[ELM] What are Security Tokens in Crypto?
Updated: Aug 31
In traditional finance, the term security refers to a document having proof of ownership in a company, right to ownership, or relation with the company. Further, a security has a monetary value, and you can trade it in the market. There are different types of securities, e.g., equity security like stocks and debt security like bonds and debentures.
Like centralized finance, decentralized finance also has tokens representing the ownership of a physical or a digital asset. Such tokens are called security tokens. Ethereum ERC 2.0 and Tezos' FA1.2 standards are very popular for generating tokens.
What is a Security Token?
As mentioned earlier, a security token is a token linked to an asset. It is created on a blockchain network. For example, your father owns a house, and now he wants to equally gift property to you and your sibling. As a blockchain enthusiast, he can get two security tokens created linked to the property's equal ownership. The advantage of having a security token is that it can't be forged. Moreover, you can verify your ownership on the blockchain network from anywhere worldwide.
Similarly, a security token is a crypto asset that can be created for anything in the real world, e.g., cars, stocks, bonds, fiat currency, the right to vote, etc. Alternatively, it can be said that a security token derives its value from the physical asset. The possibilities and use cases of a security token are endless.
Strict regulations control the trading of a security token. The companies and the individuals involved in trading have to ensure compliance with the Howey test. Investopedia explains The Howey Test as "The U.S. Supreme Court case for determining whether a transaction qualifies as an "investment contract," and therefore would be considered a security subject to disclosure and registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934".
Benefits of Security Token
A security token has all the benefits of a blockchain network and monetary value. Moreover, it overcomes the hurdles of maintaining and trading physical security as centralized equity securities are traded only five days a week, from morning to afternoon. In contrast, a security token can be traded anytime.
Further, the speed of settlement of a security token transaction is many times greater than the physical security transaction. This is due to the flexible smart contracts that make trading smooth. Moreover, smart contracts ensure compliance with regulations; hence, there is no need for human intervention and a further reduction in physical documentation and cost.
Lastly, the speed of transactions, quick settlement, and all-time trading availability increase the liquidity in the market.
Types of Security Token
A security token has four types based on the purpose of its issuance:
Equity Token: An equity token represents the fractional ownership of an asset or a company. The owner of the equity token gets dividends, profit shares, voting rights, buyback options, etc., similar to the equity security.
Debt Token: Companies can issue a debt token to raise debt from the investors. In return, the investors get an interesting return.
Asset-Backed Token: This type of token is linked to the physical or digital asset. The value of this token fluctuates in sync with the value of the asset it is linked to.
Utility Token: It helps companies to raise funds for blockchain projects. Later, the project can use the tokens to play, buy, or trade.
How to buy a Security Token?
Security tokens are issued through a Security Token Offering (STO) on security token exchanges. It is open to the public to invest in security tokens. As regulations and compliances are in place, STO emerges as a powerful instrument due to lower susceptibility to fraud.
An STO works in four layers. The first layer has blockchain protocols that have all the technical parameters. The second layer has smart contracts that govern the transaction rules. The third layer has the security token creation platform built over smart contracts. The fourth and last layer has exchanges that facilitate security token trading.
Security Token Service by ELM
ELM empowers businesses by offering best-in-class services to deliver the perfect-suited security token for modern-day business needs. Whether you are looking to raise funds for a blockchain project or looking for debt, a security token is a way to go for you. With the powerful Playmaker account, ELM offers security token creation with the latest smart contracts. The most popular smart contracts we use shall put your business ahead of your competitors. Also, it is super simple to use. All you need is to connect to your metamask wallet.