Security in Volatility: How Security Tokens Can Bridge Web3 and Traditional Finance

by | Aug 5, 2022 | Blockchain, Blog, DeFi

Regulation is the word on everyone’s lips as the blockchain community comes together to navigate a bear market. Solidifying the health of the industry during this period will be crucial through responsible and sustainable infrastructure building. During this period, it is important that the industry reflects on what is working and where it can continue to build and improve.  

Security tokens are one success story that is likely to receive renewed attention. Backed by real-world assets and fully regulated in a growing number of jurisdictions, security tokens encourage the global application of crypto and introduce a whole new world of securely-backed opportunities for ownership. On purchasing a security token, investors are granted ownership of the underlying asset, whether that is equity in a company, or physical assets like real estate, art, and other collectibles. This functionality of security tokens proves beneficial for the investor in opening access to different asset classes, beneficial for the seller in increasing liquidity, and favorable for the blockchain industry in promoting regulated transactions and greater adoption.

Security tokens should not be confused with non-fungible tokens (NFTs); they are fungible, which makes them suitable for division and fractional ownership of an asset. Owning a fragment opens greater access for investors to assets that might be otherwise unattainable. For example, there are few people in the world with the means to purchase mountain-side real estate in Aspen, Colorado. However, once fractionalized and tokenized on a blockchain, owning a portion of a luxury hotel becomes possible, as recently experienced by the newfound owners of the St. Regis Aspen Resort.

Nor is this trend limited to fine art. Real estate moguls are warming to the benefits of security tokens. For example, the tokenization of Knight Dragon’s London urban renewal project, Building 4, was recently fractionalized across 100,000 security tokens. Tokens entitle owners to a share of 80 percent of the gross profits generated from the building–bringing greater democracy and shared governance into ownership. 

More and more use-cases are emerging, as people come to learn about the drastic improvement in liquidity offered by security tokens. While traditional investment processes are notoriously long and tedious, distributed ledger technology (DLT) is comparatively quick and efficient. For vendors like art galleries, who may be used to sitting on huge amounts of ‘idle money’, tokenization can be utilized to increase liquidity through which they can reassemble their collections and reinvest in new purchases.

Another benefit for those dealing in security tokens, especially given current market sentiment, is the clarity offered by regulation. Security tokens are becoming more widely recognized by regulatory bodies, including those in Hong Kong, Switzerland and the United States. In the U.S., for a token to be considered a legal Security Token Offering (STO), it must adhere to certain conditions, be registered with the SEC, and due diligence must be conducted on all investors. Meanwhile, Switzerland’s DLT Act upholds the legal standing of ledger-based securities. These clear legal frameworks render security tokens trustworthy investment options and enable investors to engage with these assets with confidence.

However, regulation can prove to be a double-edged sword in this regard. While security tokens may be more secure than other crypto assets, the additional layers of bureaucracy detract from blockchain technology’s primary offering: transaction efficiency. For the full potential of the blockchain to be realized, the SEC will need to implement processes that maximize accessibility. The world of tokenization, unlike existing regulatory framework, is built upon peer-to-peer dynamics, which lead to speed and freedom. However, those seeking instant access to greater liquidity will have to wait while the security offering is registered with the SEC, which in the legacy space is likely to take up to several months. 

If digital security assets are to revolutionize this process, the registration steps, ancillary work, and ‘paper’ work need to be adapted accordingly. Until then, the insurgent power of blockchain technology will not be exhibited by security tokens in the same way it is with other digital assets, like NFTs. Furthermore, while adopters are excited by the various use-cases of security tokens, the infrastructure for such is playing catch-up. As is the case with any new technological development, there are still many questions on what the practical application of security tokens will look like once widely adopted–will these assets be traded on-chain? Will they be listed on exchanges?

We are at the very beginning of what can, and inevitably will be achieved with security tokens. The potential is evident and the introduction of clear regulation will further enable clear engagement and adoption. Security tokens offer a bridge from traditional finance to blockchain, encouraging investors to enter the space in a familiar and secure environment. Institutional players must lead the way. Investors are still guided by the authority of custodian banks and so, we need to continue to develop the technology, supporting infrastructure and regulatory frameworks. By doing so, institutional banks will be comfortable in their participation, attract the masses into the world of blockchain, and inject confidence back into this next-generation technology capable of changing the world as we know it. 

* Solo Ceesay is CEO and Co-founder of Calaxy, an open social marketplace built for creators, by creators.