Getting investors, especially at the beginning of a business, is crucial for the development of a project. The cryptocurrency industry understood this very quickly and ICOs were started. However, with time, more disadvantages of this solution became apparent. Thus, an alternative was created: the STO.
Previously, we wrote about Initial Coin Offering, the cryptocurrency world’s answer to IPOs. Today we will take a look at Security Token Offering (STO), which is – in the opinion of experts – a more refined solution for attracting investors.
STO – what is it?
While ICO is already widely used, STO is still considered relatively new and unknown. Security Token Offering is the first offering to sell security tokens. To understand STO properly, you need to know what these security tokens are.
Security translates as commercial paper. This is exactly what is being sold, only in the form of digital tokens. A security token is a digital representation of an actual asset (such as shares or stocks in a startup, bonds, or property).
So how does Security Token Offering work? An investor entrusts their funds to the creators of a new blockchain-based project (or other cryptocurrency creation). In return receives issued tokens that give him the right to participate in potential profits or guarantee a rate of return on the invested money.
Note that not every cryptocurrency token is a security token. For a token to receive this status, it should pass the Howey Test. In a nutshell, this test determines if the token derives its value from an external, tradable asset. Only then tokens are considered securities and are subject to security and regulation.
STO History
The first STO was launched by Blockchain Capital (BCAP) on April 10, 2017. It managed to raise $10 billion within 24 hours. However, the popularity of STO began to grow not until 2 years later.
While ICOs experienced their boom between 2017 and 2018, STOs were only then emerging. In 2018, several companies (including Science Blockchain) were raising money for their operations by offering tokenization of their funds. This was the beginning for Security Token Offering. The only problem was the lack of a second trading market for these cryptocurrency “securities”.
The breakthrough came later that year when Coinbase and several other cryptocurrency exchanges announced that they were working on adding security tokens to their platforms. Liquidity in the STO market increased fairly quickly, prompting more startup developers to follow suit.
The incentive to invest in STO is that security token offerings must be issued by those registered as brokers/exchanges/dealers. This makes the entry threshold higher, but also makes the whole initiative much more secure. The STO market is also much less crowded, as there is a much smaller number of security tokens issued.
Differences between ICO, IPO and STO
Security Token Offering was created as an alternative to Initial Coin Offering. Enthusiasts of this solution point to the numerous advantages of STO over ICO, which is much more similar to a traditional IPO in its design. Here’s a breakdown of the three most popular ways to raise startup funds:
| IPO | ICO | STO |
|---|---|---|
| There are underlying assets on which the investment is based | There are no underlying assets on which the investment is based | There are underlying assets on which the investment is based |
| Primarily for accredited investors | For everyone | For everyone |
| High implementation costs | Low implementation costs | Medium implementation costs |
| Lack of transparency | Transparent solution | Transparent solution |
| Protection and safeguarding of investors | No protection for investors | Protection and safeguarding of investors |
Security Token Offering primarily guarantees much more security than ICOs. While Initial Coin Offering is vulnerable to fraud, STO is secured with funds. This largely makes the solution much more acceptable to traditional regulators.
Regulations
Security tokens are linked to registered financial assets and are therefore regulated by dedicated institutions. Although this type of fundraising is still not legal in every corner of the world, many countries already have a constructed legal framework for this solution.
In the United States, STOs are regulated by the SEC (Securities and Exchange Commission), just like traditional securities. In the UK, STO is regulated by the FCA under the category of “Specified Investments”. The European Union regulates security tokens in MiFID II (Markets in Financial Instruments Directive). Regulatory laws are lacking in Russia, the United Arab Emirates and Thailand. This type of fundraising has been legally prohibited in only two countries: China and South Korea.
Projected security token market size chart – source: Chain Partners
STO attracts many investors mainly because it guarantees safety and is much more similar to traditional investments. Everything seems to indicate that ICO has its best days behind it. However, interest in STO is still growing.