What is an STO (Security Token Offering) &
10 Reasons Why It Will Have a Massive Impact
The world of startup financing took a major turn in 2017 as initial coin offerings (ICOs) burst onto the scene. In 2017 and 2018, more than $14 billion flowed into
blockchain projects as investors looked to capitalize on crypto euphoria and the low barriers to entry made possible by the ICO funding model.
It has been less than a year since the market for ICOs went bust, but the impact of the new crowdfunding model will endure for many years to come as startups
look to tokenize real assets and leverage the power of the crowd to finance their next major project. But in order to do so, these companies must follow standard
securitization practices laid out by the U.S. Securities and Exchange Commission (SEC), which has deemed all crypto assets, except bitcoin and Ethereum, to be
securities. At least, this is the case for projects seeking exposure to U.S. markets.
The SEC’s position on ICOs doesn’t differentiate between so-called utility tokens and security tokens. For all intents and purposes, new token offerings must comply
with federal securities laws. Naturally, this has given rise to a new paradigm: the security token offering (STO).
What is the difference
between an ICO and an STO?
While the SEC at times has been ambiguous about how it plans to regulate
ICOs, securities that fall under its purview are governed by well-defined laws.
This same principle extends to tokens that the SEC deems to be securities.
These are the so-called “security tokens” that everyone has been talking about.
A “security token” actually isn’t a universal definition, but a standard classification
used by U.S. regulators when dealing with token projects that have the
characteristics of a security.
A security token is any cryptocurrency that pays dividends, profits, shares or
interest or invests in any other asset that also generates profits. Although some
ICOs have attempted to circumnavigate this definition, the SEC uses the
so-called Howey Test to determine if an asset meets the definition of a security.
According to the Howey Test, a cryptocurrency token is a security if it invests
in money, invests in a common enterprise or expects to make a profit from
the effort of others.
STO VS ICO: THE MAIN DIFFERENCES
Unlike an ICO, a security token is essentially an investment contract into an underlying asset; it has all the attributes of a security in that it is a fungible, negotiable
financial instrument that represents actual monetary value. STOs are backed by real assets and follow the SEC’s guidance on compliance, issuance, and trading.
An ICO, on the other hand, technically has no collateral. Issuers tried to circumvent regulatory requirements by claiming their tokens were a utility as opposed to
a security (as we mentioned earlier, the SEC doesn’t buy that argument). An STO is neither an ICO nor an initial public offering a la stocks; rather, it overlaps both
During the evolution of the ICO market, the blockchain industry developed the Simple Agreement for Future Token (SAFT) framework, which ensured that
“security tokens” were only sold to accredited investors. SAFT was designed to simplify investor verification and accreditation. However, the model was
short-lived as the tokenization landscape continued to evolve. When the market went bust, SAFT wasn’t really needed anymore.
UNDERSTANDING THE STO ECOSYSTEM
When a company wants to issue a security token giving investors a stake in its enterprise,
it must seek out the support of the following players:
- # Legal
To ensure that the STO is compliant, a company needs to work within the
country’s existing regulatory frameworks. Failure to do so could lead
regulators to shut down non-compliant projects as the SEC did to
illegal ICOs in 2018.
- # Issuance platform
To issue the security token and attract a range of potential investors, a
company may choose to seek out the support of an issuance platform
designed for STOs. Some of the leading STO issuance platforms include
Polymath, Swarm, Securitize, Harbor, and Securrency.
- # Custodian
The need for custody is becoming more apparent in the age of STOs. Issuing
companies must, therefore, seek out the support of a custodian for storing
their digital tokens. Custody services are usually offered by issuance
platforms as well as STO exchanges.
- # Exchanges
Companies that issue an STO can only list their token on regulated
exchanges. This is one of the fastest growing segments of the market,
with the likes of tZero, Blocktrade, currency.com, Lykke, Open Finance
and several others already supporting security token listings.
STOS : THE ADVANTAGE
From the perspective of investors, an STO has several advantages
over the preceding ICO funding model. Firstly, STOs are lower-risk
investments because they are enforced by federal regulation. In
the United States, this means they have to meet SEC requirements
around transparency. At the same time, the STO still retains many
of the benefits of an ICO, including lower costs and ease of access.
And because they are regulated, STOs could potentially open the
door to institutional investors who otherwise wouldn’t have invested
in the previous iteration of the token sale.
A regulatory framework also means that investors can worry less
about scams and fraudulent projects that inflicted damage on
the ICO market. At one point, it was estimated that 4/5 ICOs
conducted in 2017 were in fact scams.
