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What Are Securities – Comprehensive Guide in 2020

16.09.2020

What are securities? Whether you are new in crypto or a seasoned investor, you have probably run into this question. So, let’s break this topic down and find out all about securities!

What Are Securities? An Introduction

To put it as simply as possible, securities are financial contracts that grant the owner a stake in an asset. They have two main features: they give certain rights to the owner; and they can be traded in the financial markets. There are various types of securities. For instance, bonds, stocks and options.

Let’s get a bit more technical. When looking for a more precise definition, we should talk about the Securities and Exchange Act of 1934. It states: “The term ‘security’ means any note, stock, treasury stock, bond, debenture, certificate of interest or participation in any profit-sharing agreement”. The original definition goes on for eight more lines. But the key takeaway from this definition is that securities are complex to define. 

Definitions

Before we go any further, let’s nail down some more definitions. There are three main types of securities in finance: equities, debts and hybrids. Let’s have a look at what each of these means.

Equities

Equity shares represent shares in a company, partnership or trust. The status of equity shareholders differs slightly from the norm. Equity shareholders do not usually receive regular payments (although many equities do pay dividends). Instead, investors profit from capital gains when selling the securities. This of course assumes that the equity shares have increased in value.

Debts

Debt securities represent borrowed funds that must be paid back at the end of a set term. For instance, debt securities are corporate bonds, government bonds and collateralized debt obligations. But how do debt securities differ from equity shares? Well, debt holders usually receive regular interest payments.

Hybrids

As the name suggests, hybrids are a mix between the two. Hybrid securities combine some features of equity and debt securities. For example, a hybrid security can be a convertible bond. 

Securities Meet Crypto

We have gone through quite a few examples of securities. But as you noticed, these examples derived from the institutional world. So, what happens when securities meet crypto? The answer is – the security token.

What is a Token?

Let’s start with understanding the meaning of “token”. Crypto tokens are special kinds of virtual currency tokens that are based on their own blockchains and represent an asset or utility. The exact definition of this is rather difficult to pinpoint. In general, a token is a representation of something in its particular ecosystem. For instance, value, stake, voting right. A token is not limited to just one role. It can fulfil many.

Cryptocurrency Coin vs Token

Most avid crypto enthusiasts have probably noticed the terms cryptocurrency coin and token being used interchangeably. However, this is not correct.

A cryptocurrency coin, like Bitcoin, Ethereum, Litecoin can be independent from its platform. They can be used as a form of currency outside their native environment. On the other hand, there are tokens that exist only on a particular platform. For example, Golem and OmiseGO, which are based on Ethereum. 

Howey Test

Before we can talk about security tokens, we have to understand the Howey test. Never heard of this before? No problem. 

In 1946, the Supreme Court handled an important case. This would lay down the foundation for the currently infamous Howey Test. Two corporate defendants based in Florida offered real estate contracts for tracts of land with citrus groves. They essentially offered buyers the option of leasing any purchased land back to the defendants, who would then tend to the land and harvest the citrus. Most of the buyers were not farmers and did not have agricultural expertise. So, they were happy to lease the land back to the defendants. And this is where the SEC stepped in.

The U.S. Securities and Exchange Commission (SEC) deemed this illegal and sued the defendants. But why? Well, the SEC saw a problem in defendants not filing a securities registration statement. Their investigation showed that the leaseback was indeed a security. This became a landmark decision.

A test framework was developed to determine whether a transaction is an investment contract or not. If it is, it will be subject to the securities registration requirement. The criteria for it is the following:

  • It is an investment of money
  • The investment is in a common enterprise
  • There is an expectation of profit from the work of the promoters or the third party.

All About the Security Token

You might still be wondering, how is all this relevant to crypto? Especially the Howey Test? Well, if the token meets the Howey Test criteria, it is considered a security.

Definition

By now we know that a crypto token that passes the Howey Test is deemed a security token. Since the tokens are deemed as security, they are subject to federal securities and regulations.

A security token creates an expectation of profit from the effort of others. At its very essence, a security token is an investment contract that represents legal ownership of a physical or digital asset. For example, real estate or ETFs. This ownership is verified within the blockchain.

After verification, security token holders are eligible for several actions. One of the most important being trading their tokens. However, this requires a functioning secondary market. Unfortunately, this is often overlooked in favor of the primary market

Securities in Practice

On a theoretical level, this sounds great. But as mentioned above, securities marketplaces are difficult to find. Digital securities marketplace has seen lots of hype in the past three years. Yet, there are very few on the market.

One of pioneers is CoinMetro’s partnership with Ignium. Ignium is a Central Securities Depository built on blockchain technology. The partnership between CoinMetro’s digital currency exchange and Ignium’s CSD allows both retail and institutional investors to purchase digital bonds, convertibles, and equities in already established and upcoming companies raising funding.

In short, CoinMetro provides the platform for investors to purchase the securities and the secondary marketplace for trading. Ignium provides the issuance, primary distribution, registrar and settlement of the digital securities as well as corporate services for the issuers. 

Now that you know all about what are securities, why not get into practice? Head over to CoinMetro digital securities marketplace and start exploring!