What is Security Token in Crypto and Blockchain?

A security token in cryptocurrency represents a certain form of ownership of the underlying business, tokenized and existing in the blockchain. Security tokens can be considered tokenized pieces of valuable real-world assets in the blockchain. What precisely this asset entails varies between issuing companies. However, a security token can represent shares or a claim of ownership—as mentioned above, of the issuing company. 

The concept of a security token originates from traditional finance, where the term “security” denotes a stake in the asset of a publicly-traded company. This stake can be a bond or a share of the issuing company. For a stake to qualify as a security, it must be issued by a publicly-traded company compliant with the regulator’s rules.

Security Token versus a Utility Token

A security token in cryptocurrency can denote tokenized bonds, stock, and other identifying assets whose ownership translates to benefits based on the issuing company’s revenue. By tokenizing traditional securities and deploying them on the public blockchain, the token holder is the bonafide owner of a fraction of the company’s underlying asset, as mentioned above.

Unlike a utility token whose value is backed by the developing company and expressly serves a role in the ecosystem, a security token must not necessarily have utility. It must comply with regulators’ rules as securities like any other issued stock or bond. Accordingly, a security token can sometimes be referred to as an equity token.

How do I get a Security Token?

The issuer of a security token typically requires interested holders to verify their personal information, complying with Know-Your-Customer (KYC) and Anti-Money Laundering (AML) rules. Prospective investors must transfer funds to a whitelisted cryptocurrency address. By agreeing to be part of the whitelist, the holder agrees with the issuer’s terms and conditions. Considering the global nature of cryptocurrencies and blockchain, the issuer can remain compliant with their jurisdictional laws and can block out users from certain jurisdictions from participating.

The Howey Test

Holders of security tokens are protected by law, receiving legal protection and having the most critical regulatory clarity often missing in crypto circles. Specifically, in the United States, securities fall under the purview of the Securities Exchange Commission (SEC). The regulator uses the “Howey Test” to determine whether a tradable asset is a security or not. In simple terms, if someone invests in an asset in expectation of making money—or earning a profit—that asset qualifies to be a security under the “Howey Test”.

Benefits of Security Tokens

Security tokens hold various advantages over stocks or bonds. Since they are deployed on a public, global blockchain, a security token inherits all the ledger benefits. That means a security token’s transactions are immutable and transparent. Security tokens can also be traded without the hindrance of high fees typical in traditional bourses. At the same time, the tokenization of security tokens means a user can acquire a fraction of the real-world asset, offering opportunities for all investors.