In crypto, most market participants are always on the lookout for the next big thing. The payout will be astronomical for investors who manage to get in early. We saw similar things happen with NFTs. People who saw the change in the dynamic of art and blockchain utility were able to buy top collections at low prices.
For example, the Bored Ape Yacht Club (BAYC) initiated a new trend in NFTs, and it is now going to build a whole ecosystem with $APE coin, virtual lands, and a play-to-earn video game. The holders of BAYC, MAYC, and BAKC reaped massive rewards. And they are a part of one of the most exclusive communities in the world.
So it is important to identify new trends before the market realizes its potential. While there is no doubt NFTs, metaverse, and gaming will play a huge role in building the Web3 world, we believe people are ignoring another undervalued market sector in crypto. It is none other than security tokens.
The beauty of blockchains is that they can tokenize anything. So it vastly improves asset accessibility, discoverability, and liquidity of hard-to-reach assets. In the real world, not everyone has access to financial instruments that allows them to invest in a company at any stage.
Investors can directly invest in their desired companies or any real-world asset with security tokens. As security tokens operate in a completely regulated environment, it prevents investors from falling prey to scams and hacks. This deep dive will discuss why security tokens have the potential to be one of the biggest market sectors in crypto and who is currently leading in the security tokens space.
What Are Security Tokens
Security tokens can be characterized as a limitless instrument vehicle representing ownership of any business and asset class. Compared to equity markets, the stock represents ownership in a publicly owned company. When it comes to security tokens, the underlying asset can be anything in the real world. For example, we can tokenize real estate and associate the token’s value to either the cash flows via rent or ownership.
Issuing tokens and making them available to the public to seamlessly exchange is called Security Token Offerings (STOs). We are used to hearing about ICOs or Initial Coin Offerings. But there is a stark difference between ICOs and STOs. The need for a regulated security token became profound when ICOs raised billions and popped the bubble, crashing the entire crypto market by over 70% in 2018. STOs, on the other hand, operate under regulatory frameworks. Even the most hard-to-get asset can instantly become globally available and divisible by issuing a security token.
Types of Security Tokens
In the capital markets, we have mainly four types of security tokens:
- Equity token
- Debt token
- Fund Token
- Derivative Token
In a traditional capital market, companies raise either through private investments or go public with an IPO. So the company’s shares are illiquid and inaccessible for the majority of the market cycle. In contrast, companies can kick off their fundraising with equity tokens by making their shares available to both accredited and non-accredited investors. This is an efficient method for companies to raise money because they don’t have to deal with middlemen and can immediately tap into deep liquidity.
When any entity in capital markets wants a loan, they have to go through a tedious process and negotiate a great deal in interest rate and default risks. With debt tokens, all that is eliminated. With smart contracts, two parties can establish a loan agreement that includes all the risk factors and dividend models. So a debt token is essentially representing a loan on an interest rate.
Fund token may be the least heard security token. But it offers something unique for asset management companies. When a fund wants to transfer distribution rights and other contractual interests, it will use fund tokens. The first-ever fund token was PRTS, which represented Protos Asset Management.
Derivative tokens display the most exciting use case of security tokens. These tokens are basically asset-backed, and there is an underlying asset that determines the price. For example, commodities like gold and silver are not easily accessible to a regular investor, and they can take a tremendous amount of time to process transactions. With derivative tokens, commodity trades can be simplified and made accessible to everyone. The same applies to real estate and art as well.
Why Security Tokens Offerings (STOs) Can Next Big Thing in Crypto
Okay, we know everyone claims to know the “next big thing” in crypto. But in reality, it really is all up to the markets to decide. What we can do is study narratives around crypto markets and see where the masses might be headed. In this case, security tokens have that potential because crypto markets have entered the institutional phase, and the dialogue with regulators is escalating rapidly.
In 2017-18, regulators weren’t ready to accept digital asset classes because they were more focussed on the illegal activities made possible with cryptocurrencies. After the recent growth in 2020-21, it has become clear that Web3 is the future, and masses have entered the crypto markets. So regulatory bodies made it their mission to impose laws and introduce taxation schemes. We have seen India come out on the annual budget day to announce a 30% tax on digital assets. We have also seen the SEC accept bitcoin futures proposals. And dare we forget, an entire country adopted bitcoin as legal tender.
