5 Reasons Why Crypto Investors Should Pay Attention to Security Tokens

Security tokens offer crypto investors diversification, regulatory clarity, and more predictable returns. Major financial institutions anticipate tokenization as a key trend in finance.

security tokens in 2023

Security tokens are one of the most important use cases of blockchain in finance, and crypto investors can have easy access to them, given their crypto literacy and familiarity with the technology, decentralized applications (dApps), digital wallets, and other key concepts related to the blockchain industry. But why should crypto investors care about security tokens when there are thousands of cryptocurrencies and utility tokens? The purpose of the present article is to answer this question and show that security tokens are worthy of attention, to say the least.

For those unfamiliar, security tokens, also referred to as digital securities, are tokens that represent traditional securities, e.g. equities or bonds. This type of token is the digital representation of ownership of a security. Technically, they are no different than regular utility tokens, but the purpose and legal status is what makes security tokens different.

Like stablecoins – tokens whose price is pegged to fiat money or commodities – digital securities act as a bridge between blockchain and traditional finance, but the latter fit better into the regulatory realm of each jurisdiction.

Security tokens address some of the most ardent problems of traditional securities by boosting the liquidity of underlying assets, offering unmatched security, and making the trading process more efficient.

While the performance of cryptocurrencies is impacted by variations in demand from institutional and retail investors, the price of security tokens is also fluctuant, but it is dictated by the underlying security, and the on-chain activity alone doesn’t have an impact on it.

For crypto investors, security tokens can be a great resource for diversification. Here are the top five reasons crypto fans should look into digital securities:

#1 Crypto Industry Lacks  Regulatory Clarity

The crypto industry has been around for only about a decade, and it still doesn’t have the proper means to filter out all malicious actors. From rug pulls to ‘ponzis’ and fishy investment schemes, the palette of fraudsters is diverse and can deceive many non-native crypto users, although many veterans can fall victim as well.

Chainalysis’ Crypto Crime Report released last year showed that crypto scams rose 81% in 2021 compared to the previous year.

https://blockbr.com.br/wp-content/uploads/2022/06/2022-crypto-crime-report.pdf

The increase was partly driven by a relatively new type of scam called the ‘rug pull,’ which is especially popular in decentralized finance (DeFi). A rug pull happens when a crypto project’s development team suddenly abandons the project and sells all native tokens.

Besides rug pulls, ponzi schemes are still making waves. In August 2021, the US Securities and Exchange Commission (SEC) charged 11 individuals that allegedly had a role in developing and promoting a crypto ponzi called Forsage. It managed to raise over $300 million from retail investors worldwide.

In general, the majority of crypto scams promise too much. At the beginning of 2023, SEC Chair Gary Gensler and Commissioner Caroline Crenshaw shared a few thoughts on how to distinguish a crypto scam. Gensler said:

“If something looks too good to be true, sometimes they really are. There are certain red flags that you can look for beyond it being too good to be true.”

One of the reasons there are so many scam projects is that the crypto industry still doesn’t have an established regulatory framework, although most governments are working on that.

Elsewhere, security tokens are regulated in the US and many European countries. iIn the US, security token issuers register their project with the SEC as required by the Securities Act of 1933.

While the risk of phishing and other social engineering activities persists with security tokens, it can be reduced with some basic due diligence.

Security tokens are well integrated into the securities market, which is supervised by regulatory bodies that discourage misleading statements and fraudulent activities.

#2 In Crypto, Even the ‘Too Big to Fail’ Ones Can Fail

Crypto investors are tempted to believe that if they keep dealing with mainstream projects and services only, they can stay away from unexpected losses. But that’s not always the case. FTX was the second-largest cryptocurrency exchange last year and the only platform to challenge the omnipresence of Binance. However, it turned out that its founder and CEO Sam Bankman Fried built his crypto empire using illegal practices. Basically, FTX turned out to be a fraud backed by sister trading firm Alameda Research.

At the end of December, US prosecutors said that Bankman Fried had engaged in fraudulent activities since the very beginning of FTX in 2019, using his clients’ funds to finance his political activities, buy luxurious real estate and invest in other firms.

While the extent of the collapse is still unknown, it was estimated that the FTX crash exposed an $8 billion hole. The exchange owes billions to customers and creditors. The good news is that the new management of FTX located about $5 billion in liquid assets at the beginning of 2023.

The collapse of FTX was so big that it spilled over the entire crypto market, causing other smaller firms to collapse.

What’s even more worrying is that the crash of FTX came after a series of other major crypto cataclysms in 2022. After the bearish pressure deepened at the beginning of that year, Terra USD (UST) – an algorithmic stablecoin pegged to the US dollar – and its sister cryptocurrency LUNA both crashed to zero, wiping out over $45 billion.

