All you need to know about Security Tokens: complete guide
Security tokens and crypto assets, in general, are going through a hype stage at the moment. The regulators are repeatedly adopting new crypto-tailored legislations, the research institutions like World Economic Forum state that nearly the entire economy will be soon transferred to the blockchain, and generally all the big players ― both traditional finance-based companies like HSBC or Swiss Stock Exchange, and crypto-based like Binance or Bitfinex ― are expanding into the security token industry, creating the local actors, and obtaining licenses.
In this piece, we are going to clarify the general awe caused by security tokens and explain how the ordinary business owner might take advantage of this technology.
What are security tokens?
Security tokens (aka tokenized securities) are regular securities (stocks, bonds, derivatives, and any other type of securities) transferred to blockchain and existing in the form of tokens. A representation like this allows operations like trading, purchasing, or receiving income to gain a simpler and more understandable flow a crypto token enables. Thanks to security tokens, the convenience of the crypto world can be applied to the realm of finance.
Security tokens are offered to the investors during the security token offering (STO). STO is a blockchain-based analog of initial public offering (IPO). The appearance of tokenized securities allows companies to access a new way of raising funds by issuing regulated digital shares on the blockchain.
Why are security tokens a big deal?
Security tokens owe their success to some advantages they possess.
First of all, they enable trading assets that aren’t tradable otherwise. As over 99,9% of companies worldwide are private, their shares can’t be traded on a stock exchange but only can be purchased privately. A shareholder is also limited in their possibility to make an exit, so the only thing they might hope for would be getting dividends in a relatively long time after the investment was made. In the best-case scenario, the investors get a return if the company is purchased. Unless there’s a single significant source of funding involved, a situation like this doesn’t make investing in the private sector attractive. The businesses are deprived of capital access, just as the investors are deprived of beneficial investment opportunities.
The same goes for the assets which can generate a great profit and grow in their value but are difficult to trade and make an exit from ― for instance, real estate. Investing in property is usually relevant when there’s a big check in question.
Security token offering is a solution to such an issue for a number of reasons.
1. The company’s stocks or property’s ownership are now represented in the form of tokens. Thanks to decentralized finance protocols, it’s elementary to trade them, and, respectively, the minimum investment check is significantly more accessible as well. For example, you can invest $100 in a given real estate instead of $100 000.
2. The business gains access to a bigger number of investors. Even staying private, the companies can raise money from a significantly broader circle of investors. Of course, the issuing company can also expect to get financing on better terms, as an issuer gets an increased bargaining power thanks to having more investors to choose from. Furthermore, tokenized securities are more attractive for investors thanks to better liquidity, which is a critical metric minimizing their risk.
3. The number of intermediaries involved in the financial process is reduced. For instance, brokers can be replaced with automated market-making protocols; custodians and depositories are no longer needed to hold securities. Therefore, the process of trading securities becomes more straightforward, more accessible, and cheaper ― both for investors and issuers.
4. Provide technical efficiency and automation. The dividends can be paid with one click, and the technical processes generally become simpler. There’s no need for physical signatures or numerous visits to different institutions ― everything is at your fingertips.
5. Increased profit for investors and general access to better investment opportunities. While the classic model of purchasing a share mainly suggests waiting around for dividends, a tokenized security opens a lot more opportunities for its holder, like, for example, lending them for trading purposes and getting additional returns. Also, better investment opportunities are a significant perk for unaccredited investors: now, there are significantly more companies and assets they have access to. According to the McKinsey report, private markets grow at least 50% faster than public markets, which means these new investment opportunities are more attractive than public markets.
What assets can be tokenized?
Tokenization is possible for any kind of assets that exist outside of the blockchain. It’s not only securities you can tokenize, but also commodities, real estate, land, natural resources, businesses, and, of course, art.
Tokenization works well for low-liquid assets like art and real estate. A token representing such expensive assets can be split into tens, hundreds, or thousands of cheaper fractions, increasing their liquidity and availability for investors.
A digital token retains all the characteristics of a traditional asset, to which the advantages of a blockchain are added: safety, transparency, speed, and low cost.
How are security tokens regulated?
Because security tokens are classified as securities, they are regulated as such. This is one of their advantages, which means that investors are guaranteed complete legal protection to this extent. An issuer can’t simply make an untraceable STO campaign; they have to be registered and fully disclosed to the SEC and other regulating bodies, as well as sign the agreements. It means that an issuing company has a responsibility to investors, and the latter have the power to sue it if necessary. The security token advantage that derives from this point is the fact that investors are provided with a better level of protection than when they hold any other crypto instrument.
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How to issue a security token?
The process of issuing and offering security tokens to investors is called Security Token Offering (STO). It is completed within five steps: advisory, legal, technical, marketing, and secondary trading.
Advisory. If you have decided to launch a security token offering, the first action you should take is to seek guidance. This is when you determine what your offering will be about, how it will be delivered, and it’s also when you plan and make big decisions. Negotiating with the service providers you will collaborate with is also part of an action plan developed during the consulting stage.
Legal stage. The two most important responsibilities you will encounter are establishing a corporate structure and compiling documents. Setting up or modifying a corporate structure includes forming new businesses if necessary, establishing relationships between them (for example, by merging), transferring a specific asset to the new firm, and opening bank and exchange accounts for all existing entities. When preparing the documents, you will need to deal with disclosure documents, the contracts signed with investors, and the company policies.
The technical stage is about issuing the token and making sure it fits the whitelisting requirements (which is when the IT crew develops a smart contract), and starting a token sale platform. Remember that your investors must pass the KYC (Know Your Client) and AML (Anti-Money Laundering) requirements in order to purchase the token.
After everything is set up, it comes a time to conduct a marketing campaign, which is the fourth stage of working on an offering. In our observation, STO promotion is one of the biggest pains of Stobox clients, and frequently, while attracting investments in traditional finance is mostly a discernible pattern, people are rarely aware of how to do it with security tokens.
The truth is that there’s no rocket science in accomplishing this task: all the promoting instruments are similar to the ones used by all the other marketing campaigns. Namely, this is about determining the target audience, creating a message, and promoting this message on proper channels. It can be search engines ads, direct outreach, or social media channels ― anything that corresponds to your ideal client profile.
The final stage is providing secondary trading. Its primary purpose is to deliver an extra return on tokens, making investors even more satisfied with the results and, of course, giving them a chance to sell the token whenever they want it, which is an absolute lust of this asset’s liquidity. To do this, you can provide P2P trading or create liquidity pools. At this point, the most important thing to remember is to maintain a healthy token policy and investor interactions.
Settling with a turn-key solution is probably the wisest decision while conducting an STO campaign, which is a service Stobox offers. As a result, the in-development product will be fully and carefully reviewed, and at the same time, you will avoid the issue of data transitioning operations between several providers, reducing the likelihood of delays, interruptions, and mixups. If you are interested in this solution, leave a request for a complimentary 30-minute consultation on our Tokenization Consulting page.