Guide

Digital Securities – Beginners Guide

The many benefits of blockchain technology have paved the way for a new and exciting breed of investment opportunities – digital securities. In its most basic form, the phenomenon allows people to invest in asset vehicles, with the investment represented by a digital token.

Unlike its utility token counterpart, digital securities operate in a highly stringent, transparent and regulated eco-system, much in the same manner as traditional securities such as equities, bonds, and futures.

Ultimately, although the digital securities arena is still in its infancy, there’s much to look forward to. Here we present a brief overview of what digital securities are, how they differ to ICOs/utility tokens, the opportunities ahead, and what rail blocks the industry might encounter.

Digital Securities: What are They and Why are They Different?

In order to understand what digital securities are, it is well worth looking at the problem they solve in the blockchain space. ICOs took the world by storm in 2017 with a total of $10.6 billion raised across more than 400 different projects.

Although 2018 surpassed this total with $11.59 billion in funding, the ICO space has since dried up. Regardless of the amounts collected in the ICO fundraising sector, a single denominator remains constant.

In return for funding the respective project, ‘investors’ receive digital utility tokens, proportionate to the amount of capital invested. The reason the word ‘investor’ has been inserted between two apostrophes is that those parting with their money are not actually investors.

Not in the eyes of national regulators, nor from the perspective of the company issuing the tokens.

Although these utility tokens were issued in the same light as securities in all but name, ICOs do not have the legal or regulatory remit to offer their tokens as a security.

So what’s the big deal?

Well, by holding an asset in the form of a digital utility token, investors are accustomed to virtually no rights, consumer protections, or legal recognition. Moreover, due to the nature of securities regulations, utility token holders cannot receive dividends or benefit from buy-back programs, and as they hold no legal stake or equity in the company itself, voting rights are non-existent.

With that being said, you might be wondering why consumers have injected billions of dollars across hundreds of ICOs.

The answer is simple – speculation.

Those backing ICO projects – even when possessing an understanding of what the utility token represents, did so with the hope that the value of token would sky-rocket once listed on a third party exchange.

You can read more on the disparity between ICOs and STOs (Security Token Offerings) in our in-depth opinion piece here.

Digital Securities: Traditional Investments on the Blockchain

In a nutshell, digital securities alleviate all of the aforementioned concerns. Much like in the case of a traditional company filing for a public floatation, those behind digital security ventures must get the green light from national regulators.

Whether its the SEC in the United States or ASIC in Australia, the initial process of issuing digital securities must comply fully with the jurisdiction’s relevant securities laws. This essentially takes the blockchain asset space far and away from the Wild West of ICOs.

Moving away from the regulatory side of things momentarily, it’s important to recognize just how limitless the digital securities space is. This is because, in effect, virtually any asset class that yields value can be represented by digital security built on top of the secure, transparent, and immutable blockchain protocol.

For example, imagine a multi-million dollar London-based hotel that’s listed for sale. For the vast majority of us, such an outright purchase would be out of reach.

However, by issuing digital securities under national and regional securities laws, investors could own a segment of the hotel, proportionate to what they can afford. In return, they would be in full possession of a digital token that is recognized in the same light as conventional security.  

The Benefits of Digital Securities are Limitless

On top of stringent regulation and fractional ownership, further benefits lie waiting. Fees are a major hindrance in the traditional securities space, not least because much of the industry still has a strong reliance on manual, paper-based processes.

On the contrary, as digital securities can be issued over the internet, and the fact that fewer intermediaries are required, both issuers and investors can benefit from reduced costs.

It should also be noted that the issuance of digital securities can be of significant benefit to small-to-medium companies that are not yet in a position to float on a major stock market. For those that don’t quite meet the criteria, private companies often turn to venture capital firms to attract investment.

This severely limits the opportunity to spread the risk of ownership across a large number of shareholders, as private investors often hold a significant proportion of the company they invest in.

The process of issuing digital securities alleviates these concerns. It does so by widening the scope of who can invest, and by how much. This is because the distribution of digital securities is available to a much wider pool of investor types. Furthermore, the phenomenon reduces the costs associated with compliance and distribution, as well as promoting a surplus in exchange opportunities.

You can read more on the many benefits of digital securities over traditional securities here.

Rail Blocks Must be Addressed

It is important to note that while the emergence of the digital securities arena is exciting, certain rail blocks do need to be considered. First and foremost, regulatory approval is going to be no easy feat for those looking to issue digital securities. National regulators must feel satisfied that the respective issuer meets, and is likely to continue to meet, all relevant securities laws.

Custodianship must also be addressed. In the United States, for example, most investment advisors are required to keep client funds in a qualified custodian, as per the SEC.

Regardless of whether custodianship for digital securities is a legal requirement in the issuer’s home jurisdiction, institutional and other large-scale investors will want to know that their funds are safe.

Although blockchain technology has surpassed its tenth anniversary, the phenomenon is still in its infancy. Custodianship capabilities are becoming more and more robust, however, technologies are still emerging. Both regulators and investors will need assurances that digital security tokens are safe from the threats of malpractice, loss or theft, including that of a contingency plan in the form of insurance.

To read more on the potential challenges facing the digital securities space, you can our in-depth opinion piece here.

Digital Securities: The Verdict

In summary, there can be no denying that the digital securities space has a lot to offer. This not only includes investors themselves but companies and institutions that are looking to issue securities in a more transparent, cost-effective, efficient, secure and inclusive manner.

The key point here is that although digital securities and the Wild West of ICOs are often discussed concurrently, the former will eventually break away into an industry in its own right.

Taking in to account the previously discussed rail blocks and challenges, it will arguably take some time before we see a fully-fledged digital securities arena. However, the future certainly looks bright.

Further Reading:

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