Walkthrough Overview of Security Token Offerings
Security token offerings (STOs) are widely regarded as an efficient means of raising capital. They bring regulation to blockchain-enabled crowdfunding and offer multiple benefits to investors.
Security tokens have gained popularity in an extensive range of contexts and demonstrated the power to profoundly transform the way assets and investments are perceived. Security tokens are cryptographic blockchain-based tokens that can represent various types of assets (bonds, shares, investment funds, works of art, real estate) and fall under securities laws and regulations.
Given the popularity of these tokens, security token offerings (STOs) have become a widespread concept in the financial world. They are considered to be the evolution of ICOs and a more secure way of raising capital. With STOs, both issuers and investors can enjoy a host of benefits such as better liquidity, efficient and simplified management of digital assets, greater accessibility, and fractional ownership.
Read on to get more insights into security token offerings, discover how they differ from ICOs and IPOs, and find out which STO regulations exist in different jurisdictions across the globe.
What are security tokens actually?
Security tokens (also known as digital securities) are digital representations of various assets, including fixed income, real estate, commodities, and investment fund shares that are kept and traded on blockchain. They validate and ensure ownership rights and function as value-transfer instruments for a particular asset or set of rights. By making use of blockchain technology, security tokens facilitate the automation of cumbersome manual processes and offer a reliable, secure source of truth that all parties can rely on.
Security tokens are normally programmed with unique features and have the regulatory protection that is characteristic of traditional securities. The word “security” means that tokens are regulated by governing bodies that are held responsible for determining how tokens should be issued, managed, and exchanged. It must be noted that to get the status of a “security token”, it has to undergo the regulatory scrutiny of the governing body where it is going to be issued.
Typically security tokens are traded on specialized token exchanges, which are required to conduct thorough investigations into token listings as well as multiple investor onboarding procedures.
What is an STO and how is it helpful?
A security token offering is a revolutionary concept in the financial world. It has found itself on the fine point of convergence between avant-garde blockchain technology and traditional securities that grant the protection of investor interests. STOs were introduced with the purpose of bringing institutional investors on board in the crypto and blockchain era and allowing them to enjoy unprecedented levels of transparency and convenience.
STOs are about issuing digital tokens on blockchain in the form of regulated securities. They provide the token owner with the rights to the assets promised by the security. Security token offerings are viewed as a highly secure and convenient way of raising funds for a project as well as making a public offering of the company’s shares. Smart contract integration is capable of automating legal and auditing procedures and helps store and share information in a safe manner.
STOs generally have a relatively high entry barrier — but this is a necessary hurdle for investors who wish to ensure top security for their funds.
On the whole, security token offerings are currently one of the most widespread fundraising methods used by present-day blockchain startups and they have been welcomed in a lot of countries worldwide.
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STO vs ICO vs IPO — what’s the difference?
The issuance of digital assets via blockchain has been gaining traction. Initial coin offerings (ICOs) opened the door for blockchain-based investments but once STOs entered the stage, their popularity began to decline.
As far as classical initial public offerings (IPOs) are concerned, they are still widespread but in terms of cost-effectiveness, they lose out to their STO counterparts.
These days, STOs are on top, and more and more organizations and individuals across the globe are starting to set their sights on this fundraising method. But what’s so special about it, and what advantages does it have over other options?
To get these questions answered, let’s examine the distinctions between an STO and an ICO as well as an STO and an IPO.
What are ICOs?
An initial coin offering (ICO) was the first crowdfunding option operating within the blockchain ecosystem. ICOs enable anyone from any part of the world to finance the development of a project or even a company.
Initial coin offerings were introduced in order to lower entry barriers for investors, and allow them to participate in the offering with their fiat currency and/or altcoins and get new coins in return. ICOs run on blockchain where all investor data is recorded on an immutable ledger.
Once a person has made an investment, they receive a particular number of utility tokens that provide them with access to the company’s products or services.
Properly organized initial coin offerings are a smart and cost-effective way of issuing tokens for community-based projects. In 2019, for example, ICOs managed to raise $14.8 billion for the cryptocurrency industry, which is undeniably impressive.
