Blockchain is one of the fastest-growing digital technologies in recent history, and its revolutionary decentralized model is being appropriated by industries far and wide. Part of its popularity is derived from cryptocurrency, which is now a decade old—calculating by 2009, the launch year of Bitcoin, the first established cryptocurrency.

When Bitcoin was born, cryptocurrency was just that: a currency. However, the term "cryptocurrency" is now somewhat dated. The rise of initial coin offerings (ICOs) means that thousands of different cryptocurrencies are out there, with ICO-generated coins commonly referred to as ‘tokens.'

2021 will likely signal the rise of one special kind of token, called a security token, which provides one of the most encouraging cases for blockchain technology yet.

key takeaways

  • One special kind of cryptocurrency, the security token, is on the rise.
  • Security tokens are essentially digital, liquid contracts for fractions of any asset that already has value, like real estate, a car, or corporate stock.
  • Using security tokens means investors can expect that their ownership stake is preserved on the blockchain ledger.
  • With their ability to demonstrate value, security tokens could roil traditional financial markets in favor of the newer, more hybrid blockchain models.

Moving in a New Direction

Once used to describe fiat money alternatives in general, and Bitcoin in particular, cryptocurrency is now a catch-all phrase covering literally any payment transferrable via blockchain.

Utility is where the market headed after Bitcoin became old news. The aptly named "utility tokens" are the result of an ICO whereby users of a blockchain platform pay with the tokens sold during the ICO or earn for providing some other relevant input.

Golem is a pertinent example, allowing users to lend their own PC’s power to the network which collectively employs it to run a remote supercomputer. Users earn golem network tokens, or GNTs, for connecting to the network, but they can also buy them via an exchange. Basic Attention Token is similar, with users rewarded in BAT for using the BRAVE browser and viewing ads.

However, these tokens amount to little more than the loyalty rewards points given by credit cards, in some cases, and barely need to be denominated in token form for the platform in question to work. Attaching value to them is an exercise in ambiguity as the market pretends that the underlying business’s value proposition and market (potential or real) make its tokens more valuable.

This often isn’t the case. Projects like the ones mentioned above are gaining new partners and users constantly, yet their tokens still move in relation to Bitcoin and the market. Participants with utility tokens are therefore purchasers of a service, and not investors in it. The result of their contribution to an unregulated crowdsale is simply the ability to use the service itself, and nothing more.

Once used to describe fiat money alternatives in general, and Bitcoin in particular, cryptocurrency is now a catch-all phrase covering literally any payment transferrable via blockchain.

A better balance is found in security tokens, which are essentially digital, liquid contracts for fractions of any asset that already has value, like a house, a car, a painting, or equity in a company.

Benefits of Security Tokens

Denominating fractional ownership of a real asset in security tokens is an idea that is naturally more structured and means investors can expect that their ownership stake is preserved on the blockchain ledger.

Security tokens are a natural bridge between the traditional finance sector and blockchain and benefit both equally. This is because the assets divvied up via tokens already exist in the traditional market—even the biggest markets like equities (either public or private equity) and real estate. Many blockchain projects now have platforms that directly undercut the old ICO model by tokenizing equity rights for pre-IPO companies.

A lack of regulation for utility tokens has meant that companies raising capital can circumvent institutional finance alongside the costs and accountability involved. However, given the perpetually volatile cryptocurrency market, and its precipitous 2018 slide followed by its bull rally through 2020, it has become riskier to launch an ICO and expect conditions stable enough to run a company.

Many projects have taken to cashing out immediately to remain solvent. This sinks the already weak argument that ICO participants are “investors” in young companies and opens the door to new ideas like The Elephant.

Enter The Elephant

The Elephant is the first secondary market for pre-IPO equity built on a blockchain. By tokenizing the rights to future shares in startups after their public offering, The Elephant’s marketplace brings an immense source of liquidity to the existing market for such assets, which is notoriously difficult to navigate.

With companies taking longer to go public than they used to, many can’t avail of their equity rights for as long as ten years. Blockchain infrastructure finally provides a market where these rights can be bought and sold transparently, to benefit the rights of holders and cryptocurrency enthusiasts alike.

The end game here is to merge the traditional financial market and the cryptocurrency market to better both. Other projects are working on similar ideas, such as Funderbeam, which has already helped over 100 pre-IPO startups (blockchain and otherwise) raise over $5.8 million.

Causam Exchange is using a parallel concept to sell its own stock via the blockchain, through what it calls BITE, or a Blockchain Instrument for Transferable Equity. Even Nasdaq is taken with the idea of incorporating blockchain into the listing of public companies, with its recently announced Linq platform able to issue private securities via the blockchain.

The Cryptocurrency Storms 

The enormous rise and subsequent crash of the cryptocurrency market at the beginning of 2018 and the recovery through 2020, were followed by the highs and lows of 2021’s stormy price action fueled in part by high-profile media coverage and viral retail interest.

However, what remains consistent is that in the aftermath of the storms, the projects that remain standing provide a sense of real value to investors. Digital assets in 2021 have emerged as having meaningful applications, rising above the crypto hyped by media, and having little value other than a long shot of going to the moon.

Increasingly, retail investors, institutional investors, and regulators are taking note of the potential that exists with companies that provide real value. Companies looking to raise capital will no longer try to skirt institutional models, but instead, will flock to ones that are already accommodating of the regulatory environment. Considering its real-use cases and ability to demonstrate value, the security token could have a lasting impact on financial markets.

Investing in cryptocurrencies, blockchain-based tokens, and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is for information purposes only and not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.