Securities Token

A defining feature is the ability to embed regulatory logic directly into the token's smart contract. This enables automated enforcement of rules like investor accreditation checks, transfer restrictions, and jurisdictional limitations. For example, a token can be programmed to only transfer to wallets that have passed a KYC/AML verification, ensuring ongoing compliance without manual intervention.

Securities tokens enable the division of high-value assets into smaller, more affordable units. This fractionalization lowers the barrier to entry for investors, allowing participation in asset classes like commercial real estate, fine art, or private equity with smaller capital commitments. It increases market liquidity and democratizes access to investment opportunities traditionally reserved for institutional players.

Smart contracts can automate administrative functions tied to the underlying security. This includes the distribution of dividends or interest payments directly to token holders' wallets, managing voting rights for equity tokens, and executing stock splits. This reduces operational overhead, minimizes errors, and ensures timely, transparent execution of shareholder rights.

Unlike traditional securities markets with set trading hours, securities tokens can be traded on Alternative Trading Systems (ATS) or other regulated platforms that operate nearly continuously. This provides greater flexibility for investors. However, trading is not permissionless; it occurs on licensed venues that enforce the token's embedded compliance rules to maintain regulatory status.

All transactions and ownership records are written to a public or permissioned blockchain, creating a single, auditable source of truth. This transparency reduces reconciliation costs, prevents fraudulent duplication of shares, and provides regulators with real-time visibility into market activity. The immutable ledger ensures a permanent, tamper-proof history of ownership.

Unlike utility tokens, a securities token's value is explicitly derived from an external, tradable asset. This underlying asset could be equity (company shares), debt (a bond), real estate (a property share), or a revenue share agreement. The token is a digital representation of these traditional financial rights and obligations, linking its price directly to the performance of the real-world asset.

A securities token is a digital representation of a traditional financial asset, such as equity, debt, or a fund interest, whose value is derived from an external, tradable asset. Unlike utility tokens, they are subject to securities regulations (e.g., SEC's Howey Test in the US). Key characteristics include:

• Enforceable rights: Confer ownership, profit share (dividends), or voting power.
• Regulatory compliance: Issuance and trading must adhere to jurisdiction-specific rules like Regulation D, A+, or S.
• Programmability: Rights and compliance logic can be embedded directly into the token's smart contract.

Tokenizing securities introduces significant efficiencies over traditional systems.

• Fractional Ownership: Enables division of high-value assets (e.g., real estate, fine art) into smaller, affordable units, increasing liquidity.
• 24/7 Market Access & Settlement: Trading can occur on digital asset exchanges with atomic settlement, reducing counterparty risk and clearing times from days/T+2 to minutes.
• Automated Compliance: Smart contracts can enforce transfer restrictions (e.g., only to accredited investors), manage cap tables, and automate dividend distributions, reducing administrative overhead.

Interoperability and regulatory clarity are driven by specific token standards.

• ERC-3643: An open-source standard for permissioned tokens, featuring on-chain identity verification and rule enforcement, designed explicitly for compliant securities.
• ERC-1400/1404: Earlier standards for security tokens that provide similar partition and restriction capabilities.
• Polymesh (POLYX): A purpose-built blockchain for regulated assets, with identity, compliance, and governance baked into the protocol layer. These standards ensure tokens can interact with compliant wallets, exchanges, and custody solutions.

A Security Token Offering (STO) is the compliant fundraising event. Platforms facilitate issuance:

• Securitize: Provides a full-stack platform for tokenizing assets, managing cap tables, and enabling secondary trading on its ATS.
• Tokeny: Offers tokenization and lifecycle management solutions, often using the ERC-3643 standard.
• Harbor (R-Token): Pioneered a compliance protocol for tokenizing private securities. These platforms handle KYC/AML, investor accreditation, and ensure the token contract encodes necessary restrictions.

Secondary trading occurs on specialized, regulated venues, not typical crypto exchanges.

• Alternative Trading Systems (ATS): SEC-regulated platforms like tZERO and OpenFinance Network facilitate trading of security tokens.
• Broker-Dealer Networks: Traditional financial institutions with digital asset divisions create liquidity pools.
• Liquidity Challenges: The market remains fragmented due to jurisdictional barriers and the need for integration with legacy settlement systems. True global, 24/7 liquidity is a primary goal but not yet fully realized.

Securities tokens are being applied across diverse asset types.

• Real Estate: Buildings tokenized for fractional ownership (e.g., St. Regis Aspen Resort tokenized on tZERO).
• Venture Capital & Private Equity: Funds tokenize shares to provide liquidity to early investors (e.g., SPiCE VC).
• Debt Instruments: Tokenized bonds and structured products.
• Fund Shares: Traditional investment funds issuing tokens as representative shares. This demonstrates the technology's applicability beyond startup equity.

