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contributor perspectives

Feb 9, 2018 | 09:00 GMT

4 mins read

Security Tokens: Where Digital Assets Meet the Real World

Board of Contributors
Ashwini Anburajan
Board of Contributors
Physical representations of Bitcoin tokens, a digital currency, stand on a computer at a shop in Tel Aviv, Israel.
(JACK GUEZ/AFP/Getty Images)
Contributor Perspectives offer insight, analysis and commentary from Stratfor’s Board of Contributors and guest contributors who are distinguished leaders in their fields of expertise.
  • As investors start to question the underlying value of cryptocurrencies like Bitcoin, Ethereum and Ripple, markets will turn to a different class of digital assets: security tokens.
  • Security tokens promise to appeal to a wider pool of investors because, unlike utility tokens such as Bitcoin, they have real-world assets behind them.
  • Security tokens could democratize access to investment for investors and entrepreneurs alike by enabling a larger number of parties to hold smaller amounts of equity in a project or company.

The gold rush of cryptocurrencies has created a new class of billionaires, digitally rich from having foresight into a world-changing technology: blockchain. It's been an exhilarating ride that has rapidly created immense wealth. Digital currencies such as Bitcoin, Ethereum and Ripple powered the growth by appreciating over 30,000 percent last year. Droves of enterprising individuals, however, saw the boom as an opportunity to try to create ecosystems of uncertain value through initial coin offerings, prompting concerns about today's well-documented cryptocurrency bubble. Now it looks like the bubble may burst as investors start to question the underlying value of these currencies. The big question, then, is what's next?

As the worlds of technology and finance continue to innovate, markets will turn their attention to the security token. The new asset class promises to bring the cryptocurrency trend to a wider pool of investors who want real-world value behind the digital assets in which they invest.

Decrypting the Digital Currency

So what's the difference between a security token and a utility token, such as Bitcoin? Utility tokens are designed for use in a digital marketplace. Since many initial coin offerings launch before the marketplace has been built, utility tokens represent only the promise of a future value. They trade on their perceived value within an often yet-to-be-created ecosystem. Think of them like airline miles, tokens representing points for an airline network that doesn't exist yet. If the airline turns out to be immensely popular, the value of the tokens skyrockets. But in the meantime, investors trade on what they think the airline's value will be.

Security tokens, by contrast, have real-world assets backing them up, such as equity in a company or in real estate. As a result, they have a tangible value — measurable in dollars or other conventional currencies — separate from the value of the cryptocurrency with which they are associated. A token that offers equity in a group of companies, for example, will have the opportunity to appreciate independent of its own value. If, down the road, the companies are sold or put up for initial public offering, their equity value increases and may, in turn, increase the token's value. Trading in security tokens is a lot less speculative and more focused on concrete results, compared with trading in utility tokens.

Digital tokens will reflect traditional value investing. Market investors will demand nothing less. At the same time, though, security tokens offer many of the same advantages as other digital assets.

An Opportunity Like No Other

Digital tokens will reflect traditional value investing. Market investors will demand nothing less. At the same time, though, security tokens offer many of the same advantages as other digital assets.

For instance, security tokens give investors an opportunity to put their money in a more liquid instrument. A typical startup takes seven to 10 years to get off the ground, during which time an investor's equity may be locked up in an unprofitable venture. From there, the outcome is binary: Either the startup succeeds or it fails. Have you ever tried to liquidate a limited partnership interest in a venture capital or equity fund? Probably not. But research suggests that it requires countless hours of legal work to determine transfer pricing, verify ownership and validate the transfer — not to mention finding someone else to shell out perhaps millions of dollars for an illiquid asset. A digital security token sidesteps these complications by using blockchain technology to provide immutable ownership records and a potentially robust marketplace to facilitate transfers.

One of the biggest value propositions of security tokens is that they provide democratized access to investment for entrepreneurs and investors alike. Security tokens enable each member in a large group of investors who may otherwise lack the connections or resources to invest in venture capital to take on a small piece of the pie with actual, understandable assets. They can then trade these assets with other investors, creating liquidity. Entrepreneurs, meanwhile, can access larger pools of capital and retain greater control of their companies than they would with traditional investment schemes. The cryptocurrency could create unprecedented opportunity in industries such as a real estate development, where suddenly 3,000 investors may own a project, rather than three private equity firms.

Blockchain, the technology underlying cryptocurrencies, is all about decentralized access and increased transparency. No one stakeholder can have the whole pie. Introducing real-world asset classes into a decentralized format will open the world of investing to even more people and companies.

It's fundamentally game-changing.

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