What One Should Know
11 Oct 2020
We are witnessing one of the largest economic transformations in human history from paper-based analog assets to digital ones. It is amazing that nowadays anyone across the globe can possess a digital value that may represent many types of real-life assets or may give access to rights in a global context. Thanks to tokens this is now possible.
Although considered a modern instrument, the token is not an invention of the blockchain revolution. The token business concept is widely spread in many industries of the traditional economy as it may represent any form of economic value. Tokens are being used for vending machines, the casinos’ exchange chips, tourist agencies issue vouchers, the gyms require club memberships to provide services. Some say that tokens have even existed since the first century AD when the Greek mathematician Hero of Alexandria invented a means of meting out exactly the amount of holy water that worshipers had paid for.
In the crypto world, a token is being defined as a digital value that refers to access to rights or assets and is collectively managed by a decentralized distributed ledger or blockchain network. At the core of the tokens is a smart contract, a software that mimics the provisions and the logic of a business agreement. Thus, the latter is also called a token contract. The smart contract automatically executes an action in case of occurrence of triggering event that is encoded therein. When the investor pays (usually with popular existing tokens such as ether or bitcoin) the process is triggered via the smart contract and the new tokens are issued. The process is called tokenization.
The token could be accessed through a public-private key managed by a wallet, which communicates with the blockchain network. If the token represents an asset, it could be transferred by signing the token with its private key. Should it give access to a right or represent a vote, the owner can exercise it again by signing with their private key and creating a digital fingerprint.
The blockchain initial public offerings allow companies to raise funds by issuing tokens/crypto securities, of some value in the company. They give it away to their investors during a public sale called STO (Security Token Offerings), in the case of security tokens, and ICO (Initial Coin Offering), in the case of utility tokens. In this respect, the two most important categories of tokens today are security tokens and utility tokens.
The security token is a tokenized form of asset which equates to equity in a company and/or provides ownership rights therein. Therefore these security tokens are also called equity tokens. In most cases, the security token is digital security which functions like any type of security – stakes, bonds, etc. Thus the security token is bought with the expectation that the value will be derived from the value of the company. Security tokens may also represent a tokenized asset, such as real estate. Investors in an STO may own an asset or may have any voting rights or profit share agreement. Therefore the security tokens are considered an investment product by law which is backed by a real-world asset, such as a company or property, and as such have to comply with strict regulations. The STOs are an increasingly popular way of investing in a blockchain company, as the security token offers a more reliable form of tokens and improves legal certainty. Since the security tokens are heavily regulated, there is enhanced investor protection, strict reporting requirements, and more rights for investors.
Simply said the utility token has a utility attached to it. The owner of a utility token receives benefits such as service. product or profit. Their price has a speculative nature and it may go up if there is a growing demand for the goods and services that the token gives access to. In contrast to security tokens, however, the utility tokens always have distinct utility. Thus, buying a utility token is more like buying a product or service. ICO utility tokens usually are not stand-alone blockchains, but they run on top of platforms like Ethereum. Thus, they have only value in the use of a system. Utility tokens are slightly regulated or not regulated at all.
The possibility to invest in tokens either by acquiring utility tokens that provide access to services, memberships, and resources, or buying tokenized securities which are accessible by investors in a worldwide environment, democratized the ability for projects to fund themselves. The blockchain, being the underlying technology of crypto assets, is broadly applicable to any asset in the world. Тhe token economy allows access to digital/tokenized assets which can be effectively exchanged without geographical barriers. Тherefore it may be considered as one of the key driving forces of the current global digital economy.
Security tokens are a crypto asset type that represents an ownership stake in an asset or a business. A security token essentially serves a similar role to traditional securities such as shares so it warrants the same regulatory scrutiny as those types of financial instruments. At the same time, they can bring the benefits of the blockchain revolution to traditional financial markets and help create liquidity in typically illiquid sectors. This makes security tokens a very powerful tool for bridging traditional finance and DLT-powered fintech. It also makes them an interesting case from a legal standpoint.
Regulation of the blockchain and crypto space has been notoriously hard to work out, especially after cryptocurrencies like Bitcoin and Ether rose to prominence and kicked off a larger crypto boom in the latter part of the previous decade.
The majority of legal hurdles come as a result of the inability of current financial rules and regulations to cover the various aspects of the blockchain sector, as well as from the lack of a unified approach when it comes to blockchain and crypto regulation.