Security Tokens May Safeguard the Future of Digital Currency

Opinion | August 9, 2018 By:

The current cryptocurrency markets are incredibly volatile, which can, in part, be attributed to the uncertainty around the legality of investment. This volatility based in legal uncertainty greatly hinders the growth of the industry at large. Should pension funds and endowments take the leap and invest in digital assets, such involvement could provide much needed validation to stabilize the digital assets market. Security tokens, unlike utility tokens, are registered with the US Securities and Exchange Commission (SEC) and are therefore compliant with all applicable regulations. The legal assurance provided by security tokens may be exactly what game-changing institutional investors, such as pension funds and endowments, seek in order to incorporate digital assets into their portfolios.

To say the foray of cryptocurrency into financial markets has been a roller coaster would be an understatement. 2017, deemed the year of the ICO, saw the launch of thousands of projects culminating in over $5.6 billion in capital raises. 2018 has been a more sobering one in that regulatory bodies have begun to issue statements on the legality of ICOs and have cracked down on some projects that have been found to violate securities laws. The essence of the SEC’s stance on cryptocurrencies and digital assets boils down to whether the token passes the Howey Test.

The Howey Test determines that an asset is a security if it has the potential to increase in value over time through one entity’s efforts. Not surprisingly, many of the digital tokens launched during the 2017 ICO bonanza would be determined securities by this test. The fact that many of these tokens are not registered as securities fosters justifiable wariness among institutional investors.

Some critics have argued that security tokens are antithetical to the spirit of blockchain and cryptocurrencies originally conceived of by the elusive Satoshi Nakamoto, because they are registered with a governing entity. I’d like to remind skeptics that Satoshi’s white paper emphasized the advantage of digital currency as being able to exchange value in a peer-to-peer manner – not as a way to evade the law. Dark markets like Silk Road and the criminal cryptocurrency exchange BTC-E don’t further the cause of mainstream adoption of cryptocurrencies. Instead, association with illegal activities presents a giant roadblock to convincing institutional investors to diversify their portfolios with digital assets.

Endowments and pension funds with global financial sway may be on the brink of adding digital assets to their investment portfolios, but the fear of illegality, uncertainty around regulations, and lack of liability in the case of hacks have served as barriers to entry. The emergence of security tokens addresses these concerns by providing legal assurance and compliance with US securities regulations, including those intended to protect the interests of investors.

The next step in the evolution of security asset trading is in increasing the number of avenues through which institutional investors can participate in this growing sector of the economy. In full disclosure, my company, OpenFinance Network, recently launched one of the first security token trading platforms through which investors can trade alternative assets in accordance with their accreditation status. In my view, the digital asset industry can only benefit from the participation of endowments and pension funds, and security tokens are likely to be the first digital assets to attract their attention.