Security Token Offering in 2021 : The future of Raising Money

Backed in 2017, it was the year of initial coin offering, a new way for companies to raise money. Since then, over $22 billion have been raised for companies of all sizes, from pre-product startups to companies with publicly traded equities on traditional stock markets. 

Initial coin offerings (ICO) are based on the premise that a company, organization or individual can create a digital representation of value, known as a token and sell this token anywhere in the world. This token rests on a system called a blockchain, a database that is shared across a network of computers. By having a token on a blockchain, the ICO token is easy to create, easy to store, and easy to send to anyone in the world. Initially, companies would sell the tokens, known as utility tokens, for the purpose of using their platform once it was built. 

Soon, companies would begin to focus their offerings on the investment aspect of the token as opposed to the utility aspect. Therefore, SEC put forth a framework for determining whether or not a token sold in an ICO is under their U.S laws and regulatory purview. As a result, security token offerings (STO) were born which turned a once unregulated form of raising money into a regulated one. With the current rise of the cryptocurrency market, it is important to start preparing for the next big fundraising opportunity, Security Token Offering (STO).

Security tokens (or digital securities) are digital representations of an asset such as equity, fixed income, real estate, investment fund shares, commodities and structured products that are traded and held on a blockchain. By leveraging blockchain technology, security tokens allow for many traditionally cumbersome and highly-manual processes to be automated. In short, security tokens combine the speed and ease of blockchain with the strong legal protection of traditional securities.

Security tokens are not traded on regular token exchanges. Exchanges that want to offer security token trading need to fully comply with regulations, including extensive investigations into token listings, data sharing, and investor onboarding procedures, Thus, security tokens trade on specialized exchanges.

Security token offerings are meant to be a regulatory compliant alternative to regular token sales. They aim to correct perceived inequalities on the investor side, such as granting security token holder rights to dividends or other predefined revenue streams. STO tokens are beneficial to the issuers as they clearly define stakeholder obligations regarding the token distribution, issuance procedure and secondary trades.

1. Credibility

• Different from ICO where many projects did not deliver what they promised or were scammed as the token is not regulated under U.S laws. In contrast, STO follows all regulations under a set of laws imposed by the SEC.

2. Improving traditional finance

• While traditional securities are slow and expensive due to their old infrastructure and layers of intermediaries, security tokens facilitate services at a lower cost.

3. Global Investors

• Traditional security deals mostly involve only local individuals, while security tokens are open to anyone on the internet.

4. More Liquidity

• Because of fractional ownership, security tokens make traditionally illiquid assets like real estate and fine art more liquid for asset owners. Breaking ownership down into tiny fractions, rather than just being owned by a single person or entity. It provides an opportunity for smaller investors.

5. Transparency

• The status of a security token transaction can be monitored all the way from initiation to settlement, and all relevant parties have access to up-to-date sources. With an updated record, it reduces disputes around record keeping and the need for parties to reconcile. 

1. Regulation

• When it comes to raising money through a security token offering, the goal is to raise money from a broad set of investors. Depending on who you raise money from, how much you plan to raise, where do you plan to raise and how you plan to do it, there are varying degrees of regulation. Besides that, launching STOs requires legitimate corporate structure and administration. You should consult a lawyer that is familiar with STO for more precise legal information. 

2. Technology Infrastructure 

• One of the considerations to launch a security token offering is which blockchain will your token live on. Once this is figured out, the next decision is how will the token be designed in order to be both secure and interoperable with the market.
• Designing your token with interoperability in mind is very important. Picking the wrong standard means that there may not be many options for your investors to securely store their tokens and secondary markets may not have the capability to host your token. 
• Most issuers have chosen to standardize on the ERC-20 standard. This standard simply creates a new ledger with it’s own native token or unit of account on top of the ethereum blockchain. ERC-20 has been chosen by most of the people due to the simplicity of design and the ease of interoperability. 
• When it comes to security-based tokens, as laid out in the previous section, there is an additional layer of regulatory compliance required around who is able to buy, trade and interact with the tokens. As a result, companies have created new standards that take the ERC-20 model and include additional complexities, such as address whitelistings and locking, to allow the tokens to comply with security regulation.
• There are also different token standards such as ST-20, R-Token, ERC-1400, ERC-1404 and etc. Consult with a STO advisory to understand which type of technology is suitable for you.

3. Secondary Market

• A major reason attributed to the success of fundraising through token offerings is the liquidity provided through the reduced trading friction enabled through the blockchain. This means that investors are able to invest in blockchain-backed tokens with a much lower risk profile compared to a traditional, illiquid asset (given the same value backing the asset). This makes secondary markets, a platform where investors of a security token offering can sell their tokens on an open market, an extremely valuable part of the ecosystem. To have a successful token offering, you must have a way for your investors to trade.
• However, unlike exchanges hosting traditional cryptocurrency or utility-based tokens, exchanges hosting security tokens must abide by additional regulatory scrutiny to allow trading. The result is that there are limited exchanges around the world that offer security tokens.

4. Time and Spending Plans

• From planning, organizing to successful launch security tokens, it would take up half a year or a year of time. Companies must be prepared to invest enough time and energy to settle down the company structure, drafting of prospectus, choice of technology, settling different types of issues and many other matters. Therefore, it is important to hire an experienced advisory and lawyer to help in launching the security token.

The security token landscape is taking steps in the right direction for companies to raise funds in a regulated way. New and traditional market participants are collaborating more often and institutions across the world are realising the opportunities of security tokens present. Therefore, we can see that security token offering (STO) is moving strong and growing quickly in the market now.