So, my point here is crypto is now recognized on governance and institutional level. That means we will see a massive influx of capital from big investors and AMCs. The only way they can invest in a crypto is when they are compliant with regulators. For that to happen, we need more security tokens. Assets that operate under regulation gives more freedom for investors to explore more investment opportunities. That is why we may see security tokens make some noise in crypto markets and drive more adoption.
Polymath: World’s First Purpose-Built Blockchain For Capital Markets
One of the leading forces in the digital securities market sector in the blockchain space is Polymath. Initially, Polymath was often described as the “Ethereum of security tokens”. But it has changed its stance on the Ethereum blockchain network as it is not very regulation friendly. As a result, the Polymath security token platform with 25 other companies engineered a purpose-built blockchain called Polymesh.
Polymesh adopted a new standard of security tokens, removing the KYC and efficiency problems. The ERC1400 standard extends the previous Polymath’s protocol, ST-20, with additional features related to automatic transfer control and governance.
As security tokens work in a regulated environment, blockchains must also meet certain market requirements, such as identity, compliance, and confidentiality. We know the existing public blockchains cannot match those needs, so Polymath built its own blockchain network.
Polymesh’s token studio makes the entire token creation, compliance, and distribution simpler and much more cost-efficient than traditional share issuance practices. In addition, the nodes of Polymesh’s blockchain network are operated by licensed financial entities, which elevates its regulatory status.
Progress Made So Far
The biggest achievement for Polymath so far is launching the Polymesh mainnet, as it has been in the works for more than two years. It also launched a block explorer with subscan to make it easier for users to scan through blockchain data. Recently, Polymesh announced the security token platform is finally ready for user onboarding with user interfaces and bridges live.
To grow the Polymesh ecosystem, new proposals, including a grant program, were released. The grant program offered $25 million to developers for building security token projects. Some of the ideas highlighted in the proposals are a cross-chain settlement engine and a finance-oriented block explorer.
So the team behind Polymath and Polymesh made great strides this past year in growing the digital securities space by building the foundational layer or infrastructure. Polymath also partners with Marketlend, an online marketplace to lend real estate to SMEs. This partnership saved Marketlend thousands of dollars and took only four weeks to tokenize the corporate loans. As discussed earlier, tokenized loans come in the form of debt tokens. We saw a similar digital transformation happen with RedSwan, a commercial real estate agency.
Roadmap For 2022
With the mainnet live, companies can finally start using Polymesh and leverage its security token features. But there is a lot to be done to enhance the functionality and expand the reach of Polymesh.
For 2022, the first thing planned by Polymesh is to launch smart contracts. They understand that developers can’t create multiple use-cases and maximize Polymesh’s potential with current functionality.
Polymesh also aims to integrate tokenization of non-fungible assets like art and digital collectibles. They plan to add new financial products alongside the core layer to support assets like NFTs.
Another important feature that will come down the line is MERCAT. This would enable entities to make their transactions private and withhold information on their asset holdings. To do that, Polymesh is going to use zero-knowledge proofs.
The road ahead for Polymesh is promising, and the fact that we will see more traditional companies enter the blockchain world by tokenizing their assets adds immense value to the crypto ecosystem.
Security Token Issuance would be worth $4 Trillion by 2030— Is It Possible?
Millions of companies worldwide need what security tokens offer — liquidity, global reach, and cost-efficiency. So it is not a matter of “if” but “when” regarding security token offerings. Platforms like Polymath are leading at the innovation front, with purpose-built blockchain, Polymesh, and other token offerings. For further mass adoption, we need big players to step up and adopt this new security token medium. As the capital inflows increase, we will see more people pay attention. It is already known that banks have expressed their interests. So once we build the right infrastructure and tooling, we will see a parabolic growth in usage and exchange of security tokens.
Born and brought up in India, Karthikeya Gutta is a crypto journalist and freelance contributor for ItsBlockchain. He covers various aspects of the industry with in-depth analysis and research. His passion towards blockchain and crypto ecosystem is mainly because he believes it can really change the world and help millions of people.
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