However, due to the lack of regulation, ICOs have faced a number of challenges and scams, which have made investors start looking for other more regulated options such as an STO.
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ICO vs STO
First off, it’s important to mention that both ICOs and STOs rely heavily on blockchain technology, and in both cases, the token distribution occurs via smart contracts.
Still and all, their objectives are quite different. The main purpose of an ICO’s coin is usage. It offers you an opportunity to buy either products or services once the project is up and running.
Security tokens, for their part, are regarded as a form of investment and they derive value from being a tradable external asset. They are subject to federal laws and if they fail to comply with those regulations, this may have unfortunate consequences, the most severe being penalties or even shutdown of the project development.
Another distinction is that STOs are generally safer for investors. Despite the fact that they take more time and money to launch, and that they involve entry barriers, they are more reliable compared to ICOs, which run the risk of scams and fraudulent activities. It was estimated that between 2016 and 2018 ICO scams totaled $98.6 million in value. Since then, ICOs have witnessed a decline in popularity, with investors deciding to switch to STOs instead.
What are IPOs?
When launching an initial public offering, a private corporation goes public and starts offering its shares in a new stock issuance.
During an IPO, an investor purchases stocks representing equity in the company and automatically becomes the owner of a percentage of that company, getting dividends and liquidation equity rights.
Thanks to IPOs, companies are able to raise money to fund operations, stimulate growth, create liquidity, raise their public profile, and even tackle debts.
Startups and large corporations alike can undertake an IPO. The most outstanding examples of companies going public include Visa, Airbnb, Levi Strauss, and others.
2020 was quite a successful year for IPOs; there were 407 initial public offerings in the USA alone, which almost doubled the number the previous year (195). Moreover, according to current statistics, the first quarter of 2021 saw 727 IPOs launched, which raised about $202.9 billion.
IPO vs STO
The most dramatic difference between an IPO and an STO is that the latter is responsible for distributing digital, asset-backed blockchain tokens whereas IPOs are real packets of shares. In addition, any legitimate company can offer STOs, whereas IPOs are launched only by private companies.
Initial public offerings involve lots of intermediaries, investment banks, and brokers, that take care of different procedures and issues. Inevitably, a lot of financial resources are needed to cover the costs of their services. STOs, on the other hand, are carried out on a decentralized blockchain network, where smart contracts are responsible for facilitating regulatory compliance. This will undoubtedly help cut costs and reduce intermediary fees.
Another distinction between the two is that IPOs are normally performed in the jurisdiction where the business carries out its operations. STOs, though, are not tied to a specific location, and investors can be treated as local entities under the jurisdiction where the token is issued. As a result, STOs have the capacity to enormously boost the investor pool and bring greater diversity to the business.
|Regulation||Have a specific regulatory framework (securities regulation)||Unregulated (no controlling authority)||Normally have a well-defined|
|Transparency levels||High||Low||Prescribed by listing rules|
|Issuers||Public companies, startups, SMEs||Public companies, startups, SMEs||Public companies|
|Participation||Direct||Direct||Via brokers, e.g. a bank|
|What is issued||Security tokens||Utility tokens||Company shares|
|Sale location||Security token platform||Token issuer website||Purchased from an authorized selling group|
What are the advantages of STOs?
STOs have come out on top because of the benefits provided by programmable, blockchain-based security tokens that can be smoothly transferred, traded, and traced. They also open up an unprecedented range of opportunities to investors and enable them to efficiently raise capital.
As well as this, they bring together legal regulations and blockchain technology, a combination that produces a truly powerful tool.
The core benefits of STOs comprise top security and reliability, 24/7 access, the absence of any intermediaries, high liquidity, and the opportunity to program necessary features. Let’s take a closer look at each of these below.
STOs are secure and reliable
Because security tokens are kept on blockchain, users can keep track of their origin and transaction history in a cryptographically verifiable way.
