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The Top 5 Myths About Security Tokens

It’s ok to not understand – just don’t misunderstand.

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Before we delve into all those things even experts are getting wrong about security tokens, let’s note a couple of uncontested facts.

First, security tokens comprise an ever-growing proportion of the cryptocurrency universe. In August 2022, security tokens had a cumulative value of $17.6 billion, compared with a total $979.0 billion in total crypto market cap. Today, there are around 200 security tokens available. That’s not counting the 60-plus “tokenized stocks” – a misnomer for digital derivatives engineered to mimic the behavior of such widely held equities as those of Tesla, Apple or AMC.

Less than five years ago, though, the security token category didn’t even exist. The first security token offering occurred on March 6, 2018, when New York-based Praetorian Group filed the PAX coin’s $75 million float with the U.S. Securities and Exchange Commission.

So with all that in mind, let’s dispel five myths about security tokens that might be keeping wary investors on the sidelines.

Myth 1: Security tokens are basically stablecoins.

No, they’re not – not by any stretch of the imagination. But properly structured, they might serve the purpose of being an efficient store of value better than stablecoins.

Click here to read our article comparing stablecoins to security tokens.

Let’s start with the one thing security tokens and stablecoins have in common: They’re purportedly backed by something. But what they’re backed by – and to what extent they’re backed by anything tangible – is quite material to the discussion.

In the case of security tokens, that something is the capital – usually equity but there’s no reason why it couldn’t be debt – of a corporate entity. On the assumption that it is equity backing a particular security token, it could be a voting interest or just an economic interest. That is, just like stocks, it could entitle the holder to a say in how the entity is governed or it could entitle the holder to only a share in the retained earnings.

Stablecoins are backed by the fiat currency to which it is pegged – typically the U.S. dollar. But be careful here. As the world found out earlier this year, not all stablecoins are created equal. While most actually hold reserves of the fiat currency, some – including DAI, Frax and Ampleforth – are algorithmic. That is, they have no collateral and derive their value from a smart contract that burns or mints tokens in response to changes in demand.  TerraUSD was considered a stablecoin right up until May 9, when it suddenly became Terra78cents. It’s now worth around 3 cents and its chief executive is just as likely as not to end up in a South Korean jail.

And that leads to another distinction: Security tokens are regulated in the U.S. and many other jurisdictions; stablecoins aren’t – yet. That’s likely to change, though, based on how TerraUSD unraveled.

But what if you eliminated the risk inherent in algorithmic stablecoins? What if every dollar-pegged stablecoin was backed 100% by an actual greenback in an actual vault? Is it really all that stable?

Not these days. When the first STOs hit the market in 2018, it was in response to the cratering of the market for utility tokens and true cryptocurrencies. During the full-speed-ahead year of 2017, anyone who could afford to hire a PowerPoint jockey on Fiverr could literally mint their own money and have a market for it because of that most irrational of drivers: the Fear Of Missing Out.

When the crash came, the only tokens to hold their value were those created to be used primarily as a medium of exchange – that is, the stablecoins. The highly speculative value of your bitcoin might have taken a massive hit, but you could still pay your overseas contractors in Tether with little disruption.

But the dollar to which Tether is, well, tethered has depreciated more than 8% in the last 12 months due to rampant inflation. It’s hard to make the case that Tether or USDC or anything similar is stable if the dollar itself isn’t.

A security token, though, that is a share in the value of a business in an industrial sector that is rooted in consistent real-world cash flows might turn out to be far more stable than the stablest stablecoin.

Myth 2: Security tokens are illiquid.

Listen, the market for any ill-advised asset is illiquid. In the world of security tokens, though, coins with a strong investment case have a lot of room to move. More than $2.3 million in security tokens traded hands on the secondary market in August. While that’s not an amazing amount in either absolute terms or as a proportion of the total market cap, it is more than double July’s volume.

What leads to the misconception is that security tokens tend not to be listed on the big, centralized exchanges – the Binances and Coinbases of the world. The largest security token exchange in terms of market cap is called BigONE, and the emphasis truly belongs on the “ONE”. It trades a single token, that of Energa Group, a Polish electric utility company. With a market cap of $14.1 billion and a monthly volume of less than $50,000, it kind of skews the ratios for the market as a whole.

