Security token offerings (STO) were not too widespread until October 2018. That year, Indiegogo hosted a project by St. Regis Aspen Resort — its first security token. A new form of equity has been extremely successful — in fact, it has raised over $18 million making it the first global success of this new form of investment. STOs have since started to gain traction.
However, despite this fact, many businesses still have a scarce understanding of how security token offering is different from utility tokens. So what are the opportunities it offers companies and investors?
This post is a quick comprehensive guide to STO. We’ll cover the difference between all possible kinds of tokens and explain what makes it so beneficial for investors and companies alike.
What is a security token offering?
If you have ever launched or invested in ICOs, you’re roughly familiar with the process — exchanging crypto for tokens and buying your share out once the value of a token increases. ICOs have a low barrier of entry, which is why this form of investment is generating so much hype.
However, as time is showing, ICOs aren’t secure either. There have been a ton of pump-and-dump schemes — basically, after having paid for tokens, investors couldn’t cash out on them.
To protect the rights of their investments, companies started looking for new forms of crowdfunding. Instead of utility tokens, STOs offer more use cases — they can be cashed out as equity points, property trust funds, bonds, and stock. It’s worth noting, however, that unlike other forms of tokenization, STOs have a fairly high entrance barrier, and only accredited investors can get these tokens.
Differences between STO and ICO
While the term STO (security token offering) has been around for only 2-3 years, the idea of regulated tokens has been in the making for a while. Without having to change the structure and the process of the deal, companies wanted to ensure that transactions are regulated and secure.
After a while, however, it became apparent that STOs are different enough from initial coin offerings to get their own name instead of being known as ‘ICO 2.0’. What are the differences that make investors and businesses approach the two forms of tokenization as separate entities?
It can be looked at in the following way:
STO = ICO + Legal regulation
Keeping in mind all the security concerns of ICO, the market entrance of security tokens was highly anticipated. A strong desire of governments to finally regulate the token market in order to protect investors forced the Securities and Exchange Commission (SEC) to come up with a more reliable investment mechanism than ICO.
While the difference between ICO and STO seems to be relatively formal, there are several options to consider if you’re wondering which one to choose.
- STO provides startups with additional security — all tokens are registered and inspected by the SEC. That reduces the risk of an unreliable investment.
- STO is only accessible to accredited investors. Companies, in turn, can make sure the investor is reliable and assess their previous activities before letting an outsider jump into the company and sharing equity or trusts with them.
- STO is regulated while ICO isn’t. ICO is known to be the Wild West of investments — there are no guarantees for investors and a huge risk of becoming a pump-and-dump victim. With STO, every transaction is overseen by the SEC as well as the parties involved. This regulation can be both a blessing and a curse — while it provides both companies and investors with security, it slows transactions down as well.
- Investment transparency due to thorough regulation. Comparing ICO to STO, it’s clear that the latter provides businesses with more transparency. All business plans and strategies will be revised so that investors can have a better idea of the company they’ll be investing in.
- Smaller investor pool — that’s one of the STO’s fewer downsides for companies. The choice of STO investors is more complicated than that for ICOs. On the other hand, available funders will be more reliable and experienced, all of their actions will be meticulously monitored.
- High entrance barrier for STO investors. Most token investors enjoy a high level of liquidity and low-level control when it comes to tokens. Unlike ICOs, security token offerings don’t offer such an open market. While making contact with startups is certainly easier, STOs are not about to cut middlemen and supervision entirely. All the exchanges are controlled by FINRA and SEC-registered. Moreover, STO exchanges will take place on separate platforms – Alternative Trading Systems (ATSs).
It’s hard to determine which form of tokenization is better overall. Small startups and investors are more likely to go with ICO due to its open markets and fewer constraints. However, if your business generates over $10 million per year and aims to provide stakeholders with liquidity and issue transferable assets, STO is the way to go.
Here’s what STO brings to the table
With the decline of ICO-related activities, STO stands a chance of bringing confidence and reliability back to the tokenization market. There are certain advantages the system offers to business owners as well as investors.