The status of all security token transactions is monitored at all stages, from token initiation to settlement. Just as importantly, all relevant parties have access to a reliable, single source of truth, which helps prevent disputes around record keeping.
STOs can operate 24/7/365
The majority of traditional markets are tied to settled working hours, which can sometimes be a grave disadvantage, since traders may miss out on profitable deals. Security tokens, however, can be traded at any time on censorship-resistant blockchain networks. This allows investors to act on new information quickly and stay in an advantageous position.
STOs encourage disintermediation
With security tokens, investors can avoid market intermediaries as well as the other middlemen who are usually involved in asset management processes. STOs also help do away with multiple paper-based procedures, making reporting and auditing more efficient and less time-consuming.
As a result, security token holders can substantially reduce the costs and processing time of their transactions. Plus, because the number of intermediaries is so much lower, the risks of corruption and manipulation by third parties are almost eliminated.
STOs provide higher liquidity
As security tokens enable fractional ownership, there will be greater liquidity within the market. More people have an opportunity to buy smaller stakes of illiquid assets like real estate, collectibles, and works of art, which could contribute to unprecedented levels of liquidity.
By using security tokens, it’s also possible to attract investors who can quickly help projects raise large sums of money and at the same time foster awareness of the business all over the world.
STOs are programmable
Another aspect worth highlighting is that security tokens are flexibly programmable. This means that users are allowed to program particular rules into the security token, enabling it to execute, regulate, and govern itself.
For instance, security tokens can be programmed to verify who can buy them and prevent a non-eligible counterparty from trading those tokens if they haven’t passed the required verifications.
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Examples of STO regulations and their peculiarities
Investors globally have shifted their focus from the once-so-cool ICOs into STOs because of the multiple advantages that the latter offer. As a result, we can see that the number of STO launches globally is on the rise and more and more companies and individuals alike have opted for STOs.
However, to ensure the success of an STO campaign, it’s essential to choose the most suitable jurisdiction and consider all the related aspects, including a regulatory framework, setup costs, and taxation infrastructure.
The majority of countries have been welcoming and enthusiastic about STOs and have relevant regulations in place, whereas others have been skeptical about STO adoption and are not willing to introduce any frameworks (e.g. China).
Now let’s take a peek at some countries that have embraced STOs, and discover which regulatory authorities are responsible for monitoring STO compliance.
STO in Malta
Located in the Mediterranean, Malta has been eager to make blockchain and cryptocurrency advances. In fact, crypto solutions and blockchain have been so widely embraced here that Malta is dubbed the “Blockchain Island”.
Malta’s government, including the Prime Minister’s office, has held progressive views on blockchain and expressed a keen interest in adopting the technology alongside cryptocurrency for everyday financial transactions. To this end, the Malta Stock Exchange joined hands with the profound crypto exchange Binance to design a novel security token for the country.
As for security token offering regulations, back in 2018 Malta introduced the Malta Digital Innovation Authority Act and became the first jurisdiction to adopt an all-encompassing legislative framework for issuing security tokens. The country has also developed the Virtual Financial Assets Act, under which it makes use of a financial instrument test to assess investments and determine whether they can be tokenized.
It’s worth noting that Malta boasts a pool of outstanding investors who are rigorously promoting the new market. The country has drawn the attention of multiple STO companies and startups from across the globe since it allows them to safely and conveniently issue and hold their token offerings on Maltese exchanges.
STO in Switzerland
Switzerland has always appealed to businesses that operate within the financial sector. So, it comes as no surprise that the country was one of the pioneers who championed the adoption of crypto regulations.
In Switzerland, all STOs are regulated by the Swiss Financial Market Supervisory Authority (FINMA) — the local financial markets regulator. FINMA supports STO projects, reviews token proposals, and confirms the designation of the offering.
In Switzerland, STOs are regulated by the same laws as traditional securities, including bonds and stocks. They are also subject to KYC laws alongside Swiss banking regulations.
STO in Lithuania
Lithuania was the first country in Europe to host security token offerings. It has introduced STO regulations that allow users to smoothly trade security tokens and has even established the Blockchain Centre in Vilnius.
