What is a Security Token? What is Security Token Offering (STO)?
If you were aware of the crypto world then you have to know that in 2017 and 2018 ICO rise was unprecedented bringing enormous funding. But this ICO (Initial Coin Offering) rise was hit by series of scams and then people were shocked by the 2018 downtrend. So to make regulatory corrections, it was about time for the world of Blockchain to find some common ground.
So the top minds used this opportunity to learn more about distributed ledger technologies and went on ‘BUIDL’ instead of just ‘HODL’. So the year 2018 was an “incubation” year for ICO that led everyone to ‘what is an STO?’
Overview of Security Tokens
A security token is a regulated digital asset that lies at the common junction between traditional financial assets and digital currency. For example, consider if Bitcoin is “programmable money”, then a security token is “programmable ownership”. Any type of asset that can be owned like stocks, real estate, art, bonds, private equity, or even cars – whether physical or not, can also be tokenized.
One of the best features of a security token is its inherent value; the basic fact that it is asset-backed, thus offering investors legal rights to ownership.
Traditional securities acquired by investors are difficult to exchange into fiat without significant effort. Therefore, security tokens are looking to solve this issue by closing the gap between the crypto market and traditional financial markets to serve people’s best interests. They unlocked liquidity, by enabling easy asset trading while also protecting investors by Blockchain technology and the smart contract system.
Security tokens can achieve a phenomenal degree of liquidity because they self-execute. With smart contracts in place, the actions will be carried out automatically and independently. This feature alone offers investors with compatible, more freedom when trying to move and control assets.
Main characteristics of a Security Token are:
- Compliances
To continuously work by a strict set of rules and regulations is one of the most challenging features of trading securities. This is because regulation differs by investor type, asset type, and jurisdiction. The programmable nature of a security token makes it to ‘back compliance’ into the token. Two legally compliant protocols are Harbor and Polymath that work with trading platforms such as ‘tZERO’ to ease compliance and automate processes. - Market exposure
Asian investors who want to invest in US real estate or private startups are really difficult. By using security tokens, owners can have market deals worldwide with whomever they want within given regulatory limits. Security tokens provide international trade, democratizing, and relaxing the exchange of securities. - Fractional ownership
With high-priced assets like Artwork and real estate which are worth millions of dollars, most investors are deprived of the opportunity to invest because they cannot afford to. But, with security tokens, you can benefit from fractionalized ownership. Instead of spending a fortune on a whole property, they can be owned by just investing in fractions of that asset. - Low fees
The fees are very low because there are no middlemen when using security tokens for trading digital assets. By having smart contracts in place, the process, e.g. wiring funds, signing papers, and mailing checks become programmable with low costs involved and hassle-free.
Key takeaway: Utility tokens are tokens issued in an ICO (initial token offering) in exchange for money. Security tokens are tokens that share profits, pay dividends/interest with the purpose to generate profits for token holders, aka the investors.
What is Security Token Offerings (STO)?
Despite the big fall of the crypto market in 2018, security token offering (STO) came as a valuable, secured, and extremely powerful alternative to private equity fund and venture capital for many international startups.
STO provides new opportunities for investors to buy security tokens backed by real-life assets. Startups are easily benefitted by running an STO, where it will help access more trustworthy funding that guarantees future success.
Benefits of STO :
- International capitals:
All the companies, irrespective of size and shapes can market themselves easily to investors i.e, STO goes beyond borders. The security token offering is so flexible, it provides startups with a unique opportunity to access deeper funding pools, while also increase brand awareness.
- Regulations
The cryptocurrency tokens regulations should be improved, this is agreed by Global regulators such as SEC (US), BaFin (Germany), or FINMA (Switzerland). To maintain transparency, an STO demands KYC/AML verification to provide safety to both investors and the companies issuing an STO. - Fundings
STO provided better terms than virtual currencies. No need to give up company ownership by Startups, which means management teams will remain in control of their business decisions. Moreover, STOs don’t demand equity and also startup owners can have a higher ownership percentage of their business.
Layers Of STO
There are four layers of STOs which are:
- Blockchain Protocols
- Smart Contracts
- Issuance Platforms
- Exchanges
Blockchain Protocols
This protocol is the underlying technology on which a project is built. Although, Ethereum is the most popular protocol for thousands of developers and contracts, there are many more protocols that are leading in the market. One such example is the EOS which quite popular with gaming and gambling DApps.
Smart Contracts
The automated contracts are called Smart Contracts. Basically, they are self-executing with specific instructions that are written on their code. They get executed only when certain conditions are made.
Usually, when someone wants to accomplish a task on Ethereum, they initiate a smart contract with one or more people. These Smart contracts are a series of instructions that are written using the programming language, “solidity”. This works on the basis of IFTTT logic which is abbreviated as IF-THIS-THEN-THAT logic. Eventually, the first set of instructions is done then the next function is executed, later the next and this keeps repeating until the end of the contract is achieved.
Issuance Platform
Basically, the issuance platforms are responsible for having a compliant, regulated smart contract. Few of such platforms are:
Polymath
Polymath is a blockchain protocol that helps in issuing and distributing token-based securities. Basically it helps to streamline the process of launching financial products on blockchain to make sure the new security tokens are financially secure.
