Security tokens are blockchain-based digital assets that represent ownership of company shares or other assets — often those not available through traditional financial avenues.
In the private sector, for example, some startups are using security tokens as a fundraising mechanism through Initial Coin Offerings (ICOs). Because the blockchain is decentralized — meaning transactions don’t require middlemen — it can streamline processes, reduce costs, and increase liquidity.
However, it can also raise confusion among investors, particularly when it comes to regulatory matters and other technicalities.
This breakdown of SEC rules for private companies outlines how exemptions and securities classifications are handled — an essential read for understanding how tokens may be treated under U.S. law.
So are security tokens considered equity securities under U.S. law? Let’s break it down.
Securities are tradable financial instruments in public and private markets — stocks, bonds, investment contracts, and so on. The three main types are equity, debt, and hybrids.
Security tokens are like digital property deeds for securities, stored cryptographically on a blockchain. Just as a deed proves you own a piece of land, a security token proves you own a share of an asset, company, or project. But instead of sitting in a filing cabinet, it lives on a secure, transparent, and programmable digital ledger.
Security tokens differ from utility tokens, which allow holders to use a specific product or service on a blockchain. Think of a utility token as a concert ticket, and a security token as a VIP’s backstage pass. A regular ticket just gets you into the show, as a utility token would give you access to a product. A security token ticket not only gets you in — it also gives you a share of the concert’s profits. And it’s recorded on a blockchain, so ownership and resale are transparent and verifiable.
But not all security tokens are created equal. Some represent equity, while others do not.
Traditional equity securities are assets representing ownership stake in a public or private company. Tokenized equity represents the same kind of asset, except it’s stored on a blockchain. They grant certain rights to their owners, such as voting or dividend payments.
Tokenized securities are still securities, according to Hester M. Peirce, a Commissioner of the U.S. Securities and Exchange Commission (SEC). Security token issuers must therefore adhere to SEC registration rules, unless they qualify for an exemption. This includes providing investors with detailed financial information and risk factors.
Reg D is one of the most common exemptions used today — and this guide breaks down who qualifies and how it opens access to private investments.
The SEC uses the Howey Test — a legal standard established by the 1946 U.S. Supreme Court case SEC v. W.J. Howey Co. — to decide whether digital assets are security tokens. The four-part test determines which assets qualify as “investment contracts”:
The SEC has forced compliance on crypto companies in the past. Consider this 2018 example. The regulatory body brought enforcement actions against two companies it accused of engaging in unregistered, non-exempt ICOs. After applying the Howey Test, the SEC determined that the ICOs were offering investment contracts. The companies agreed to pay back investors the difference between the price they paid for the tokens and their current value, and subsequently registered their outstanding tokens as a class of “equity security,” rendering them a public entity required to submit periodic reports to the SEC.
That said, according to an analysis by Winston & Strawn LLP, the SEC’s statement left unclear whether security tokens without equity-like features could still trigger equity security classification.
Alternative assets have become a go-to option for investors looking to diversify their portfolios beyond the average stock or bond, per Moody’s. And unlike high-priced pieces of art, natural resources, or real estate, tokenization has helped even the playing field for potential investors hoping to participate.
But security tokens face regulatory and technological hurdles investors must consider. In addition to the SEC rules, opaque pricing is another potential issue. Security tokens and other private assets are not listed on heavily regulated exchanges like the Nasdaq or NYSE, making it more difficult for secondary market investors to analyze whether a security token is fairly valued.
On the bright side, platforms like Augment* are making price discovery for private assets easier than ever, by seamlessly connecting buyers and sellers of shares in pre-IPO companies.
Whether a security token qualifies as an equity security depends on its structure and rights. Investors should thoroughly review token documentation and the company’s regulatory filings before making any transactions. Security tokens may revolutionize equity, but one traditional investing rule still rings true: due diligence remains essential.
This deeper dive into tokenization in secondary markets explores what’s real, what’s regulatory gray area — and what investors should watch.
*Securities transactions are executed on Augment Capital, LLC's ATS and offered through Augment Capital, LLC (member FINRA/SIPC).
Important Disclosures: Investing in private securities involves substantial risk, including the potential loss of principal. Private securities are typically illiquid, have limited pricing transparency, and often require longer holding periods. These investments are available exclusively to qualified accredited investors and offer no guarantee of returns. Additionally, past performance of private securities does not indicate or predict future results.
U.S. regulators typically apply the Howey test, evaluating whether the token represents an investment of money in a common enterprise with an expectation of profit from others' efforts.
Yes. Regulators have taken the position that a token's classification can shift over time based on how it's marketed and used, even if it wasn't originally sold as a security.
Not automatically. Protections depend on how the token is structured and registered, so investors shouldn't assume equivalent legal protections without confirming the specific offering's structure.
Checking whether the offering was conducted under a registration or specific exemption, like Reg D or Reg A, with the SEC, and reviewing the offering documents, is the most reliable way to confirm.
Generally no. If the token represents equity, the underlying tax treatment of gains typically follows normal capital gains rules, though investors should confirm with a tax professional given the space's evolving guidance.
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