In recent times, tokenization is making a comeback. This may be reminiscent of the golden age of 2017-2018, when everything was tokenized and put on the blockchain. Banks scrambled to introduce proof of concept but few customers seem to be. Now, the experiment has spread beyond the original team, and even managers are paying attention to the topic.
Naturally, more people interested would also cause more confusion. You may find that the asset is sometimes referred to as a “security token” and sometimes a “tokenized security”. So, what’s the difference between these two terms?
Security tokens are tokens that share some characteristics with securities. More technically speaking, they are blockchain-based representations of some perks such as revenue sharing, access rights, governance, or a combination of these privileges with others, and because of their incentive structure. incentives should be classified as securities.
Tokenized securities are securities that move on the blockchain. They are tokens that represent specific off-chain assets or mimic established groups of assets such as bonds, stocks, or funds.
All tokenized securities can be classified as security tokens, but the reverse is not true. Misperceptions of these two terms will damage a broader understanding of the underlying potential and hinder classification efforts, which in turn affects both regulation and investment.
Point of difference
Security tokens are a new concept. They are created on-chain, serve on-chain purposes, and do things that were never done before until a few years ago. They enable new forms of funding, driving user engagement, investor rewards, project governance, and more.
Tokenized securities are a “old wine in a new bottle” concept. They use existing formats and add add-ons like improved checkout, transparency, flexibility, and wider reach. Therefore, this type is being extensively tested in recent times. Over the past few months, we have seen financial institutions and formal institutions not only test but actually issue stocks, bills, municipal bonds, development bonds, funds, commercial paper and gold on blockchain.
Security tokens, however, are struggling amid a lack of regulatory clarity and the all-too-familiar enforcement approach of the U.S. Securities and Exchange Commission (SEC). For example, starting in 2016, decentralized communication service and storage protocol LBRY funded their development with the issuance of LBC tokens, allowing access and interoperability after the platform. is set up and operated. To many, these are clearly utility tokens as they enable the use of the service. But to the SEC, they are security tokens because of project funding. In 2021, the regulator introduced enforcement action against LBRY. The issuer firmly denied it, but a judge ruled in favor of the SEC in November.
On the surface, the two concepts seem similar, but on detailed analysis, you can see that the difference is very obvious, in terms of transparency, agency support and level of development. With security tokens, fear of SEC retaliation is preventing many potential projects from testing ideas in the market, while tokenized securities are becoming more and more exciting.
Why the significant difference?
As a result, differences are widening due to different regulatory approaches. Tokenized securities are unlikely to attract much attention beyond classification adjustments and custody requirements. International regulators are working on clear rules for dealing with blockchain securities adaptation. Along with official support, there will be more established tests and eventually customer demand.
Security tokens, however, are somewhat controversial. The process against LBRY as mentioned above took nearly 2 years to go through the courts. The SEC’s lawsuit against Ripple for allegedly issuing unregistered securities has now entered its third year. In the US judicial system, case law plays an important role, but imagine what if there were so many legitimate resources for the SEC to cite in its decision-making. This is unsustainable, but until US regulators get it, progress has been slow.
The difference is also reflected in the investment point of view. Incorporating terms implies there is no basis for accepting security tokens yet. It also underscores the innovative potential of security tokens by suggesting that they are merely securities on the blockchain.
Still, tokenization of securities is interesting, and the recent activity around this concept is a welcome result of years of silent work by developers, market infrastructure companies, banks and financial supervision. Security tokens are one of the main vectors through which the crypto market will transform the traditional market.
Security tokens, however, have an even loftier goal. Once the regulatory parameters are resolved, they are likely to impact more than just the market. Ultimately, it can transform conventional investment and engagement concepts, possibly unleashing not only new business models but new sources of value.
To summarize, tokenized securities and security tokens are similar overall. But looking deeper, they have notable differences. Both concepts have important properties to find a place in.