Harbor
An open-source platform that helps in seamless migration from traditional investment classes onto the blockchain is the Harbor. They allow a Reg D-compliant private sale that integrates KYC/AML, tax rules, reporting information, and accreditation status into each new token formulated through the system.
Securitize
Securitize is a regulatory compliant cloud service solution basically for the tokenization of securities. This platform provides various services like Establishing the legal and regulatory readiness of the issuers and their legal team, streamlining investor registration in compliance with KYC/AML accreditation, or other legal requirements, customizing smart contracts to match issuers’ unique requirements and security token data throughout the lifetime of the security.
Exchanges
Exchanges serve the most critical functions in the crypto ecosystem. They basically act as a portal between the Fiat world and the crypto world. The two types of exchanges are:
Fiat to Crypto
This exchange helps you buy cryptocurrencies in exchange for Fiat money. Coinbase will be the best example of one such exchange. It helps you buy BTC, BCH, LTC, and ETH in exchange for fiat.
Crypto to Crypto
This exchange helps you exchange cryptos like BTC, ETH, BCH for other cryptocurrencies. The best example for one such exchange is Binance Exchange.
STO use cases
It is expected STO’s will reach a $10 trillion market cap By 2020. Polymath, the market growth catalyst of STOs is a platform that will simplify the process of running a security token offering.
Polymath’s own standard ST-20 token will help bridge the gap between Blockchain and financial securities.
tZero, a global leader in the Blockchain innovation platform for capital markets, holds the distributed ledger technology to revolutionize conventional Wall Street operations. The project raised around $134 million amount in an STO and recently the distribution of its security tokens to investors was completed.
Various crypto exchanges have already been in the race to become regulated in order to be able to list STOs and security tokens. For example, Coinbase, the Gibraltar Stock Exchange, and Malta Stock Exchange are some of the few to be named.
Difference between STO and ICO?
STOs are backed by real assets and abide by regulatory governance. Whereas most ICOs, position their coins as a utility token which gives users access to the native platform or decentralized applications (DApps).
According to the purpose of the coin is for usage and not for investment. As a result, ICO platforms avoid certain legal frameworks and do not have to comply with the strict rules of regulatory bodies. This is why there were a lot of scams discovered in ICO.
STO is regulated strictly by the rules of the governance body, So it is a little difficult to launch. But they would provide safety and trust. Also, there would be typically trusted people to raise funds from verified investors who have themselves passed certain requirements.
Will STOs Replace ICOs?
Usually, it’s common rhetoric that STOs will replace ICOs. In fact, some have gone far to say that “ICOs are dead”.
During the panel, Salant said, “thinking the STO will revive the ICO market is a misunderstanding of the concept of what a security token is.”
Also, for NEO and its developers, STO isn’t a primary fundraising tool, rather it is a part of the ecosystem it’s trying to build. Myint continues saying it’s about providing a “quicker path to liquidity and allows you to fractionalize… and allow more people to own things that are typically illiquid.”
Eventually, using an STO as a funding mechanism then is not to utilize their full potential. Moreover, STOs are about creating ownership opportunities that are legally supported, regulated, and previously very difficult to offer.
Difference between STO and IPO?
STO’s and IPOs both are regulated. IPO’s are used only in private companies that want to go public. They raise funds by offering shares to accredited investors through the IPO process.
Whereas, STOs tokens represent a share of a real asset which are issued on the blockchain to accredited investors. These can be shares of a company or a share in the ownership of a property, fine art, investment funds. This is because of tokenization, which can be really of any asset that is expected to turn a profit.
STOs are a low cost than IPOs. For IPOs, the companies need to pay high brokerage and investment banking fees to get entry to a deeper investor base.
STOs also need to pay lawyers and advisors, but they offer more direct access to the investment market and hence won’t be required to pay large fees to investment banks or brokerages. The post-offering administration for STOs is also efficient and cheaper than with traditional IPOs.
STO’s Future
The question ‘What is an STO’ will disappear by the next few months. Instead ‘How do I do an STO?’ will be asked by the end of 2019. It is estimated that the things will flow at a more relaxed pace with STOs this year compared to what had happened with initial coin offerings throughout 2017. Even if the IPO route has proven troublesome, the startups need to raise money.
Virtual currency funding is no longer a viable option as it takes a lot of time and also not to forget that startups end up losing too much control over their companies.
STOs came into the market after the ICO bloodbath of 2017. Equipped with better rules that fully abide by securities regulations, security tokens are backed by real assets.
By having Blockchain, all real assets can be tokenized even if they are stocks, real estate, or art. By the end of this year, we could hear more startups with Silicon Valley material to accept STOs. Why? Because it will be a good opportunity for them to raise money, expand their business, keep ownership, and at the same time make investors happy. This will bring a lot of benefits to everyone involved.
Final Thoughts
Preferably, STOs may become the most liked crowdfunding in the near future. It is because they are more regulated and secure than ICOs and much cheaper than IPOs. STOs also has the potential to open-up asset-ownership for a variety of people.
