How to evaluate a security token?

Security Token has been the buzzword from the second half of 2018. Governments of many countries are supporting this trend and releasing guidance and related regulations. Here are some factors to consider.



Briefly, what is a Security Token?


Security (or Asset-backed) token is a digital representation of value that is subject to regulation under security laws.

The essence derived from this notion is the necessity to evaluate the underlying assets. And then to add other metrics related to the security wrapper and handling technology.


Do you, as an investor, have access to all information necessary to take a decision?

Jay Clayton, the SEC chairman emphases “ the two key principles the SEC has followed (1) embrace new technologies that cut costs and provide new investment opportunities while (2) continuing to require that our retail investors have access to the material information necessary to make an investment decision, including the key risks involved, and other fundamental protections.“

European regulators have echoed the calls for investor protection, stating in FCA consultation paper: "Our objectives as a regulator mean that we need to strike a balance between supporting innovation and ensuring consumers are adequately protected".

In most cases with ICOs, the information about the project was very limited and the investor was not able to understand if that is a stage of an idea or a prototype.


Do you understand the business logic and able to evaluate the project?


Another challenge is that the investor should have the expertise to access and evaluate a specific underlying technology or an asset.

One the advantage of DLT (Distributed Ledger Technology), the elimination of the middleman results in a lower cost of capital and widens access to investors. However, the removal of those financial intermediaries leads to additional responsibilities for both parties of the transaction. The intermediaries such as financial institutions have a very crucial role in formatting the market. The bunch of such functions as underwriting, background check, compliance regulation, security evaluation, preparation of marketing and certain educational materials, solicitation of investor interest will shift those functions and responsibilities to the investor and the issuer.


Smart contract features


Security token is a smart contract coded natively as software for the blockchain for the distribution, transfer, and store of value. A lot of conditions can be specified through the code, such as dividend payment, proxy voting, events triggered by hitting a milestone, lock up and holding periods and other financial conditions, and even asset pool segmentation. Thus, a smart contract brings automated compliance for the applicable cases. Some business cases require implementation of Smart Contracts Using Hybrid Architectures with On- and Off-Blockchain Components. Although hybrid architectures are largely unexplored.

In both case, it worth to question : "Is anyone using the smart contract in production?" And if the answer is no you may not be wanting to get involve and to take such risks.[1]