Understanding security tokens
Developed on public or private blockchains, Security Tokens are cryptographic financial instruments giving the holder the same rights as a traditional financial instrument such as a share or a bond.
In France, Decree No. 2018-1226 of December 24, 2018 (the “Blockchain Ordinance”), (Article L211-3 of the Monetary and Financial Code) frames digital financial securities registered in a DEEP (Dispositif d’Enregistrement Électronique Partagé).
These securities are issued by companies (listed or unlisted) and subscribed to by financiers via the Security Token Offering (STO).
A bit of history
In 1982, David Chaum, an American cryptographer, proposed in his thesis entitled “Computer Systems Established, Maintained, and Trusted by Mutually Suspicious Groups” a cryptographic protocol whose purpose would be to create a computer system developed and maintained by several organizations in order to ensure transparency and to establish a climate of trust between these organizations, which from the outset distrusted each other.
Since then, several scientists have worked on related topics such as Stuart Haber and W. Scott Stornetta. Their work focused on cryptographically secured blockchains, where no one would be able to falsify the timestamp of a document.
However, it wasn’t until 2008 that the blockchain technology as we know it emerged. It was introduced under the alias of Satoshi Nakamoto.
The development of these blockchains has enabled the emergence of “decentralized” finance that simplifies customer journeys by structurally modifying traditional intermediaries such as brokers, exchanges and banks, to offer financial instruments.
Companies can now offer their financial instruments using “smart contracts” developed on public or private blockchains. Since 2018, blockchain-based finance has gained momentum and more and more companies are using it to finance their projects and business.
How do security tokens operate?
Security tokens are cryptographic representations of securities issued by a company on blockchains such as the Ethereum blockchain via smart contracts. These smart contracts allow the issuing company to choose the rights and restrictions they wish to grant to these financial instruments (shares, bonds, etc.).
For bonds, a company can choose to index the interest rate according to social and environmental criteria such as improving the carbon footprint of its business, reducing energy consumption, or ensuring the safety of its employees.
The securities issued in this way are encrypted in the blockchain and secured via a system of cryptographic keys. There are some platforms that facilitate access to issuers and holders of security tokens using a password system.
Several platforms now offer their services to enable companies to digitize their financial instruments and offer them to financiers. As with any business related to financial services, these platforms are, in France, under the supervision of the regulatory authorities: the ACPR and the AMF.
What are the advantages of security tokens for unlisted companies?
A simplified use for the issuing companies
The use of shared registries and smart contracts simplifies the administrative procedures that are long and costly in the case of an IPO (Initial Public Offering). Companies can thus eliminate intermediaries such as brokers, stock exchanges, banks…
At the same time, they regain control over the issuing and management of the securities they issue.
Facilitated use of unlisted financial securities
Unlike an IPO, which is often expensive for the company, and requires a minimum valuation, security tokens are much cheaper for companies to issue and can be issued by companies of all sizes.
The financial securities of unlisted companies, when digitized in the form of security tokens, become easily transferable over-the-counter between financiers (because of their forgery-proof nature).
The automation and speed of the settlement process allow for the establishment of trusting relationships between the seller and the buyer of securities who did not know each other beforehand.
A flexible contract
Based on the properties of the smart contract, security tokens issued by a company can be endowed with different properties. For example, a company can choose to increase the value of the security token if the buyer keeps it for a certain period of time or to give its buyers benefits under certain conditions.
A field still in development
Decentralized finance, of which security tokens are a part, is still a very young field with constantly changing regulations. In France, this emerging technology, would allow companies to find a new source of financing for their projects and thus develop their activity.