Why Security Tokens Could Help Redefine What it Means to be an Accredited Investor.

The cryptocurrency revolution has long been synonymous with the idea of financial freedom and the ability of people to take control of how they store,  spend and invest their money. This libertarian ideal has mostly been realized through Bitcoin and the slew of Altcoins that have entered the market in the past few years. However, with the introduction of security tokens, we are on the cusp of creating new opportunities for financial inclusion that have never been experienced before.

Imagine for a moment that a construction worker who earns less than $20k a year is able to gain access to the same investment deals that fly across the desk of Jamie Dimon or Warren Buffet on a daily basis. Imagine a Banksy painting that cleverly depicts the age-old theme of class struggles, yet is ironically worth over $1million. What if this painting could be tokenized so that anyone with $50 in their pocket could own a piece of it? Security tokens are bringing us closer than ever to this reality.

What is a security token?

A Security Token is essentially an investment contract that represents legal ownership (as recognized by the SEC) of a physical or digital asset (like real estate, artwork or ETFs) that has been verified on the blockchain.

Investors can exchange fiat money or cryptocurrencies for security tokens via a smart contract. With this verifiable and legal ownership, security token holders can easily trade their tokens for other assets, use them as collateral for a loan, or even fractionalize them to store in different digital wallets.  

The true value of security tokens is their ability to completely change how we define asset ownership, making assets that have traditionally only been available to wealthy people in developed nations more accessible to regular people all over the world to own (even if only in portions) and collect dividends from.  

When we think about all the physical and digital assets of the world that hold value (company equity, rewards, art, gold, personal brands, etc), and recognize that these assets can be tokenized and sold as securities on the blockchain, the possibilities for security tokens are endless.

Despite the optimism around this innovation, there are concerns that the traditional financial system is threatening to handicap this technology so that it becomes nothing more than another tool to help the rich grow richer.

How will the security token revolution be handicapped? Simply through the stale and restrictive laws of investor accreditation.

As an investor, to be ‘accredited’ is to have special status under financial regulation laws. This special status grants you access to complex and higher-risk investments such as venture capital, hedge funds, and angel investments.

In the United States, accredited investor rules dictate that you must have a net worth of at least $1,000,000, or earn an income of at least $200,000 each year for the last two years. The assumption with this status is that only people with large amounts of money should be afforded the privilege of investing in risky companies where their entire investment could drop to zero. Although the goal is supposed to be to protect regular investors, this is actually the opposite case.

Founder Vitalik Buterin, a prominent member in the crypto space, has shared his concerns about this issue:

“I personally am willing to publicly say that I find current accredited investor rules of many countries, which allow only millionaires to invest in securities, very unfair and plutocratic, and in some cases they can make things actually worse because they mean regular people can only buy in at higher prices and thus more easily become victims.”

Many who understand that the only way to make ‘real’ money as an investor is the get in early have expressed this sentiment.

Accredited Investors have the privilege of investing in stocks or tokens at a 50% discount, and can simply choose to sell their stake once the stocks or tokens go public and everyone else starts buying in. This creates a cycle whereby accredited investors don’t even have to recognize any long-term value in a company in order to profit. They simply have to get in early and rely on non-accredited investors to jump in later so they can profit off of them.  

In the end, the regular investors whom the laws are supposed to protect end up getting hurt because, by the time they have bought in, the price can only go down, as accredited investors begin to sell their stake.

Unfortunately, with the SEC overseeing the process of approval for security tokens, it seems like we are likely to create a whole new asset class that will once again be kept away from the people who could benefit from it the most.

The democratization of information has allowed everyday investors to become more educated about markets than ever.

What’s most concerning about the accredited investor restrictions is the fact that they do not reflect an understanding of the ways in which today’s investors actually become sophisticated. The law chooses to work backward; looking at a person’s wealth as a determining factor of their sophistication, rather than the history of smart investments they made that allowed them to generate that wealth.

Investor accreditation should be based on competence and experience, not simply one’s bank account balance.

Today, information about how to make smart investments and trade all kinds of assets is more freely available than in any other time in the history of financial markets. From daily shows on CNBC to blogs, Twitter feeds and Youtube videos; a regular person with time and dedication can become just as sophisticated an investor as any well paid Wall Street financial advisor.  

In the crypto space, the education is even more democratized. With millennials representing a significant demographic of crypto investors, we’re seeing young and tech-savvy traders freely sharing ideas on Twitter, Youtube or Telegram. Thousands of people from online communities help each other identify the best opportunities in the market, while also absorbing information about how to become a smarter, more sophisticated investor.

Solution: a new rubric to determine accreditation: Investment record & Market competence

One possible use case for the blockchain is as a tracking tool to measure the sophistication of investors based on their gains from tokens held over a period of 1 year, starting from 2018. Why 2018? Well, this year represents a critical time for cryptocurrencies. We have hundreds of tokens that can be bought for cheap, yet only a handful will likely accrue real value in the next 5-10 years. Any investor who can make a strong case for why they acquired certain tokens, and is proven to be correct in their assumptions deserves to be considered an accredited investor.

Evaluating token performance is more difficult because many tokens will take several years before they achieve a real market valuation. However, the ability to demonstrate a deep understanding of the markets while justifying certain token picks in one’s portfolio should be a quick and seamless way to evaluate accreditation.

Just as how legally driving a car or becoming a financial adviser requires passing a test of competence to attain a license, being able to make high-risk investments in registered securities should also be based on competence.

Conclusion

The excitement of Security tokens is due to the promise of a gateway to limitless investment opportunities for everyone in the world regardless of income level or connections. By requiring security token investors to be accredited (based on the current criteria for accreditation), regulators threaten to derail this promise and further increase the rate of wealth inequality. The basic measure of a sophisticated investor is not how much money they currently have, but their ability to justify their investments while displaying a basic understanding of the markets for whatever asset class they are participating in. Only through this method can regulators protect retail investors, while granting them the freedom to participate in deals that have the potential to rapidly move them up the social economic ladder, ultimately decreasing the rate of wealth inequality in the US and around the world.

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