The cryptosphere is still in the midst of its teething stage, with a seemingly relentless bear market and increasing distrust towards ICOs after their rise and fall in 2017–2018. This is due to the ICO model of issuing utility tokens, bought in exchange for often ambiguous and undelivered promises of a company’s future product or service, which are quickly being replaced by Security Token Offerings.
What are STOs?
STOs, or Security Token Offerings, is the evolution of the ICO. They act as digital investment contracts and offer a compromise between the Wild West of the ICO community and the traditional finance sector.
A security is a financial instrument with monetary value that can be traded and is backed by something that can be invested into. It typically includes stocks, bonds, investment trusts, real estate, and even assets such as intellectual property and rare art.
When purchasing a security, a shareholder traditionally receives some kind of certificate in paper or pdf format that represents the ownership of the stock. An STO is a digital wrapper for this process. Sounds dull, right? So why the hype?
The recent popularity of STOs emerged with the ongoing SEC regulations in the United States and leaders such as Jay Clayton stating that every ICO is a security. Although some believe that regulation is detrimental to innovation within the space, others are adamant that it is the only way we will see crypto adoption on a mass scale. Regardless of one’s stance, it is understandable why the US government, among others, are eager to impose regulations following the vast amount of money lost to ICOs last year.
STOs as an alternative to utility token offerings combine the reliability of traditional finance with the versatility of crypto. Aside from being a more secure way to prove equity ownership, blockchain and now STOs are already beginning to overhaul financial systems as we know them.
Improved Access to Asset Classes
STOs are opening up the trading sphere to assets that, until now, could not be traded quickly and easily. With more than $256 trillion in real-world assets that have yet to be tokenised, STOs present a real alternative for companies and investors.
Hosting an IPO (Initial Public Offering) is undoubtedly expensive. With an STO, companies can allow for investment through tokenisation, which significantly cuts admin and legal costs while keeping the company and the process transparent. Any compliance costs that would typically be required for an IPO or other securities trading can further be reduced by embedding trading restrictions into a token via smart contracts.
PrefLogic is one example of a company already doing this, with smart contracts (SERC20) that facilitate complete compliance with Reg D, S, and CF regulation. Their STO Wizard platform is going live in Q1 of 2018, which will allow anyone to become a securities issuer without the burden of the prohibitive legal costs that currently limit the STO sector, further opening up this space.
Despite the move to digital trading, traditional markets are still only open for trade during working hours (typically EST) as they rely on human maintenance. By merging with blockchain and crypto, markets can stay open for trading 24 hours a day, 7 days a week, increasing trading volume and liquidity.
You may remember me mentioning fractional ownership in my article discussing the implications of blockchain on art. Fine art, collectibles, and real estate are just a few industries that have consistently drawn investor interest over the years due to their uncorrelated nature, meaning their value does not appear to increase or decrease in relation to other assets.
Unfortunately, because fine art and real estate are among the most illiquid assets, they’re difficult to convert into cash without their price being affected. By allowing investors to purchase fractions of a rare painting or a skyrise, more people can expand their portfolios without needing a large sum of money…
Liquidity relies on the number of buyers and sellers in a given market. Fractional ownership through tokenisation of assets and speeding up transactions improves liquidity by allowing more people to enter the investment space and trade at higher volumes.
Raising Capital on a Global Level
Alongside the ability to trade at any time of day, any day of the week, STOs allow for companies to raise capital on a truly global level. Similar to online fundraisers, people from around the world can invest in projects they feel personally inspired by, regardless of their location. This further impacts liquidity and the legitimacy of a company by growing an organic following of supporters of a product at an early stage.
Eliminate Risk of Scams
Since early 2017 there has been a huge influx of money into the ICO space, currently estimated at $13b. However, the Wild West of ICOs also gave rise to scams and the failure of 50% of these projects.
I’m confident that, with improved regulations, STOs will become the more desirable choice for investors as increasing amounts of VCs and Family Offices eye-up the space, hoping to capitalise on the distribution power of ICOs with a legal, secure method of investing.
Additional Features for Securities
Traditionally, investing in securities means that when you purchase shares of a company, you simply receive shares. The only incentive for holding shares is that, when sold, you receive cash (hopefully) with higher returns.
With tokens, anything that can be coded into the token can be added. For instance, companies could offer discounts or rewards to shareholders for their loyalty or for reaching certain benchmarks in investment.
With utility token offerings now being considered illegal according to SEC guidelines and uncertainty surrounding how utility tokens can realistically increase in economic value, the importance of security tokens cannot be ignored.
I’m confident that STOs will be hugely popular by 2019 as they offer a familiar path for traditional investors to enter the space and an array of benefits compared to both the traditional finance sector and ICOs.