The Year Ahead: The Security Token is Ready for Its Close Up

The Year Ahead: The Security Token is Ready for Its Close Up

Spend any amount of time on digital media, and you’ll find a basic story trope: “X is the new Y.” Until the advent of hit Netflix series “Orange is the New Black,” nary a season would go by without some fashion news outlet proclaiming some other hue is set to replace basic black. A smaller US metropolis with some semblance of restaurants, an art scene and semi-affordable apartment inventory? Voilà: it’s the next New York. Since trend pieces typically merit at least three examples to make the story stick, let me round out this trifecta with a cryptocurrency-specific question: Are security tokens the new crypto coin?

Understanding Security Tokens

Over the past year or so, much has been ado about the initial coin offering (ICO). During the first six months of 2018, according to Bloomberg, ICOs raised a record $7 billion. Amid the contraction seen across many cryptocurrencies during the third quarter, many would-be ICO launchers have instead turned to private placements for fundraising. The security token offers a middle path for investors and startups left wary by the PR mess left by some of the less successful ICOs to date. A security token is a cryptocurrency-backed investment that offers an ownership stake in a company, not unlike a traditional equity. It offers the security of an asset-backed investment. Where it differs from the equities traded on the NYSE or Nasdaq: security tokens offer more liquidity and with the twist of being priced in cryptocurrency.

In essence, the security token is a somewhat novel asset class that may prove appealing to longtime crypto watchers and decidedly more reserved institutional investors alike.

“The easiest way to understand the security token in layman’s terms is if you had bought into an IPO 12 months ahead of the launch,” says Kyle Asman, advisor on cryptocurrency tokenization and partner and co-founder of BX3 Capital, a business advisory firm for companies in the blockchain and cryptocurrency sectors.

Crypto tokens offer ICO backers a reward for helping a startup get off the ground. Like crypto coins, they are tradable on cryptocurrency exchanges. Unlike standard cryptocurrency coins, however, security tokens are backed by and derive their value from external, tradable assets. They check off the boxes to fulfill the SEC’s Howey Test of being an investment contract, meaning that security tokens live up to their name: They are full-fledged securities, subsequently subject to the relevant SEC rules. As an asset class, security tokens are thus free from much of the regulatory ambiguity that weighs down other cryptocurrency investment vehicles in the US, meaning that they could be a game-changer for opening up accessibility to a wider pool of investors looking to shake up their usual equities portfolio.

The first question an investor may have is how do crypto security tokens differ from traditional equities. The biggest advantage of a security token has over traditional equity, says Asman, is liquidity.

“Someone who’s been investing in private equity deals for a while, or any private equity firm, will tell you that liquidity’s not going to come for three to five years,” Asman notes. “With most security tokens in the US, you basically have a liquid asset after a 12-month lock-up.”

Another advantage of the security token over its stock-exchange cousin isn’t one with an immediate direct payoff. It’s the inherent appeal that comes from a brand-new asset class. While traditional IPOs happen all the time, only the biggest market-cap stories tend to garner any media fanfare. Security tokens, Asman points out, are still an object of curiosity for both the media and investors. The novelty can help spark attention in new issuances, spurring traction for the asset class and for cryptocurrency as a whole.

“Who’s buying it?”

A crypto-skeptic might retort with a multi-entendre “who’s buying it?” The first answer includes broker-dealers, for one. For at least the time being, generally access to security-token funds will have to be via buy-in to an institutional investment-backed portfolio. SEC rules at present prevent anyone who doesn’t qualify as an accredited investor — either having a net worth of at least $1 million, excluding the value of one’s primary home or having earned more than $200,000 / yr for the past two years. This stipulation effectively cuts off crypto to many retail investors. A security token-based fund might not be the best fit for risk-averse investors, such as people nearing retirement with a 60 percent allocation to bonds. “But for somebody in their 20’s or 30’s or 40’s — or even 50’s — who is approaching near peak-earning power, security tokens could be a prime choice for investment that offers explosive growth,” Asman continues.

That a crypto-based investment has the cachet to gain the attention of fund managers — much less get official billing as a security — shows that crypto is reaching maturity. It also shows promise for security tokens as being a bridge into cryptocurrency’s general accessibility as an investment vehicle. Speaking more broadly, the relatively straitlaced security token could burnish cryptocurrency’s image as being some untamed, unregulated other. “I think that 2018’s actually ended up being the year of transition from this Wild West market into one that is regulated,” Asman notes. “The ICO boom of 2017 and its wave of projects that made capital without having anything is gone. Now people want things for their assets and real profits.”

“That’s for the right reasons.”