A security token (also "equity token" or "investment token") is a cryptographic token that is tied to a value or security.
Security tokens are digital assets that represent the tokenized (profit participation) right to an investment, which comply with the regulations of the German Federal Financial Supervisory Authority (BaFin) for securities and are therefore treated like traditional regulated investments (securities/company shares) in regulatory terms. Conversely, this also means that the investors (token holders) are entitled to similar rights (e.g. claims to dividend-like payments, co-determination rights or interest payments) vis-à-vis the issuer as with traditional securities.
In early 2019, the German Federal Financial Supervisory Authority (BaFin) classified security tokens as a fundamentally tradable store of value and approved the first securities prospectus for a security token offering (STO) in Germany. For a Security Token to be allowed to be issued, it must be sufficiently standardized and of the same type. "The type of transfer is not decisive in this regard. The token must merely not convey different rights and must be able to be determined in business transactions according to the type and number of pieces," BaFin noted in an official statement. Accordingly, the crucial factor is the rights associated with the tokens, which, according to the requirements of the WpHG and MiFID II, must basically be membership or asset rights. This means that a token must embody either a membership right similar to a share or a debt instrument.
The token structure distinguishes security tokens from conventional assets:
In principle, any existing security can be issued as a security token. Unlike assets, however, issuer tokens do not have to be securitized first. The main difference to a traditional security (e.g. to a share) is the change of the medium (token instead of certificate) as well as the change of the settlement infrastructure (blockchain infrastructure instead of electronic securities registers and clearing houses). Thus, tokens are independent of settlement agents and central securities depositories or clearing and settlement organizations (e.g. Clearstream Banking AG).
Which asset classes can be tokenized?
Standardized issuance products can be mapped and transferred via security tokens. In principle, almost any asset can be tokenized, e.g. shares, bonds, loans, real estate or company shares, but also participation rights in concrete projects and plans (e.g. the right to a piece of music) as well as certificates. Unlike utility tokens, security tokens also do not have to have a concrete blockchain use case. Rather, the decisive factor is the legal situation in the respective jurisdiction of the issuer, as well as the legal and technical structuring of the security. However, the prerequisite is that they pass the Howey test.
• Tokenization of company shares: At present, BaFin (the German Federal Financial Supervisory Authority) has not yet implemented a blockchain strategy for the tokenization of notarized company shares (e.g. shares in a Ltd. or GmbH), so company shares in Germany are mainly tokenized in the form of profit participation rights. Profit participation rights are financial instruments that are part of the mezzanine capital of issuing companies (issuers) and are debt-based means of financing with membership-typical asset rights. As an asset class, profit participation rights are characterized by their high flexibility: They can completely replicate company shareholdings in economic terms. In other parts of the world, however, company shares can already be tokenized in their entirety.
• Tokenization of real estate: Real estate properties and projects can be tokenized via a special purpose vehicle (SPV) process. For this purpose, a (real estate) company is first founded that holds the real estate. Subsequently, the shares of this company can be made transferable in the form of tokens.
• Tokenization of real tangible assets: Tangible assets (e.g. a vehicle, a work of art or jewelry) are usually tokenized in a similar way to real estate: They are first transferred to an SPV, which is then tokenized.
• Tokenization of digital tangible assets: The rights to digital objects (e.g. in-game objects or digital collectibles such as jingles, music tracks ...) can be tokenized as fractional shares and thus "owned" proportionally by several investors. However, there is usually only one legal owner who tokenizes the usage or enjoyment rights. For the tokenization of unique digital assets, NFTs) are therefore more suitable.
Tokenization of (existing) securities: Existing securities (e.g. individual securities or funds) can also be tokenized by mapping them via a legal structure that resembles a tracker certificate.
Security tokens offer a number of advantages over traditional assets:
• Increased transparency creates trust
• Increased security protects against fraud and manipulation
• Increased process efficiency reduces complexity and friction
• Increased price efficiency due to lower issuance costs
• Increased speed due to instant P2P transactions
• Increased market accessibility (also for retail investors) thanks to fractional shares
Security tokens contribute to the institutionalization of the crypto market.
Until recently, the crypto market has been too new, too dynamic, too volatile, and too unregulated to meet the demands of professional financial institutions such as banks and asset managers. With the introduction and regulation of security tokens (as opposed to cryptocurrencies or NFTs), this is starting to change:
1. Security tokens provide investor protection. The tokenized assets are regulated financial products. This implies that issuers must be listed with their clear name and company address with the relevant securities regulator (e.g. BaFin), which drastically minimizes the risk of exit scams, which are common with ICOs.
2. Security tokens are P2P tradable. Blockchain-based assets can be traded 24/7 between investors (peer-to-peer); unless the issuers have explicitly excluded this at issuance. Furthermore, the peer-to-peer structure reduces the complexity of the traditional financial sector, which can lead to higher transaction costs, friction losses and a reduction in trading volume.
3. Security tokens enable fractional ownership and are an attractive participation vehicle for retail investors. Most non-exchange traded value assets (real estate, artwork, antiques) have horrendous unit costs that are far beyond the budget of most investors. Security tokens, on the other hand, allow high-priced assets to be scaled down into individual tokens, i.e. into fractional ownership. This allows individual investors to build a diversified portfolio while also giving retail investors access to the premium capital market.
How and where can Security Tokens be bought and traded?
At iVE.ONE, investors have two options to invest in Security Tokens: First, they can purchase newly issued securities (STO) on the primary market (iVE.ONE Investment Hub) directly at a set price. Second, they can resell tokens to or buy tokens from third parties on the secondary market.
Security tokens are typically traded on secondary markets in one of two ways:
On the one hand, investors can buy and sell tokens over-the-counter (OTC); the token changes hands here together with the private key for the wallet. On the other hand, tokens can be sold on (regulated!) trading venues. While the former is largely straightforward under German law due to the direct P2P exchange, the latter poses a challenge for professional financial market players based in Germany: Because many of the crypto exchanges are not based in Germany and cannot or do not want to prevent customers from other jurisdictions from participating in trading, financial professionals must be able to trust and rely on the KYC mechanisms of the marketplace. As a consequence, the regulations of the domestic authorities no longer apply. Instead, the laws and regulations of the respective foreign authorities have legal effect.
iVE.ONE fills this gap and guarantees to both investors and issuers that the strict European standards are met at all times.
Virtual Stock Option Plan (VESOP) gives every employee the benefit to be a shareholder of a company without an actual ownership rights structure between employer and employees.
Utility tokens provide access to a product/service and/or represent the right to use a product/service or function of a project.
Learn about our products for tokenization and crypto trading, or contact us to get more information. Our experts will be in touch soon.