In order to fully understand what security tokens are and why they have the potential to change the token economy and the financial industry as we know it, it’s important to understand securities.
A security is a financial instrument that holds some type of monetary value. Securities can be used as a way of spreading risk across a group of different investors, and they come in various forms, such as shares, options, bonds, debentures, warrants, royalties and income rights. This can be exemplified using the following analogy.
A company, in need of capital, issues shares in order to raise the money required from a host of investors. In return, the shares represent a percentage ownership of that business and, if profitable, a promise of a return on that investment. This can be in the form of a dividend, interest or some other share in the company’s revenue. In this way, companies can raise capital secured against the business, without necessarily relinquishing ownership via debt (bonds).
Map all this onto the blockchain and offer it to investors via a smart contract, and you have the Security Token Offering (STO). Simply put, STOs (unlike utility tokens, as we’ve explained previously) are tokens that have the ability to pay dividends, share profits, pay interest or even invest in other tokens or assets to generate income for the security token holders. Tokenise’s Founder and CEO, Michael Kessler, explains further:
“A security token is simply a unit that is owned by the investor in an asset and represented by a digital certificate. Utility tokens do not give you any direct ownership or rights within the assets or growth of the company. They simply give you a promise of a future development — that you can use your token as an advanced purchase.”
Security Tokens can also be traded on what is termed a ‘secondary market’, giving people the ability to buy and sell security tokens, and potentially add liquidity to a previously illiquid market. It could be game-changing for the securities market.
Improved Trading Through Blockchain
Security tokens have the potential to completely revolutionise the financial industry; adding liquidity, improving scalability, giving greater access, improved settlement and ownership capabilities, as well as increasing transparency. Additionally, the Distributed Ledger Technology (DLT) the smart contracts are built upon promises to increase efficiencies in trading, record-keeping, and improvements in governance. These improvements have the potential to increase capacity and, therefore, trading volumes. Simon Telfer, COO at Tokenise, offers further insight into the potential benefits of tokenising securities:
“Securities are well established for bonds, funds, and shares. Tokenisation enables you to access these instruments as well as other forms of ownership, including rights (e.g. royalties to a film, music, patents, etc). It also enables more people to syndicate and trade an investment. In addition, you can also give people rights to an income stream from profits through tokenisation, and not necessarily equity rights. This is a significant advantage as some highly profitable companies distribute very little in the way of dividends and build up big cash reserves. Whilst the value of the equity may increase, it does not necessarily help the investors who would maybe prefer a percentage of the income or profits.”
Turning the illiquid, liquid, is perhaps the most interesting aspect of STOs. DLT frees up trading in a way it has not been able to before, assisting Small to Medium Enterprises (SMEs) looking for a means to raise funds. Currently, small businesses struggle to raise capital through traditional methods. Becoming publicly listed is often impractical, expensive and altogether unfeasible. These friction points can be reduced, possibly even removed completely, by security tokens.
Security Tokens in Practice
The crypto economy is borderless. Blockchain’s decentralised nature and its trustless consensus mechanism for verifying transactions via smart contracts, make it so. But how do security tokens work in practice?
Historically, with traditional paper-backed assets such as shares, bonds, or even real estate, liquidity has always been problematic. However, going digital and representing the security in token form, bound by a smart contract as an immutable record written on the blockchain, removes the problem. Add to this the programmability of the smart contract (where elements such as payment of dividends on a specific date upon meeting certain conditions can be added to the smart contract) and suddenly a whole new level of automation, speed and efficiency is added to the security. Security tokens are set to behave exactly like their traditional financial counterparts — but more efficiently.
Liquidity aside, perhaps the most important aspect of security tokens (unlike utility tokens to date) is that they would inherit and operate under the same legal framework as traditional securities, including rules surrounding investor protections, rights, and expectations. Token issuers would need to abide by the regulations, having to meet certain obligations and duties as part of the issuance.
The Evolution of Finance
At Tokenise we believe the potential that security tokens have to offer heralds the next step in the future of finance and capital raising. We look to play a significant role in facilitating the transition to STOs. Simon Telfer summarises the Tokenise proposition:
“Tokenise is aimed at the SME market, helping to reduce the costs and barriers of raising capital, and offering a potential, larger (global) audience. We’re creating a platform to enable SMEs to tokenise assets that may otherwise be difficult to list, whilst reducing the costs for both the investors and the investees. In this way, Tokenise is looking to help local and international markets by offering a far more inclusive capital raising experience than traditional securities exchanges.”
The financial markets are evolving. Security tokens will bring much-needed regulation to the token economy. At Tokenise (a trading name of Kession Capital Limited) we aim to leverage our FCA regulatory permissions, to be able to offer a regulated, fully compliant crowdfunding platform for the issuance of security tokens, and a bilateral secondary market to facilitate trading.
Our goal is to be ahead of the curve in our offering to startups and established businesses. The Tokenise platform will offer cost-effective, secure, and new financing solutions, leveraging the power of blockchain and smart contracts to welcome a new future in tokenised securities — helping to transform the securities market as we know it.