There have been times when some top crypto assets like Ethereum have been argued as security tokens. There have been issues in categorizing some cryptocurrencies.
Ethereum co-founder, Vitalik Buterin recently stated that Ethereum is not a security token as argued by some crypto community members.
Understanding crypto security tokens is important for crypto traders and investors. The first thing to understand before this is tokenization i.e. how tokens are being created.
In this post, we’ll learn more about security tokens, how they work and are regulated, and how they are different from other digital assets. Before then, let’s learn more about crypto tokens.
What is a Token?
A token, in data science, is a value—like a randomly-generated number—assigned to sensitive data to mask the original information. So in a blockchain, a token is a number assigned to data stored within the blockchain.
A crypto token is a type of cryptocurrency that represents an asset or specific use and resides on its own blockchain.
A token can be used to fundraise for crowd sales, but it can also serve as a substitute for other things. Tokens can be used for investment purposes, to store value, or to make purchases.
These tokens are usually created, distributed, sold, and circulated through the initial coin offering process. This involves a crowdfunding exercise to fund project development.
Its holders can use them to make purchases or they can trade tokens just like other securities to make a profit. Token holders can also be part of the company’s decision maker as some projects allow holders to be part of its governance.
What are Security Tokens?
Security tokens represent rights of ownership, transfer of value, or promise of returns that are tokenized on a blockchain. It is intended to be treated as an investment instrument.
Security tokens are the digital form of traditional investments like stocks, bonds, or other securitized assets. Companies that need to raise funds can decide to issue fractionalized ownership of their company through a digital token instead of issuing stock. These tokens can then be offered to investors on an exchange that allows digital security tokens.
There are three primary types of traditional securities: equities, debt, and a hybrid of debt and equity. Examples of securities include stocks, bonds, ETFs, options, and futures.
Understanding Crypto Security Tokens
As stated earlier, security tokens are different from cryptocurrencies even though they are created on the blockchain. To understand security tokens, you need to first understand tokenization.
One thing about tokenization is that anything can be tokenized. As for security tokens, the investment criteria are selected. The information is entered into the blockchain, which then creates a token.
Security tokens could be a digital form of paper stock certificates given to investors that purchased stocks. This digital certificate in form of a token for investors always goes through a blockchain tokenization process.
A security token might take one of a few different forms to be identified—it could have an image assigned to it that could be displayed in a digital wallet along with its value. On the other hand, it might only be a number your wallet keeps track of.
The wallet could display your holdings, value, and any dividend distributions. Your wallet might also provide quick access to a prospectus or annual reports.
How to Differentiate Between Cryptocurrencies & Security Tokens
Security tokens and cryptocurrencies are almost the same. They are created by and stored on a blockchain. They are both tokens, but the crucial difference lies in their purpose, intended use, and actual use.
A cryptocurrency is designed to be used as currency, money, or payment method. A security token on the other hand is intended to be used the same way a stock, bond, certificate, or other investment asset is used.
There has been an argument that top crypto assets such as Bitcoin and Ethereum are security tokens. In fact, investors & traders have treated Bitcoin as a security token even though it was not designed as one. Several members of the crypto community have argued that ETH is security and should be considered as such.
Investors and traders noticed that they could reap significant returns from Bitcoin when it was listed on cryptocurrency exchanges. Ether, because it is being traded on exchanges and held for its increasing value, investors treat it as a security token.
However, because BTC and ETH are not designed to be used as security tokens, and there is no expectation of profits from the developers, they do not currently meet the criteria to be considered securities by the SEC.
Cryptocurrency and security tokens are almost the same but different in their use cases. Bitcoin & Ethereum are top of crypto assets that are discussed as security tokens even though they are not. Stocks, bond, certificate, or other investment assets are security tokens that can be created by companies and put on exchanges for investors.