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The Argument for Security Tokens (Part 3 of 3)


Over the course of three posts, this thought experiment will lay out the problems that exist and will exist as long as utility tokens are seen as vehicles of speculation, and assert the reasons why security tokens will be the new standard for how crypto companies capitalize themselves.

This thought experiment is broken down into three scenarios:

The first two scenarios lay out the problem that exists in crypto today given the lack of security tokens, and the potential problems that may arise down the line if crypto companies do not adopt security tokens as the standard to raise capital.

The thought experiment will be easier to follow by taking an illustrative company as an example. For the purposes of this thought experiment, let’s use a made-up blockchain company with the following criteria:

· Company name: HouseChain

· Product: Provides short-term rentals through a decentralized network

· Utility Token: HouseCoin

· Security Token: HouseST

Before getting into the nitty-gritty, feel free to reference my posts on utility tokens and security tokens, which may serve as quick refreshers on what these things are.

Let’s dive in.

Scenario 1 (Summary): Role of Utility Tokens in an Environment Where Security Tokens Do Not Exist and Blockchain Companies Have Yet to Develop Their Products

Currently, blockchain companies are distributing utility tokens in such a way that make their utility tokens not much more than a vehicle for speculation. For one, blockchain companies are first selling their tokens to early accredited investors who are buying and hodling them with the intent to resell them at a higher price. Furthermore, blockchain companies issue tokens to founders, developers, and to other members of their teams in order to compensate them for their time and efforts. Such a practice is akin to any company’s employee stock compensation program. Those awarded with tokens stand to gain if the price of the token appreciates just as those awarded with stock incentives stand to gain if the company’s stock price goes up. These individuals have the incentive to hold their tokens and resell them later to a third party for a gain.

The positive side of speculation is that it has given the crypto industry global recognition. The downside is that it has created a state of crazed hype that is analogous to the bubble or to the Tulip mania.

Read the full post here: The Argument for Security Tokens (Part 1 of 3)

Scenario 2 (Summary): Role of Utility Tokens in an Environment Where Security Tokens Do Not Exist and Blockchain Companies Have Developed Products

At the time when blockchain companies finally have developed products, a utility token has two potential uses:

· Means for speculation

· Means of trade for goods or services

Most type of utility token holders may be speculating on the token and not using it within the network. A lack of active users create “zombie networks”, which are networks that are up-and-running but do not have active users. Since active users are the source of value for any network, networks that lack active users lack intrinsic value.

Read the full post here: The Argument for Security Tokens (Part 2 of 3)

Scenario (3): Developed Product; Existence of Security Tokens

Security tokens are an obvious answer to the “zombie network” phenomena. In this article, security tokens are defined as tokens that have equity-like characteristics. For example, if HouseChain issues 100 HouseSTs, and a person owns 10 of those, then he or she owns 10% of HouseChain and has 10% of the shareholder votes.

By insisting HouseChain raises capital through a security token issuance, cryptoinvestors are separating raising capital and the speculation associated with it from the product HouseChain is selling.

On the capitalization side, a HouseChain issues a certain amount of HouseSTs that it then distributes to founders, developers, etc. and sells some to early accredited investors. After the lock-up period is over and HouseSTs are listed on an exchange, initial security token holders would be able to sell their HouseSTs. This provides a liquidity event for initial HouseST holders and expands the investor base. In this scenario, utility tokens are purchased directly from the company, and exchanges become market makers for HouseST.

Exhibit 3: Issuing Security Tokens Eliminates Unnecessary Speculation from Utility Tokens

On the utility token side, HouseChain interacts directly with its customers and decides whether to burn, hold, or re-sell utility tokens based on the demand/supply curve of its specific product. HouseCoins become what they were meant to be all along: a means to book short-term rentals in a decentralized marketplace. In this scenario, those in charge of HouseChain now have an incentive to create a valuable network, as a greater number of HouseChain constituents will benefit from a valuable network. Selling more HouseCoins for users to book short-term rentals will increase the number of users in the network, increasing the number of transactions in the network, which will increase total network value and drive stronger cashflow generation, which in turn will increase the value of the security token. Founders, developers, and other members of the HouseChain team would have been paid in HouseSTs so now their incentive is to increase the value of the network, and thus their personal wealth. This set-up forces founders to think of the long-term prospects of the HouseChain network instead of focusing on short-term price appreciation.

Because of the dynamics that play out when you separate speculation from utility tokens, I can see a world where issuing security tokens becomes the standard for raising capital, and utility tokens become nothing more than inventory that a company has either pre-sold or will continue to unload just like “traditional” companies have been doing.

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