Other large exchanges carrying security tokens include CryptoSX, tZero ATS, INX and Uniswap, according to data analyst Samuel J. Sachs. While Uniswap remains studiously decentralized, the others follow the rules of the road that enable them to be regulated by the countries in which they seek to operate. CryptoSX is a Philippine concern while the others choose to conform to SEC regulations. There are many smaller exchanges and they tend to be decentralized. They tend to encourage projects to launch their STO on their platform but will also list security tokens that were first offered elsewhere.

Myth 3: STOs’ success rates are just as low as ICOs’.

It’s worth noting that the aforementioned PAX token went nowhere. A year after making its prospectus public, Praetorian went back to the SEC and withdrew its registration due to “unfavorable market conditions”. The early bird gets the worm, it is said, but it’s the second mouse that gets the cheese.

A widely cited Swiss study found that 64 of the first 120 STOs were successful. The study has not been updated since 2019, but that’s still heartening news that they exceeded the 50% mark, considering the market dynamics are similar today. There was a crypto winter going on then, and there’s another one going on now.

A successful launch, though, is a far different thing than a successful secondary market. While it’s hard to compare this market – which is still relatively niche – with the broader crypto space, a quick glance at the Security Token Market analytics site shows that there are plenty of winners out there. While Energa is basically treading water, as is second-ranked Dignity Gold, third-ranked Millennium Sapphire jumped in value by about one-third this past week. Spice VC and Exodus are two other names that have gained in value in recent days.

That said, you’re just as likely to pick a loser as a winner if you don’t do your own research. Most likely, though, you’ll find an asset that maintains its value.

Myth 4: Security tokens? Might as well be shares of stock.

Maintaining value is not a bad thing, especially if it pays dividends. That’s why people buy income stocks, and it makes the same kind of sense with digital assets. Perhaps more.

“If Apple offers a dividend, you and Joe would both get the same percentage, despite the fact that Joe got in long before you, but if these assets were programmable, like they can be with security tokens, companies could do something more unique,” notes Tim Fries at The Tokenist. “Joe could get a higher dividend because he’s held it for so much longer than you. This incentivizes long-term holding, which helps the asset maintain and increase its value over time.”

Smart contracts, such as those that can be embedded in security tokens, can customize the dividend payment schedule, but that’s just the start. According to Fries, they can also reduce transaction settlement time from two days to virtually instantaneous and ensure that all regulatory compliance occurs automatically – that is, it can be rendered impossible to illegally trade a security token.

Combine all that with the potential to trade these assets any time, any day, and you can see some of the added benefits of trading in digital coins rather than stocks.

Myth 5: Security tokens are over-regulated.

With all due respect to those who adhere most keenly to the crypto space’s libertarian ethos, not all regulation is over-regulation. The American stock market is certainly the most regulated in the world – and it’s also the biggest. Investors want to mitigate the chance that they’ll be defrauded and have recourse if they are ever victimized. They also want to know that the intermediaries know what they’re doing and can be relied on to behave in a professional manner with an adequate level of competency. If the Big Money doesn’t get these guarantees, then they’ll take their balls – all 25 trillion of them – and find another playground. The fact that the appeal “Hey, we’ve got all the technology of New York but none of the rules” hasn’t led to a mass drain of American capital is proof enough of that.

So despite the technological advantages to trading digital assets rather than legacy stocks and bonds, institutional investors have been slow to move money into the crypto space. Pretty much every Wall Street counting house has put some flier money in crypto, but that’s just because the potential returns are irresistible when the timing is right.

To get institutions to move their money into tokens on a regular basis might require some kind of external event but, once that happens, watch those zeros and commas pile up. In the meantime, the nature of security tokens gives institutional investors that on-ramp so that they can come in as soon as they’re ready.

“Many corporate giants have recently announced platforms for trading security tokens, and in doing so hope to offer institutional investors a relatively safe and easy way to begin investing in blockchain,” according to Fries. “The founder of the company that owns the NY Stock Exchange, for instance, recently announced a new venture, Bakkt, and the Swiss Exchange also plans to build a regulated exchange for tokenized securities. Both systems aim to bring together the huge amount of capital present in more traditional investment markets with the adaptability, speed, and potential returns, of cryptocurrency.”

 

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