Security Tokens vs Tokenized Securities

Tokenization is making its return in recent years. This may be reminiscent of the 2017-2018 golden period when everything was tokenized and placed on the blockchain. Banks rushed to introduce proof of concept, but few clients appear to be interested. The experiment has now gone beyond the original squad, and even managers are taking notice.

Undoubtedly, more people who are interested will lead to greater confusion.  You may hear the asset referred to as a “security token” or a “tokenized security” at times. So, what is the difference between these two terms?

• Security Tokens are tokens that resemble securities in some ways. More precisely, they are blockchain-based representations of some benefits, such as income sharing, access rights, governance, or a combination of these benefits with others, and because of their incentive structure. Securities should be used to classify incentives.
• Tokenized Securities are securities that may be transacted on the blockchain. They are coins that represent specific off-chain assets or replicate recognized asset classes like bonds, equities, or ETFs.

Although all tokenized securities can be categorized as security tokens, the opposite is not true. Misunderstandings of these two concepts will harm a greater understanding of the underlying potential and stymie classification attempts, affecting both legislation and investment.

Distinctive feature

Security tokens are an innovative idea. They are formed on-chain, serve on-chain purposes, and do tasks that were previously unheard of until a few years ago. They enable new types of funding, promoting user participation, investor rewards, project governance, and other benefits.

Tokenized securities are an example of an “old wine in a new bottle” notion. They take existing formats and enhance them with features such as improved checkout, transparency, flexibility, and a broader reach. As a result, this type has recently been thoroughly tested. We have seen financial institutions and formal institutions not only test but also issue stocks, bills, municipal bonds, development bonds, funds, commercial paper, and gold via blockchain in recent months.

Security tokens, on the other hand, are floundering due to a lack of regulatory clarity and the Securities and Exchange Commission’s (SEC) all-too-familiar enforcement strategy. For example, beginning in 2016, the decentralized communication service and storage protocol LBRY sponsored their development by issuing LBC tokens, allowing access and interoperability after the platform is set up and operational. Many people see these as utility tokens because they allow them to use the service. However, due to project funding, they are considered security tokens by the SEC. The agency took enforcement action against LBRY in 2021. The issuer strongly contested it, but in November, a judge decided in favor of the SEC.

On the surface, the two concepts appear to be similar, but when examined closely, the differences in transparency, agency support, and level of development become clear. Fear of SEC punishment prevents many potential enterprises from testing ideas in the market with security tokens, despite the fact that tokenized securities are becoming increasingly attractive.

Why?

As a result of differing regulatory methods, disparities are widening. Beyond classification modifications and custody requirements, tokenized securities are unlikely to garner much attention. International regulators are developing clear guidelines for dealing with the adaption of blockchain securities. Along with official support, more established tests and, eventually, client demand will be conducted.

Security tokens, on the other hand, are quite contentious. As previously stated, the legal process against LBRY took approximately two years. Ripple’s SEC case for allegedly issuing unregistered securities is now in its third year. Case law is vital in the US legal system, but imagine if the SEC had access to so many legitimate materials in its decision-making. This is unsustainable, but change has been gradual until US regulators realize it.

The distinction is also represented in the investment perspective. Incorporating phrases suggests that there is currently no justification for accepting security tokens. It also emphasizes security tokens’ revolutionary potential by implying that they are essentially securities on the blockchain.

Still, security tokenization is an intriguing notion, and the new activity surrounding it is a welcome result of years of quiet work by developers, market infrastructure businesses, banks, and financial regulation. 

Conclusion

Security tokens, on the other hand, have a loftier purpose. Once the regulatory constraints are established, they will most likely have an impact on more than just the market. Finally, it has the potential to change traditional investment and engagement paradigms, thereby unlocking not only new business models but also new sources of wealth.