In the United States, the Howey Test is the primary legal framework for determining if an asset is a security. A securities token is classified as such if it involves: 1) An investment of money, 2) In a common enterprise, 3) With an expectation of profit, 4) Derived from the efforts of others. This classification subjects the token to SEC regulations, including registration requirements or exemptions like Regulation D or Regulation A+.

Issuers must implement on-chain compliance mechanisms to enforce regulatory rules. This includes:

• KYC/AML Verification: Identity checks for token purchasers.
• Accredited Investor Checks: For private offerings under Regulation D.
• Transfer Restrictions: Programmable logic that prevents tokens from being sent to non-verified wallets or exceeding shareholder limits, ensuring compliance with securities laws throughout the asset's lifecycle.

Securities tokens are typically issued using specific token standards that embed compliance logic. The most common is the ERC-1400 standard on Ethereum, which provides a framework for security token offerings (STOs). It supports:

• Document Management: Attaching legal prospectuses.
• Permissioned Transfers: Enforcing transfer rules.
• Partial Fungibility: Representing different share classes. Other chains have similar standards, but interoperability between different regulatory jurisdictions remains a technical challenge.

Regulation varies significantly by jurisdiction:

• European Union: Governed by MiCA (Markets in Crypto-Assets) regulation and existing financial instruments directives (MiFID II).
• Switzerland: Regulated under the Financial Market Infrastructure Act (FinIA), with a clear taxonomy for tokenized assets.
• Singapore: The Monetary Authority of Singapore (MAS) regulates securities tokens under the Securities and Futures Act. This fragmentation creates complexity for cross-border issuance and compliance.

Holding securities tokens requires qualified custodians that meet regulatory standards for safeguarding client assets, as defined under rules like the SEC's Customer Protection Rule (15c3-3). This involves:

• Cold Storage: Secure offline storage of private keys.
• Insurance: Coverage against theft or loss.
• Corporate Actions: Automated handling of dividends, stock splits, and voting rights directly on the blockchain, which is a key technical advantage over traditional systems.

A Security Token Offering (STO) is a regulated fundraising method where issuers sell digital tokens that represent ownership in a real-world asset, such as equity, debt, or real estate. Unlike ICOs, STOs are designed to comply with securities regulations (e.g., SEC Regulation D, Regulation A+, or Regulation S).

• Key Feature: Provides investor protections like disclosure requirements and accredited investor rules.
• Example: A real estate fund tokenizing ownership of a commercial property and offering shares to accredited investors via an STO.

A Utility Token is a digital asset that provides access to a specific product or service within a decentralized network or platform. Its primary purpose is functional, not investment. The key legal distinction from a securities token is that utility tokens are not designed as an investment contract.

• Purpose: Grants rights like network access, voting, or payment for services.
• Regulatory Test: Evaluated under frameworks like the Howey Test; must not promise profits solely from the efforts of others.
• Example: Filecoin (FIL) tokens used to pay for decentralized storage.

The Howey Test is a legal standard derived from a 1946 U.S. Supreme Court case used to determine whether a transaction qualifies as an investment contract and is therefore a security. A transaction is a security if it involves:

1. An investment of money.
2. In a common enterprise.
3. With an expectation of profits.
4. Derived solely from the efforts of a promoter or third party.

This test is the primary tool regulators like the SEC use to assess if a digital asset, including a token, is a security.

ERC-1400 and ERC-3643 are Ethereum token standards specifically designed for security tokens. They embed regulatory compliance directly into the token's smart contract logic.

• ERC-1400: A standard for security tokens that includes features for document management, forced transfers, and granular control over token transfers based on investor status and jurisdiction.
• ERC-3643: An open-source standard that provides a framework for self-sovereign identity and on-chain compliance, allowing for permissioned transfers based on verified credentials.

These standards enable programmable compliance, automating restrictions like investor accreditation and transfer locks.

An Alternative Trading System (ATS) is a regulated trading venue, often operated by a broker-dealer, that provides a marketplace for matching buyers and sellers of securities. In the context of securities tokens, an ATS is a crucial infrastructure for providing secondary market liquidity in a compliant manner.

• Regulation: Regulated by the SEC and FINRA under Regulation ATS.
• Function: Allows for the trading of digital securities (security tokens) after their initial issuance (e.g., post-STO).
• Example: Platforms like tZERO or INX operate as registered ATSs for security tokens.

Fractional Ownership refers to dividing an asset into smaller, tradable shares, allowing multiple investors to own a portion of a high-value asset. Securities tokens are the primary technological enabler of this concept for illiquid assets like real estate, fine art, or private equity.

• Mechanism: A single asset is tokenized, and ownership rights are represented by multiple security tokens.
• Benefits: Dramatically increases accessibility and liquidity for assets traditionally available only to large institutions or wealthy individuals.
• Example: Tokenizing a $10 million commercial building into 100,000 tokens, each representing a 0.001% ownership stake.