- A possibility to combine the flexibility of crypto with the reliability of traditional finance. ICO was favored by companies and investors alike mainly because it was simple to issue and invest in. With STO, it’ll stay this way, adding only a need for obligatory registration for issuers. In November 2018, SEC issued a report where the illegal ICO activities were described and reported. With STOs in play, all the tokens are registered by the SEC, meaning they are legal and fraud-protected.
- Tokenization is cheaper and more flexible than IPO. Where starting an initial public offering (IPO) provides companies with more certainty, STO is superior in terms of flexibility. The latter is not tied to one country, has a lower barrier of entry, and offers more transparent access to investors. Moreover, due to fewer constraints and compliance norms, STOs are way cheaper to issue than stock market offerings.
- STO enables 24/7 trading that wouldn’t be possible in traditional markets. As traditional trade markets rely on human maintenance, they are normally open only during work hours (EST time zone). Blockchain and crypto markets, on the contrary, are open 24/7 — that results in better liquidity and increases the overall trading volume.
- Empowering fractional ownership. Most forms of investment (such as real estate) are non-liquid — they cannot be sold or exchanged easily. With STOs, an investor can purchase a fraction of an investment — this way, he’ll increase his portfolio without having to pay large amounts of money.
- Lower risk of scams and pump-and-dump. According to CoinDesk, in 2018, there’s been a huge money influx into ICO investments (the first three months of last year were enough to outperform 2017). However, due to hostility and the lack of regulations of the ICO markets, a fair share of these projects ended up being abandoned and investors never got a chance to cash tokens out. STO gives venture capital firms the option to capitalize on the simplicity and flexibility of tokenization because it would be a legal and secure investment.
- Regulated international market. Security token offering development allows investors and companies to create a global regulated investment market. With platforms like KYC Legal and ICO Pass, everyone can register a security token that’ll be 100%-legal. There are no nationality requirements to invest or issue tokens, which allows companies and investors to access global markets with no constraints.
Stats about security token offerings and examples of popular STOs
There’s enough evidence in today’s market to suggest that STOs will dominate 2019. Coupled with the overall interest in the crypto investment and the decline of trust to ICOs as its primary forms, it’s clear that STOs will be exactly what companies are looking for. Here are some statistics to prove the point:
- It has been estimated that the projected cost of all STOs will be equal to $10 trillion by 2020;
- According to ICORating.com, the growth rate of STOs in Q2 and Q3 of 2018 was 1.6%, while that of utility tokens has dropped by 10%.
- Companies can raise extensive funding to launch an STO — investment funds like the Singapore-based Golden Gate Ventures are willing to invest up to $10 million in early-stage crypto companies, security providers, and blockchain startups;
In order for investors to get a better grasp of the market, here’s a list of the most popular STO issuance platforms.
Polymath is positioned as the second Ethereum-based investor aimed at security token issuance. The tool has a proprietary ST-20 token standard, and there’s a system of smart contracts as well.
Similar to Ethereum, Polymath has a native token used for all Blockchain-based operations within the platform — POLY. Moreover, the platform provides companies with legal and security advice regarding tokenization.
Next on the list is Securitize — a platform that provides end-to-end support for companies seeking asset tokenization. Securitize analyzes the profiles of investors, from login to the source of capital in order to make sure the company has reliable shareholders.
Harbor is another platform for token issuance that, apart from launching an STO itself, the platform helps companies to make sure these tokens are compliant with security protocols.
To tokenize assets, Harbor uses a proprietary R-token which enables transfers once they are approved by the Regulator Service.
Steps to starting a successful STO
Once you’ve decided that STO is a fit for your company and has the possibility to engage with investors, the next question to ask is: how does one create, launch, and promote an STO?
Here’s a checklist of steps to get started.
Step 1. Gathering a team
In order to launch an STO, you’ll most likely need a founding team. You can either hire a small in-house department that would expand as soon as the token development becomes a steady commitment, or you can contact teams like Unicsoft, with established workflow and years of experience — a risk-free way to go about this.
