The term “security token” emerged as a result of rising regulatory concerns. Regulatory authorities, such as the U.S. Securities and Exchange Commission, sought to specify cryptocurrencies using terminology that didn’t wrestle with existing legal definitions.
Generally, a security is an instrument issued by a company, trust, government, or other legal entity that memorializes an ownership interest and provides evidence of a debt, a right to a share of earnings, a right in property distribution, or other similar legal rights. Types of securities include, among others, bonds, debentures, notes, options, shares, and warrants, and may be traded amongst investors or otherwise freely transferable. While not yet ubiquitous, security tokens are tokens that serve as direct, on-chain representations of real-world securities or tokens that are on-chain instruments serving a similar purpose for blockchain projects and/or digital assets.
Security tokens can represent property interests. For example, investors on the Meridio platform can seamlessly trade tokens representing real estate shares and pay in Dai, while Fluidity Factora allows people to invest in a Brooklyn, New York, property by paying with Dai.
In a case where a token represents ownership of an off-chain asset, such as real estate, equipment, payable invoices, or a business, similar to a share of stock, the security token’s value is directly tied to the asset’s valuation; the more valuable the asset, the more valuable the token.