Are Security Tokens Ripe For Public’s Investing Appetite?

Let’s be brutally honest about what attracts people to crypto: it’s ridiculously volatile – for any crypto asset a 20%+ intraday swings are a regular occurrence. 

When you talk to people about where they’d like to invest their nest egg, crypto-assets don’t really make the cut.

And predictably stable assets don’t always generate the returns an average investor wishes for. There have been previous attempts to tokenize assets that can provide stable returns, but they have failed because of the reputation of volatility cryptocurrencies have earned. Fractionalization of tangible assets has not proven enough to get people to invest. The security tokens have not gained the investment dollars other asset types like DeFi and utility tokens have in the crypto asset classes.

Another big problem that the security token offering or STO’s have faced is they never offered any prospect of meteoric returns other digital assets have garnered. Real asset tokenization, like real estate tokenization, provides steady returns.

Another huge problem that early offering of STO’s faced was the unmitigated fraud cases that piled up that sullied the trend of relying on STOs to tokenize tangible assets that could take off.

Attaching a regulatory body like SEC’s blessings might bring out some conservative investors. Still, the question lies in the volume of investments that such an offering might create and the associated costs that might overburden the laissez-faire approach original crypto investors are used to, and whether it will produce the massive returns everyone has gotten addicted to and expect from the crypto asset. 

Are Investment Vehicles Like Stablecoin the Answer?

Most of you may not need to be told, “what is a stablecoin?”. But, to be thorough, a stablecoin denotes a digital currency that is often pegged to a more stable underlying asset such as a global fiat currency or a precious metal like gold or silver.

It is well understood that although stablecoins are infinitely more secure than, say, cryptocurrencies like BTC, they are primarily being used as a payment medium with a predictable long-term value and have minimal growth as an investment.

Unlike a stablecoin, security tokens are an investment, like owning stock in a public company. When the company does well, your investment also grows. Owning a security token comes with an expectation of pay off through profits or distribution. A stablecoin is used as payment in an ecosystem. Security tokens give you ownership in that ecosystem.

Security Tokens and the Burdens to Bear

Unlike other crypto assets, a security token is more stringently scrutinized by regulatory authorities such as the U.S. Securities and Exchange Commission. It must have full SEC approval to be sold to the public, mainly when it is sold to non-accredited investors or traded on secondary exchanges. Regulatory requirements may have been one of the reasons why the growth and adoption of security tokens have been lackluster.

But, as of the past few years, there’s hope on the horizon. The SEC albeit gradually is starting to qualify security token offerings. And that might be for the better since transparency, and regulatory clarity are now stoking a fire under the STO pot to boil up.

As recently as July 2019, the SEC qualified its first STO under Regulation A token offering (a $23 million offering for Blockstack). It was instilling this precedent by approving the Blockstack token sale to both accredited and non-accredited investors. This approval also provided clarity around secondary sales. 

Later in July 2020, Arca Labs received approval to begin trading its digital security token, the ArCoin. The ArCoin is registered with the SEC as an equivalent of shares in Arca’s U.S. Treasury Fund.

As recently as September 2020, the SEC also registered an $85 million security token offering from INX. INX, a foreign crypto trading company, was the first company to offer the first-ever security token initial public blessed by the SEC.

In April 2021, approval for a Reg A+ token offering was granted for Exodus, a first for digital asset security for a U.S.-based issuing company. Exodus went on to raise an impressive $75 million from 6,800 individual investors.

The security tokens phenomenon is not unique to the US. In 2021, a Singapore-based bank also issued its first security token, an $11.3 million digital bond that pays an annual coupon of 0.6%.

Although the move towards STOs making the mainstream is not a roaring thunder yet, an important transition is occurring in acceptance of the crypto industry, not as the Wild West, but something transitioning to complete regulatory compliance. This may herald a new era of mainstream adoption as a viable investment medium for the masses.

These are not the only signs of light at the end of a tunnel

Nihon Unisys also recently announced its plans to launch a security token platform in the spring of 2022. The proprietary blockchain platform is geared towards supporting the issuance, transfer, and redemption of the STOs. As anticipated this tokenization platform is geared towards tokenizing real estate or wine bottles, as examples. 

Unisys will support ERC-20 fungible Ethereum tokens and may consider supporting NFTs in the future for digital art and other intellectual property. 

A Twist of Fate

It is said that what doesn’t kill you might make you stronger.  In a recent twist for the history books, famed NFT platform developer “Dapper Labs,” the famous creator of the NBA’s Top Shot platform, was recently taken to court for allegedly selling its NFTs as unregistered securities.

It may not seem plausible, but if the current craze for NFTs required it to sell NFTs as security tokens, it might inject a new life into STOs. 

If certain NFTs may qualify as securities SEC regulations in Securities law parlance as the “Howey Test,” it is not far-fetched to assume that the rules and regulations that apply to STOs will also apply to NFTs which are deemed securities. We can therefore conclude that under the right circumstances, NFTs will have to comply with the applicable SEC rules and regulations that exempt from registration and AML/KYC requirements of STOs.

As we discussed above, besides the unregistered sale of securities, what may provide STOs its ideal secondary market is the fact that in such a scenario, an NFT issuer and an NFT Platforms may constitute “Financial Institutions” under the AML Act of 2020, which recently revised the definition of securities to include “dealers in art” and companies that engage in transmitting virtual currencies.

What is more, a platform or entity facilitating trading of NFTs or payment for such a purchase via virtual currency movement from one party to another can also be subject to government money transmitter licensing requirements and be answerable to law enforcement jurisdictions on both federal and state levels. This can be a godsend since the above-stated onerous requirements and risks stemming from the updated definition of “Financial Institutions” might have NFT sellers taking advantage of licensed ATSs, allowing compliant issuance and trading of their tokenized securities.

In conclusion, STOs can greatly benefit from the clear and transparent definition of investment terms and enforceable regulation to speed up the tokenization of tangible assets. 

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