In order to get started with STO development, you’ll need a business developer to work on a business plan for tokenization as well as someone responsible for legal and financial documentation.
Step 2. Prepare marketing materials for an STO.
Before bringing the idea to life, take some time to test it. A few things you need to verify include:
- Are investors interested in sharing assets in your business?
- Do they have an understanding of STOs?
- Are people willing to purchase an asset token in your company?
After a business owner sees some interest regarding the upcoming project, he has to keep feeding it. This includes creating eBooks, white papers, and blog posts explaining why you have decided on security token offering development and how investors can profit from cashing in.
Step 3. Register a token symbol
When registering a token system, there’s no need to choose a unique one since it’s not monitored nor regulated.
You can protect a symbol according to federal trademark law; however, be prepared for the fact that someone could clone your contract and symbol and deploy it.
Step 4. Choosing providers
When choosing a KYC token provider, make sure to take the following details into account:
- Legal experience. A provider should have a strong grasp of the international jurisdictions.
- Data security. Make sure a token provider understands the importance of data security and uses the means compliant either with GDPR, the Asian local directive, or a set of US Federal Laws targeting privacy protection.
- Fast integration. Make sure the provider is capable of creating a front-end and back-end integration for the solution.
Step 5. Security token offering development
After an STO founding team has chosen a reliable provider, it’s time to settle on a platform for the token launch. We’ve outlined the most popular options above – the list, however, is not complete.
Choosing a reliable development platform will be easier if you have a set of criteria to narrow down the list of options and choose the best fit among them.
Step 6. Setting up the offering details
This means defining the nature of your token — essentially, what you will be offering investors. Here are some ideas to consider:
- Right token. This provides an investor with a set of rights within the company — access to the market, the right of product usage, or the option to contribute to the governing action.
- Function. This token allows users to get access to a particular product feature or a service (for instance, BI software can offer advanced analytics tools to those who’ve invested in STOs).
- Currency. The token is used as a currency that allows performing operations within the ecosystem.
Step 7. Marketing campaign
Now that the token is created and the offering itself is well-defined, a business owner needs to start a marketing campaign to spread the word of the launch. This includes networking, publishing guest posts on industry-related websites, conducting Google AdWords and social media campaigns, etc.
Risks to overcome while adopting an STO
Adopting a security token, while being overall a solid investment, comes with its own risks that companies have to be ready to deal with. Here are some hurdles a business can encounter during STO adoption.
- Legal compliance. As companies are inspected by the SEC, they have to make sure all the finances are on point before adopting STOs. For startup founders with no dedicated departments, it’s known to be quite challenging.
- Backup withholding. While adopting security tokens, keep in mind that they are subject to backup withholding tax (at the very least in the US).
- Security risks. Unlike traditional tokens that only offer investors the monetary value, STOs let investors behind the curtains of the company. That provides possible security risks as a token issuer never knows if an investor is not going to misuse the company’s data.
- Profitability risks for investors. Seeing that STO is still relatively new, there are fewer cases of successful Investments. That way, investors could be more confident in the profitability of their contribution through the traditional financial system.
STOs are a product of thought out an innovative approach to tokenization. The reduced risks of investment, the ledger transparency, improved protection, and exchange flexibility makes the new form of tokens highly sought out. It’s worth noting that, as of now, STOs are only issued by a small fraction of the market. However, along with the disappointment and the downfall of ICOs, an investor’s need for security and protection will grow — and with it, so will the STO market.
Being among the first to start issuing security tokens allows businesses to be the pioneers in highly lucrative markets. There are STO issuance platforms to help you out but the fees for the token launch are not high yet. The market is still in its founding stage and businesses would do better to jump on the bandwagon now.
If you’re looking forward to starting security token offering development or any other Blockchain-based project, Unicsoft is ready to have your back. Take a look at our work or leave us a message to discuss your project.