When collateralized assets are tokenized, they allow for fractional
ownership of real assets, which gives investors more options to
diversify their portfolios – again, at a lower cost. This means
STOs will continue to offer opportunities to smaller investors who
were originally drawn to the ICO model.
STOS : THE DISADVANTAGES
Although regulation is considered advantageous from the perspective
of investors, compliance is relatively complex for token issuers. That
largely explains why the STO market has been much slower to launch
than its predecessor. In fact, during the ICO boom, many blockchain
companies refused to sell their tokens in the United States due to
complex regulations and the need to identify as a security token.
The hold up is also due to a lack of appropriate exchanges to
facilitate security token offerings. Overstock’s tZERO, arguably the
most closely-watched token platform, officially launched in January
to accredited investors but this doesn’t seem to have created a strong
STO pipeline just yet.
10 REASONS WHY STOS COULD CHANGE THE CRYPTO MARKETS
Taking into account the market’s appetite for high-quality, compliant cryptocurrencies, there’s a strong reason to believe that the STO model will have a lasting impact on the
blockchain ecosystem. Below are ten reasons why STOs may in fact change the dynamics of the crypto industry as a whole.
STOs that follow federal guidelines and are approved by
the SEC should gain instant credibility, taking much of
the grunt work out of evaluating projects. This means
investors can spend less time researching project
members’ LinkedIn profiles to prove they are legit and
spend more time evaluating the merits of the actual
- BREAKING THE CRYPTO STIGMA02
Increased regulation and credibility will put an end to much of
the stigma surrounding cryptocurrencies among traditional
investors. This could enrich the ecosystem with new capital and
market players. Investors who are banking on greater institutional
adoption should look beyond just bitcoin futures and custody
services and toward STOs.
One of the most attractive features of ICOs was the low barrier
to entry relative to other capital markets. STOs could take
micro-investing mainstream and allow more people to participate
in startup ventures that were previously restricted to accredited
investors and venture capitalists.
- TRADED AS SECURITIES04
Platforms like tZero are working to ensure that STOs
have a regulated venue for trading. This means
cryptocurrencies will be traded as securities, giving
investors ownership, voting and asset allocation rights.
This may open the door to STOs one day being included
in tax-free savings and retirement accounts.
- ACTUAL OWNERSHIP OF UNDERLYING ASSETS05
Whereas so-called “utility tokens” were meant to give investors
future access to a product or service, a security token represents
actual ownership of an underlying asset. If you invest in a real
estate STO, your holdings represent actual shares in physical
property rather than an IOU for a future date.
- PROGRAMMABLE OWNERSHIP AND COMPLIANCE06
Security tokens are programmable by nature, which
means compliance protocols can be embedded into
the actual asset and amended over time. This also means
there’s no limit to the types of rules and systems that a
security token can bring to the table. The ICO model
didn’t have this level of sophistication.
- HIGH SUCCESS RATE07
Whereas most ICOs have either gone bust or are in the process
of going out of business, the early track record for STOs has been
overwhelmingly positive. According to one estimate, STOs currently
have a success rate of 99%. Whereas ICOs merely sold their whitepaper,
STOs are more likely to have something real to offer. Most ICOs
merely sold a pipe dream.
- LOW FEES ARE HERE TO STAY08
Blockchain technology has reduced the need for an
expensive middleman and has passed on those savings
to investors. The emergence of low-fee investing will only
strengthen under the STO model given its programmable
compliance and ownership features.
- DECENTRALIZED ASSETS REMAIN DECENTRALIZED09
As the SEC has already noted, regulation impacting security
token offerings have no bearing on assets that are “sufficiently
decentralized,” such as bitcoin and Ethereum. Decentralized
money is here to stay, except now the stigma associated with
cryptocurrency and digital assets go away.
- INCREASED INNOVATION10
A regulated ecosystem for tokenization will likely open the door to
greater adoption and, ultimately, new innovations in the blockchain
arena. A more innovative environment means more investment
opportunities and wealth creation. This trend is already well underway
as startups and institutions continue to utilize decentralized ledgers.
THE BOTTOM LINE
The ICO boom may be long gone, but the age of tokenization has only just
begun. According to digital asset banker Finoa, tokenization has the potential
to do to ownership rights what digitization did to media. This new paradigm will
impact everything from standard issuing products like stocks and bonds to
smaller and more illiquid assets like business shares and real estate.
For these reasons, there’s a lot to be bullish about when it comes to security token
offerings. A current reading of the market suggests demand and adoption will be
slower to materialize given that regulatory standards have only just been applied
and implemented. But the launch of tZero and the growing appetite for
blockchain-based projects means STOs are a potentially future-proof asset class.
※ Source : ccn.com