Security token trading is a multi-trillion dollar blockchain opportunity
The big question hanging over cryptocurrencies at the moment is, “Are they securities?”
According to William Hinman, the SEC’s Corporate Finance Director, the answer is no if you’re talking about Bitcoin or Ethereum. For other cryptocurrencies, the SEC is still working out the answer, but the question itself poses an opportunity: Why not create cryptographic assets that are securities?
The regulatory framework exists, we have the technology, and it would create new investment opportunities and liquidity for capital markets around the globe. With trillions of dollars worth of securities being traded every day, this could be the biggest disruption to the stock market since computerization.
What is a security?
Securities represent something valuable in the real world, such as stocks, bonds, or other assets. They often come with benefits like voting rights, equity, and dividends, and are easily converted to cash.
To trade securities, you need to find and match buyers and sellers, operate within SEC regulations, and pay fees to brokers, fund managers, or others involved in making a trade.
What is a security token?
Security tokens, on the other hand, are digital contracts that divide securities into cryptographic segments, which can be traded independently. If you want to buy a stake in a property, artwork, or business, for example, you could purchase digital tokens that prove your ownership with blockchain certainty.
Most importantly, security tokens are SEC compliant. That means issuers can offer inducements such as profit shares without worrying if they’ll fall foul of regulators. Such certainty helps reduce volatility, which attracts more investors.
Important note: Security tokens shouldn’t be confused with utility tokens, which may or may not be SEC-compliant depending on the issuing organization or project. Security tokens can incorporate a utility function, but will only be defined as a security token if they meet SEC criteria.
Why are security tokens so important?
There are three components to this.
First, tokenization democratizes capital markets. Breaking down large assets into smaller pieces increases liquidity, but crucially helps low-income investors buy stakes in assets they might not have been able to afford.
Second, tokenization makes the market more efficient. Blockchain smart contracts guarantee asset ownership, secure trading, and ensure regulatory compliance without the need for intermediaries. The end result is lower costs for all parties.
And finally, tokenization opens up trillions of dollars in liquidity. Imagine if every investable asset was represented by security tokens, unrestricted by geography, computer systems, or bureaucracy. The global real estate market, one of the best use cases for security tokens, is worth $217 trillion dollars alone, so the potential is huge.
In short, security tokens bridge the gap between traditional and cryptocurrency markets. The security token represents a tradeable fraction of real-world value, while also giving a blockchain-assured transaction record for peace of mind.
Blockchain businesses want clearer rules and a regulatory framework for securities already exists. By bringing cryptocurrency and institutional investors together in a highly liquid, global market, security tokens could be the biggest shift in asset exchange in decades.
What’s wrong with traditional securities?
To make money in securities trading, you need to start with a sizeable investment. Sure, you can buy a few AAA stocks with as little as $500, and if you’ve got the patience and foresight you could make decent money. But the complexity and low gains can deter low-income investors from entering the market – especially when CFDs (Contracts-for-Difference) and crowdfunding sites offer more compelling returns and hedging opportunities.
However, while CFDs and social trading apps like eToro have made it easier for new investors to enter the market, you never own the underlying asset, and spreads make trading expensive. Similarly, if you want to invest in property through a crowdfunding site like Realty Mogul (US), your investment is tied up in a highly illiquid markets. So neither CFDs nor crowdfunding are perfect alternatives to traditional securities trading.
Also, depending on the size and type of asset you want to invest in, you might not have sufficient capital to buy a share outright while still spreading risk. Your broker or fund manager could also incur additional fees to buy or sell illiquid yet desirable assets – such as fine art – costs which are ultimately borne by you.
How do security tokens solve these problems?
First, tokenizing a real-world asset makes it easier to match buyers and sellers. Few of us could invest in an entire hotel, for example, but you could potentially afford a stake in it. The increased liquidity also makes it easier for low-income investors to get involved in projects that would’ve been economically out of reach. Better liquidity means smaller fees, too.
Second, the fractionalisation of assets creates new, safer investment opportunities. If you’re interested in a property portfolio you could, through security tokens, purchase stakes in properties all over the country, spreading risk across all your invested assets.
Finally, security tokens leaves regulatory compliance to the blockchain, not people. All transactions are verified on a digital ledger which everyone agrees upon in a trustless manner, so there’s no room for human error.
Everything from proof of ownership to contract conditions can be written into smart contract code within the blockchain. And with blockchain handling the bureaucracy, we need fewer bureaucrats, fewer intermediaries and checks, resulting in a much cheaper and efficient trading ecosystem.
What’s happening now?
Already, blockchain projects like Swarm, Harbor, and Polymath are making it easy to create, trade, and invest in security tokens that represent real world assets. Property Coin is currently undergoing a sale of their own security token, PCX, backed by a portfolio of real estate and loans.
On July 17th, Coindesk reported that Coinbase, the world’s largest cryptocurrency exchange, was approved for listing security tokens on its trading platform. Even Nasdaq has stated they are open to the concept of incorporating blockchain into the listing of public companies.
Altcoin.io is also helping clear a path towards a token-based economy by offering a secure, fast, and easy way to trade digital assets. We expect you’ll be able to trade security tokens on our decentralized exchange in the next few years or so, once the regulatory fog has lifted and they’ve gained public and institutional support.
Security tokens are still gathering momentum, but they’ll cause a transformative change in the financial industry. From opening up global liquidity pools to helping new investors – professional and amateur – enter the market, security tokens could be the next evolutionary step for capital markets.