Within blockchain, there is an emphasis on protecting data and maintaining that data's integrity. One way we can accomplish this is through the use of security measures including security tokens. What are these tokens and how do they work? Let's talk about them and how your organization's invaluable data can stand to benefit from this added layer of security.
Let's first address what a security token is. This can be immediately confusing because a security token can actually refer to two different things. First, a security token may be a portable device which is designed to authenticate a person's identity. They can be used alongside passwords to provide an added layer of security when logging into a network or service. For example, they may take the form of a USB drive or an input device such as a number pad. These act as a key into the system. Second, a security token may be a financial instrument which holds value and can be traded. It is the latter which we will discuss today.
Next, let's talk about how this form of security tokens work. These tokens are issued as Security Token Offerings—STOs—and are equipped with security features. With security tokens, it is possible to convert real assets into digital tokens in a process known as "tokenization." It is, therefore, possible to transform tradable financial instruments including stocks or profit-participation certificates into digital assets in a blockchain. Security tokens represent an improvement to classical securities because they inherently follow all regulatory rules and automatically process dividend payments through smart contracts.
It would be prudent at this point to introduce utility tokens and ask what the difference is between these and security tokens. In some ways, they are similar: they are managed by smart contracts, sent to blockchain addresses, and are traded on exchanges or through peer-to-peer transactions. However, they differ in the economics and regulations that underpin them. Utility tokens are not intrinsically valuable. If a project does become successful, investors aren't entitled to a portion of profits. As a result, the value of utility tokens is often driven by pure speculation. Security tokens are issued in a similar way, but from an investment standpoint, they represent different instruments. Security tokens are also more heavily regulated to prevent fraud.
So, what are the tangible benefits of security tokens when compared to classical securities? Often, small and medium-sized business are unable to use stock issuances as a source of funding. Because of STOs, however, the issuing costs can be reduced.
Security tokens appear to be the next logical progression for the financial industry. Even though security tokens are closely associated with blockchain, which is sometimes considered synonymous with cryptocurrency, the tokens are much closer to traditional securities. There is still work to do on the regulatory front, but with automation systems like smart contracts in place, security tokens continue to show great promise.