An Introduction to Security Tokens

For an example of how these work, we will use SiaCoin – we’ll just pretend that SiaCoin was offered via an ICO and not mined from its inception. SiaCoin provides a platform for the buying and selling of data storage. Sellers offer up storage space in a contract on the platform and buyers accept that contract for a price, paid for in SiaCoin. This reinforces SiaCoin’s classification as a Utility Token. SiaCoin does not entitle holders of the token to any profits made on the platform, does not denote any ownership interest in the Sia project, nor does it give the holders any voting rights for decisions made in regards to the platform or the Sia Project as a whole. The tokens value is derived from within the platform itself. The specific use of the token on the platform – solely being a medium of exchange for data storage within the bounds of the Sia platform – is vital for its classification as a Utility token. Despite being classified as a Utility Token, projects such as SiaCoin are still susceptible to future SEC regulations as the space evolves.

Security tokens serve purposes such as the token representing shares of ownership in the project itself, a tool for profit/loss sharing, giving the holder status as a creditor/lender, giving the holder a claim in bankruptcy as an equity interest holder/creditor, or giving the holder the right to repayment of purchase price and/or payments of interest.

An example of a security token would be the SiaFund Token. 10,000 SiaFund tokens were issued as a means of funding the Sia project, and 1,159 were initially sold in an IPO in 2014. As of recently, Nebulous – the parent company funding most of the Sia Project – still holds 8,741 SiaFund tokens and recently hosted a Tokenized Security Offering (TSO) in compliance with SEC regulation to sell an additional 750 SiaFund Tokens.

Here are a couple of important details that help make the SiaFund Token a Security Token: SiaFund Tokens were offered to the public in exchange for money, holders of the SiaFund token are entitled to 3.9% of the fees from every transaction made on the Sia network, and funds from the sale of the SiaFund Tokens are being used to fund the Sia Project venture. It is important, therefore, that the Sia team took the time to register the sale of SiaFund Tokens with the SEC as a Tokenized Securities Offering (TSO) and only offered the sale to qualified investors.

So SiaFund Tokens are considered a Security Token, but why do these qualities make it a security and how do I know what other coins can be considered securities?

The most common way to determine if an offering is considered a security – therefore subject to SEC securities regulations – is theHowey Test. The Howey Test states that an offering is considered a security if:

In the case of the SiaFund Token, the purchasers of the token are investing money or digital assets for the token. Furthermore, the investment is in a common enterprise as the investments are pooled and each investors shares evenly in the profits of the project. Token holders reasonably expect profit from the investment – in this case from the fee distribution mechanism. The success of the project is heavily reliant on the efforts of a promoting third party (SiaCoin development team) who will strive to capture a share of the market.

This outlines the details surrounding what classifies a token as a security. Until recently, the SEC has been passive, content with letting the space foster innovation. Increased public interest over the past year has forced them to take a more active stance, publishing guidelines for what constitutes a security token and their thoughts on the overall ICO environment. For more information regarding the complications in classifying tokens as a security – and what this means for the token – read part two of this series here: Classifying Security Tokens and the Associated Implications.