Estate industry, many companies are trying to use blockchain technology to extent their customer base, working on the tokenization of property. Brickblock, Realecoin, Propertycoin, Leaseumpartners, and Slice are some of the pioneers out there.

That the Security Token world does not know weekends or opening times is another advantage over the traditional financial system - allowing all participants 24/7 global access in the Security Token market, which will provide even more liquidity to the market.

4. Efficiency & Scalability

Blockchain technology and smart contracts have the potential to replace many of the current inefficiencies in the financial industry. Here is a list that shows you some of the benefits the tokenization of securities will bring:

    • reducing costs by removing huge parts of the back office banks still need
    • simplifying accounting and auditing processes
    • automating KYC and AML process (no backoffice needed to vet every single investor)
    • reducing complexity and paperwork with managing securities (e.g. collecting signatures, wiring of funds, mailing of distribution checks etc.)
    • lowering issuance fees by removing the middleman (banks) from investment transactions
    • decreasing the reliance on lawyers (in the long-run) due to the use of smart contracts
    • enabling real-time settlements between buyer and seller on secondary market, therefore less settlement risk
    • using smart contracts to automate the service provider function through software
    • automating dividend payments
    • proxy voting
    • more accurate and fair asset valuations due to the exposure to a free and more competitive market

5. Transparency

Blockchain allows a uniform method of verifying and tracking data and prevents tampering due to its immutability. With these characteristics in place, it becomes the perfect infrastructure to document ownership of securities in a fully transparent way. This will make reporting and auditing much easier which will help to prevent fraud, mispricing, arbitrage, manipulation by financial institutions and corruption.

Conclusion

It seems obvious that blockchain technology can offer huge opportunities for creating a more open, inclusive and efficient marketplace for securities. However, yet there are no Security Tokens tradable and there are still many challenges ahead of us:

    • The puzzle of being decentralized, secure, scalable and user friendly all at once still has to be solved within the blockchain world.
    • Education, lobbying and persuasion of authorities and decision makers has to be done in order to convince of this new opportunity.
    • The connection between off-chain and on-chain has to work in order to bring physical assets and (inter)national law onto the blockchain.

I`d like to finish this article with a quote I found on the Medium blog of Open Finance Network - an US based regulated Security Token trading platform:

“The essence of blockchain, at its core, is perfect for the problems we are trying to tackle. Once we started building the platform, we realized how simply some things were solved, just by applying existing blockchain technology. In an industry that is still using snail mail and fax machines, blockchain looks like interstellar travel.”

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