A few months later, crypto lender Celsius showed signs of insolvency and crashed abruptly, owing users almost $5 billion.

These major downfalls surprised crypto investors, generating a state of confusion. While the crypto industry is maturing, security tokens already benefit from the stability of the securities market, which has well-established rules. The advantage of security tokens is that they are fully backed by real-world assets, and their performance cannot go crazy unless the underlying assets do so.

#3 Financial Giants Anticipate Tokenization to Be the Next Big Trend

The crypto community may not be a fan of the big players of traditional finance, such as the big banks and asset managers, but listening to what they say does make sense considering their influence. While the global financial elite doesn’t endorse cryptocurrencies, it admits the great potential of security tokens. In fact, many important players go even further by recognizing that tokenization is the next major trend in finance.

At the end of 2022, Larry Fink, CEO of BlackRock – the world’s largest asset manager with over $10 trillion in assets under management (AUM) – said during an event that “the next generation for markets, the next generation for securities, will be tokenization of securities.” He highlighted the main benefits of security tokens, suggesting that tokenization would provide instantaneous settlement and lower fees.

Other big players that not only endorse tokenization but already offer related products are JPMorgan, the largest US bank with about $4 trillion in total assets, and Goldman Sachs.

JPMorgan has its proprietary blockchain platform called Onyx, which offers tokenization services to enterprises and organizations. The bank plans to bring trillions of tokenized assets to DeFi. Tyrone Lobban, head of Onyx Digital Assets, said during an event:

“Over time, we think tokenizing U.S. Treasurys or money market fund shares, for example, means these could all potentially be used as collateral in DeFi pools. The overall goal is to bring these trillions of dollars of assets into DeFi, so that we can use these new mechanisms for trading, borrowing [and] lending, but with the scale of institutional assets.”

Meanwhile, Goldman Sachs launched its proprietary tokenization platform at the beginning of 2023. Known as GS DAP, it is built on top of Digital Asset’s Daml smart contract language and Canton blockchain. Daml-based tokenization platforms integrate the full complexity of rights, obligations, and cash flows.

#4 Overlap with Crypto Infrastructure

Another good reason for crypto investors to consider security tokens is their familiarity with blockchain. While traditional investors may find security tokens quite exotic at this point, crypto investors know what’s behind them: the same blockchain infrastructure, smart contracts, transactions, digital wallets, etc.

On top of that, the fundraising mechanism for issuing security tokens is the Security Token Offering (STO), which looks pretty similar to an Initial Coin Offering (ICO). Given that the ICO market has been plagued with scams, it has been losing ground during the last few years, but STOs continue to thrive because it’s much safer.

Today, the majority of security tokens are issued on Ethereum, which also hosts most of the utility tokens and non-fungible tokens (NFTs). Technically, security tokens are quite similar to regular tokens. In fact, some entities choose to issue security tokens based on Ethereum’s ERC-20 standard, which is used by most utility tokens. Nevertheless, considering that security tokens have to comply with more rules, they have their own standards on Ethereum, such as ERC-1400 or ERC-1404. These standards enable a customizable experience when tokenizing real-world assets. Besides Ethereum, there are other blockchain networks supporting security tokens.

All in all, crypto investors have easy access to digital securities, which helps them diversify their portfolios by getting exposure to real-world assets on blockchain.

#5 More Predictable Returns and Better Fundamental Analysis

Cryptocurrencies are extremely volatile and highly unpredictable. The majority of digital currencies are following the performance of Bitcoin, but anticipating its next move is a difficult task, even though there are tons of headlines with Bitcoin predictions. No one could see the BTC peak near $70,000 at the end of 2021 and the eventual crypto winter.

In 2022, only about 30% of US millennials felt comfortable investing in cryptocurrencies, as per a survey by Bankrate’s. That was down from 50% in 2021.

With security tokens, there is a level of predictability depending on the underlying asset. For example, if the token is backed by real estate, you could argue that it would at least hedge against inflation and aim for long-term gains. This is because property assets have traditionally performed well for decades.

Also, it’s easier to conduct fundamental analysis with security tokens. For example, if they represent company shares, one can look into the company’s business model, team, historical performance, high-profile partnerships, relevant announcements, etc. Security tokens can also be highly volatile, but the price doesn’t defy logic so often, which is the case with so many cryptocurrencies out here.

The Final Note

In conclusion, security tokens are worthy of attention, and crypto investors shouldn’t miss the opportunity to diversify their portfolios by taking positions in them.

While we discussed the prevalence of scams and fraudulent activities in the crypto space, the purpose of this article is not to put the crypto industry in a bad light. On the contrary, blockchain has triggered major changes in the financial world, and cryptocurrencies are the technology’s first use case.

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