Day: January 9, 2020

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What is Tokenization?

Security tokenization is the process of materializing the ownership in a security through the issuance of a “token” registered on a distributed ledger technology (DLT) infrastructure. Therefore, a tokenized security can be equity, a bond, or an investment fund. It could also represent a securitized fraction of a real asset (e.g. a piece of art).

The DLT infrastructure used to issue the tokens can, depending on the legislation and the choice of the issuer, either be the “primary register” for the security or a representation in the form of tokens primarily issued on a different infrastructure outside of the blockchain.
For the purpose of this Ebook, we will refer to these tokens as ‘security tokens’ and we will detail how they work in the following section. Most players in this emerging industry refrain from calling these ‘digital securities’, as the term is too vague, and in fact, securities have been traded digitally for years.

Our world is full of these securities, but many are currently difficult to physically transfer or subdivide, so buyers and sellers instead trade paper or unsecured digital files that represent some or all of the asset.
These systems are cumbersome, difficult to transfer and can be hard to track. The underlying assets can also lack transferability: For example, if the underlying asset is a piece of property, transferring the ownership of that asset requires for it to be sold. Through tokenization, the rights of these assets can be shared almost instantaneously thanks to peer-to-peer trading. This is one advancement of many when applying blockchain technology in financial markets, other use cases are explained later in this Ebook.

What Exactly is a Security Token?
2018 has been the inaugural year of Security Token Offerings (STOs) and many think that by 2030 tokenized securities will be the primary method of issuance.
To understand security tokens, it’s fundamental to understand securities. With securities, it’s mandatory to respect the relevant laws and regulation for every jurisdiction the assets are issued in, and in every jurisdiction the securities will be distributed. As you might expect, the exact same process is needed when issuing security tokens on a blockchain.

Utility Tokens vs Security Tokens

To precisely define security tokens, let’s define something they are not, utility tokens. An ICO is a way to raise funds for a distributed network. A company, or a foundation, issues tokens that can be used by contributors to redeem a service the entity is offering. For example, if the issuer of the token is a company launching a decentralized car sharing platform, each kilometer of travel could be represented with a token. The tokens are a way to exchange value between participants of the network by representing a unit of service. As such, they are called utility tokens.

However, if the main purpose of the token is to generate an increase of monetary value for its holder, it is an investment and therefore will be considered a security in most jurisdictions.

STOKENIZED SECURITIES

Obviously, if the issuer needs to collect funds in order to finance a company in the form of debt or equity, or if an asset manager wants to issue an investment fund, the token representing these financial instruments won’t be utility tokens, they are  representations of securities and are therefore called security tokens. The key difference here is that utility tokens represent a right to use a predefined good or service. Security tokens represent a right to future financial flows resulting from the main activity of the issuer of the token. Here are some other key differences between the two:

UTILITY TOKENS VS SECURITY TOKENS

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