The Lithuanian Ministry of Finance has also released detailed STO regulations that cover aspects such as auditing, taxation issuance, and compliance. The official authorities of the country provide institutional support for STO projects as well as free consultations from financial markets supervisors.
STO in the United States
The United States is definitely on the radar of those who are planning to run an STO campaign. The U.S. Securities and Exchange Commission (SEC) has played a pivotal role in regulating security token offerings in the territory of the country.
The SEC has worked out multiple legal acts that regulate different types of securities as well as their sales. Thanks to this, blockchain and STO startups are able to organize security offers under various conditions. Every startup located in the USA or attempting to solicit funds from US-based investors is required to consider one of the exemptions ( CF, D, A+, S) provided by the SEC.
The USA is considered to be one of the best jurisdictions for STO campaigns. The adequate and relevant regulations provided by the SEC contribute to the positive image of the country as a place to invest. According to the Global Alternative Finance Market Benchmarking report, about 70% of players believe that the present legislative framework is suitable for their platform activities.
STO in the United Kingdom
In the United Kingdom security tokens are managed the same way as other types of securities with corresponding substantive characteristics, which makes the UK’s regulatory regime technology-neutral.
The Financial Conduct Authority (FCA) covers the territory of the UK and is responsible for developing relevant STO frameworks that help regulate the issuance of security tokens.
The FCA differentiates between three types of tokens: exchange, utility, and security.
In the UK, security tokens are qualified as special investments and fall under the Regulated Activities Order and within the regulatory area of the FCA. In its Guidance on Cryptoassets, the FCA defines security tokens as cryptoassets that grant holders rights and obligations similar to traditional financial instruments.
The Financial Conduct Authority has maintained a supportive stance towards blockchain and all its related concepts. In August 2020, it even approved the first security token exchange, making the UK one of the first authorized trading spaces for assets in the world.
STO in Singapore
Being a global hub for financial services and blockchain, Singapore is often referred to as one of the key players in the tokenization industry. The city-state offers an unambiguous, concise regulatory framework for STOs and low taxes as well as access to a pool of institutional investors from regions such as South-East Asia, North Asia, and India.
Singapore has introduced all-encompassing regulations for STOs and the use of tokenized securities. The Monetary Authority of Singapore (MAS) is the authority responsible for enforcing the relevant laws and regulations. It has set up a sandbox with market participants to operate and govern security token exchanges and platforms. The MAS also issued a guideline for Digital Token Offerings, which defines security tokens as traditional securities and obliges them to follow similar regulations and requirements.
STO in the United Arab Emirates
Always at the forefront of tech trends, the United Arab Emirates believes that blockchain and cryptocurrency are the drivers of future progress, capable of digitizing and enhancing almost every industry. In 2018, the UAE Government introduced the Emirates Blockchain Strategy 2021, which will focus on using blockchain to shift 50% of government transactions onto the blockchain platform by the end of 2021.
As for security tokens, the UAE’s Securities and Commodities Authority (SCA) deals with monitoring and regulating the territory’s financial markets while the Dubai Financial Services Authority (DFSA) has been tasked with enhancing local cryptocurrency-related regulations. It plans to launch a regulatory framework for different digital assets as part of its 2021-2022 business plan.
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Security token offerings have established themselves as an efficient and highly secure means of generating capital, and there is no question that this state-of-the-art technology is here to stay.
Launching an STO campaign is no small task; you will need to handle a plethora of details to the smallest minutiae. It would be a smart idea to partner up with an experienced STO company that will accompany you on each stage of your STO launch journey, from consultation to the issuance of security tokens.
Here at PixelPlex, we have been so enthusiastic about ensuring the success of our customers’ STO launches and helping them hit the mark that we have developed our own end-to-end STO platform. It empowers users to digitize any type of asset and provides the full ecosystem needed to run an STO campaign. The platform possesses a high degree of customization and allows for a quick and smooth STO launch.
Don’t hesitate to reach out to us for more details about our STO solution. Let’s start making the future today.