The Beginner’s Guide to Security Tokens

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The world of cryptocurrency is often more diverse than people expect. Although you might be familiar with certain coins, there are actually several types of assets within the crypto space. Along with the broader categories of coins and tokens, there are subcategories in each of these spaces. One example is the security token.

If you’re thinking about investing in crypto, it’s essential to understand what security tokens are, how they work and how they differ from other tokens. That allows you to make wiser investment choices, plan for tax implications and more. And because some financial experts believe the landscape is growing — with estimates security tokens will hit $162 trillion in volume by 2030 — now might be just the time to dive into security tokens. Here’s what you need to know to get started.

Security Tokens: A Basic Definition

A security token is a digital asset that represents ownership rights in another asset, such as a stake in a company from a stock. The main difference between these traditional securities and security tokens is that the tokens are part of blockchain environments, while other securities aren’t. Beyond that, the two financial instruments have quite a bit in common.

Security tokens are like securities you can acquire through a brokerage using traditional investing strategies. After purchasing one, you become a shareholder. This gives you the ability to have a say in the future direction of the company. The value of security tokens is also determined by the value of the underlying asset they’re tied to.

That latter point separates security tokens from coins. With coins, the value is primarily based on public sentiment — there’s no other asset backing the coin. With security tokens, there’s an underlying asset. This gives the token a basis for its value on the market.

How Security Tokens Work

As mentioned above, security tokens aren’t unlike stocks in companies. They represent fractional ownership of an underlying asset. But, with security tokens, a record of this ownership is included on a blockchain ledger.

Security tokens are highly liquid. In most cases, transferring ownership requires little more than what it takes to trade any kind of cryptocurrency. Additionally, new exchanges are in the works to make the trading process even more similar to that of stocks — an ideal development if you’re familiar with trading stocks online already.

However, while security tokens are tradable and most people consider them cryptocurrencies in the broad sense, they aren’t spendable like crypto coins. You can’t head to an online retailer and pay for a purchase of real goods using a security token. Instead, like stocks, you have to sell the security token to get a usable currency, whether that’s in crypto coins or fiat currency. Since that’s the case, security tokens work more like investment vehicles. They’re a chance to support a company directly — and potentially profit from its ongoing growth or success.

Using Security Tokens

As mentioned, security tokens aren’t spendable — at least not exactly. Instead, they’re investment vehicles representing a share in a company or other high-value underlying asset. This can make security tokens wise additions to your portfolio. If the underlying asset increases in value, the value of the associated security token also rises. That creates opportunities for profit.

Additionally, as long as you own the security token, you maintain rights similar to those of stock shareholders. You may get to vote on various matters relating to the underlying asset, giving you a say in its future.

Now, it’s important to note that the value of security tokens isn’t guaranteed to rise. Like traditional stocks, the value may shift up and down based on changes in the underlying asset’s value or market perception. While it isn’t subject to the whims of the masses to the same degree as coins, public sentiment is technically a factor in influencing security tokens’ value, just as it is with stocks. Still, security tokens are potentially less volatile than coins because the underlying asset provides security.

The Difference Between Security and Utility Tokens

Both security and utility tokens have a lot in common. Each doesn’t serve purely as a digital currency. Instead, there’s additional functionality that allows them to stand apart from coins in the cryptocurrency landscape.

However, what that functionality is is what differs. Security tokens operate like stocks. But utility tokens are different. Instead of representing an ownership stake in a company, utility tokens give you access to specific services within the associated blockchain landscape. For example, a particular utility token could be the way you make a payment within an associated crypto environment. Without the utility token, you wouldn’t be able to engage in the environment’s marketplace.

Essentially, a utility token is a marketplace-bound currency. That can make it seem like a utility token and coin are the same. But, it’s important to note that, while coins may be usable across several platforms or marketplaces, utility tokens are limited to one or a select few. Additionally, utility tokens are required in their associated environment; without them, you can’t access services using other payment forms, such as coins.

How Are Security Tokens Regulated?

Part of what determines how various crypto assets are regulated involves whether they pass or fail the Howey Test. When all four parameters of the Howey Test apply, an asset is considered a security, legally speaking. As the name suggests, security tokens are generally considered securities from a regulatory standpoint because the four conditions apply. As a result, the U.S. government treats them just like stocks.

The Pros and Cons of Security Tokens

There are benefits and drawbacks to security tokens. Some people feel that the high degree of regulation is a hindrance, particularly when it comes to access. Generally, only accredited investors are able to purchase them. That makes them less flexible than other kinds of cryptocurrency. However, treating security tokens like stocks also offers investors protections they don’t get with other kinds of crypto. Some investors see this as a benefit instead.

Additionally, security tokens are far more liquid, with transaction speeds well above traditional securities. The fact that blockchain is involved can also increase your sense of security; all transactions are recorded in a public ledger that’s nearly impossible to alter.

As for drawbacks, security tokens aren’t spendable like coins. On top of this, they generally don’t have marketplace applications like utility tokens. Instead, they’re primarily an investment vehicle, which may or may not be appealing to you, based on your investing strategy.