What is a Security Token? Everything You Need to Know About This Asset

By Enrique

To dive into security tokens, we first need to lay the groundwork with the concept of a token. A token is a digital asset developed on an existing cryptocurrency's blockchain; in most cases, they are built on the Ethereum network and utilize its smart contracts.

Like other tokens, security tokens are offered through an Initial Coin Offering (ICO)—or as it is known in Spain, an Oferta Inicial de Moneda. Their primary goal in this process is to establish a new crowdfunding mechanism to fund startups or other innovative projects.

Now, let's define more specifically what a security token actually is.

A security token is essentially a cryptographic token linked to traditional securities. In other words, they are tied to financial assets, meaning this type of crypto-asset grants the owner a series of rights and obligations (such as the right to dividends or voting rights).

The most well-known traditional security for the vast majority of users is company shares. So, what is the difference between a traditional stock and a security token? Essentially, the implementation of blockchain technology allows a security token to offer faster transaction speeds, lower costs, and reduced bureaucracy, alongside other benefits inherent to this technology, such as transparency and enhanced security.

Security Token vs. Utility Token

Along with security tokens, we must also define utility tokens. As the name suggests, this type of token is designed for a specific utility or purpose. Once the token is launched via an ICO, investors who acquire it gain certain future advantages within the company, allowing them to “redeem” these tokens for products or services within that same company.

To use a more traditional analogy, we could compare it to airline miles. There comes a point where the customer can redeem those miles for in-flight meals, preferred seating, VIP lounge access, or even a full flight. Therefore, it is a token with a future utility, which is the main reason investors purchase it.

Consequently, we can understand that security tokens do not provide a future utility within the company itself; instead, they are considered assets. They offer owners the opportunity to profit from a company's growth, meaning that, for legal purposes, they are classified as investments.

Earlier, we mentioned that tokens are launched via an ICO. However, that applies to utility tokens, not security tokens. Because security tokens are considered assets, they must comply with a strict set of requirements and obligations before being issued. This means they are not introduced through an ICO, but rather via an STO (Security Token Offering). Therefore, the primary difference between an ICO and an STO lies in the type of token being launched and the regulatory frameworks they must comply with to be deemed legal and valid.

Regulations

Given how novel this technology is—as we previously noted in our post on NFTs—regulations usually take time to develop, and when they do arrive, they can still be somewhat vague.

Until relatively recently, all tokenized projects were launched via ICOs as utility tokens, allowing creators to bypass the bureaucracy and stringent requirements that security tokens must meet. To establish a framework for distinguishing between a utility token and a security token, the U.S. Securities and Exchange Commission (SEC) implemented a regulatory standard based on the Howey Test.

The Howey Test relies on four core questions to differentiate between a utility token and an asset (which, in this case, would be a security token):

• Is there an investment of money?
• Is there an expectation of profit?
• Is the investment of money in a common enterprise?
• Does any profit come from the efforts of a promoter or a third party?

If all these questions are answered in the affirmative, the SEC considers the token to be a security token—and therefore an asset that must comply with mandatory regulatory requirements when offered to the public.

Reental and Regulations in Spain

In Spain, the National Securities Market Commission (CNMV) also stipulates a series of requirements that must be met to offer investment assets to the public.

One such requirement is the Know Your Customer (KYC) form, which is mandatory for investing in Reental real estate. Since the tokens representing the property are security tokens, we must comply with investment asset regulations. Another example of a mandatory requirement is the Anti-Money Laundering (AML) compliance framework.

If you want to dive deeper into this topic, we invite you to join our Telegram channel, where we and fellow "Reentels" will help clear up any questions you may have. In addition to our Telegram channel, you can also contact us by clicking the button below. Don't forget to check out our other blog articles and join the new way of doing finance!