Security Token Offering (STO)

In traditional finance, fundraising sometimes takes place in the form of initial public offerings (IPOs). New shares are then sold, with which the company tries to raise money to invest. For example, Facebook raised over $16 billion in 2012 through an IPO.

There are also projects on the blockchain that raise money, for example with an ICO (Initial Coin Offering). As an investor, you can invest in a project for a low company. However, there is a chance that you will be scammed; there are already plenty of stories of people who saw their investment go up in smoke.

A fairly new way to raise money is through an STO, which stands for Security Token Offering (also sometimes called Security Coin Offering). Simply put, this is a presale where you can buy security tokens for a reasonably low price. In this article, we explain what an STO is, and what the difference is between ICOs and IEOs.

What is a Security Token Offering (STO)?

STO stands for Security Token Offering and is fundraising (way of raising money) that is performed through a pre-sale of tokens that are created on a blockchain. These tokens are similar to financial products (stocks, bonds, mutual fund shares, etc.) The term is derived from the term Initial Coin Offering (ICO), which is derived from Initial Public Offering (IPO).

The business model of STOs is similar to that of ICOs and CEOs, and only the nature of the tokens issued differs. As an example, let's take a company that wants to fund itself to carry out a particular project. To do so, it issues tokens on a public blockchain (usually Ethereum): these tokens are security tokens that in this case correspond to shares of this company. Investors buy the tokens with cryptocurrencies (Bitcoin, Ether, etc.) or traditional currencies (dollar, euro, etc.) in the hope of making a profit.

Unlike ICOs, where pre-sales are conducted directly through the token's standalone contract, and IEOs, which are conducted through exchange platforms, STOs usually take place on specialized issuance platforms that are highly regulated. This is due to the regulatory constraints associated with the financial world. After all, it involves stocks, bonds and other financial products.

How does an STO work?

Security tokens can represent different forms of financial assets. There is a test, used by the SEC (Securities and Exchange Commission) to determine whether a token is a security or not: the Howey test. This test is based on a 1946 case in which the United States Supreme Court determined that the services provided by the Howey company were "investment contracts.

As you may already know, security tokens can be stocks, bonds or other financial instruments. It means that the holder is also entitled to vote or receive a dividend. For example, DigiShares has issued a security token on the Ethereum blockchain.

It can also be shared in an investment fund. For example, consider a listed real estate investment trust or SIIC. For example, not long ago, the BTG Pactual bank in Brazil launched the ReitBZ token on the Tezos channel. This is also a security token, given that it represents an actual share.

Bonds can also be represented by security tokens. A bond is a debt that a country holds. But a security token can also represent the value of future contracts, swap contracts and the like.

What is the usefulness of STOs?

STOs offer a few advantages over a traditional fund of funds (IEOs). First, traditionally, raising money for IPOs has been reserved for very large companies. STOs, on the other hand, offer any start-up the freedom to fund itself. STOs facilitate traditional financing by making trading fast and cheap.

Moreover, STOs have the merit of facilitating traditional financing by making exchanges fast, cheap, and most importantly, scalable. This could have a positive effect on a market used by large institutions by firmly reducing the number of intermediaries and actually increasing the number of investors.

The main advantage of STOs is their flexibility. Since the security token is issued on a decentralized blockchain, this token could then be involved in the contracts of organizations. For example, a company's shares could be issued in the form of a token that could be used for a vote. In this way, token owners have a say in what happens within a company.

Some companies could be managed so completely on the blockchain, which is why they are called Decentralized Autonomous Organizations or DAOs.

What is the difference between an STO, ICO and IEO?

ICOs and IEOs have the unfortunate shortcoming of issuing utility tokens, which do not give users any control over a product. Nor does it provide any legal guarantee: if the company decides to run off with the money and not launch the project, it can do so without any problems. This is because there is little regulation for this now. It seems easy to set up an ICO or IEO, but it's not. It is easier for start-up organizations to set up an STO.

In doing so, STOs also offer guarantees to the investor: voting rights, dividends, etc. However, this comes at the cost of freedom and privacy, as the investor will first have to submit to identification measures (KYC/AML). This is due to the very strict regulation of financial products, especially in the United States.

Despite the fact that an STO seems safer (a scam is almost impossible), ICOs, on the other hand, are a lot more popular among users and investors. This is because it is much easier for users to participate in an ICO. Even if it is obvious that often enough people are scammed through an ICO that turned out to be a scam in the end. With an STO, you don't have to worry about being scammed because this is incredibly difficult due to the strict regulations.

How can I participate in an STO?

If you have to choose between an ICO, STO and IEO, STOs are clearly the least accessible. ICOs often require nothing more than interaction with a standalone contract. IEOs, on the other hand, require registration with exchange platforms, usually involving an identification process. Thus, it is fairly straightforward to participate in these.

However, for an STO, the KYC (Know Your Client) identification procedure must be followed, as well as the anti-money laundering procedure. In addition, some projects limit the number of investors to a whitelist that they create themselves.

There are several platforms on which tokens for STOs are issued. These are in most cases the following platforms:
  • Polymath (on this, for example, Corl's had an STO)
  • Swarm (Robinhood Equity for example had an STO on this)
  • Harbor
  • STOscope (only deals with cryptos)

Conclusion

With Security Token Offerings, companies raise money by issuing security tokens. An STO has strong limitations because users will have to register themselves according to strict regulations. This is one of the reasons that an ICO, for example, is still much more popular.

However, security tokens are becoming increasingly important, and more and more companies are using them. With security tokens, companies also enjoy the advantages that the blockchain offers, while there is still enough distance from cryptocurrencies.