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ICOs are dead. Long live STOs. The poster child of the cryptocurrency bubble of 2017, initial coin offerings (ICOs) raised more than $20 billion from main street investors across the world. But, they risked the wrath of the SEC by failing to comply with securities regulations. And the SEC cracked down.
In contrast, security token offerings (STOs) are regulatory-compliant offerings that still involve the sale of cryptocurrency tokens to fund new businesses. Though a relatively new approach, STOs have raised $380 million so far. And many analysts predict 2019 will be the year of the STO.
In this two-part guide, you will learn what security tokens are, how to create a security token and how to run your own security token offering.
What is a security token?
A security token is a blockchain-based, tradable financial asset, which meets strict criteria and regulation, specific to the country it is issued in. Tokenizing a security offers multiple benefits, such as being able to fractionize it, which you can’t do with stocks and bonds.
The U.S. has strict regulations on securities. It uses the “Howey test” to determine whether an asset is a security, which asks:
- Is there an investment of money in a common enterprise?
- Is there an expectation to profit from the efforts of others?
If the answers to both of these questions is yes, then the SEC could deem the asset a security. This means if you are a company running an offering—you are likely to meet both these criteria as offerings tend to imply that the value will increase throughout the sale. Regulations are also tight on who can invest in security tokens because they use certain rules that have specific limitations. Other countries have different rules on securities, which will be covered later.
Security tokens are used to raise funds for a company. The token can be designed to give owners tangible value, like a share in equity or return via revenue distribution. Due to this, it is more likely to maintain a steady value as long the company is profitable, compared to cryptocurrencies, which are highly volatile.
What is a security token offering (STO)?
A security token offering refers to when a security token is issued at a set price, typically before the tokens are made available on an exchange. They often include “discounts,” during the time of the initial crowdsale. They will typically have restrictions on who can invest in the offering.
In the U.S., a securities offering must either be registered with the SEC or qualify for an exemption. All security token offerings are conducted in accordance with one of the various registration exemptions afforded to companies under federal securities laws. This means that these investment opportunities will be limited in how they can be marketed and to whom they can be sold—they are almost always restricted to accredited investors.
Security token offerings try to be the grown-up version of the initial coin offerings, a trend in the cryptocurrency sector that brought in more than $20 billion in revenue over the last two years. But many initial coin offerings failed to register as securities, or qualify for an exemption, despite the SEC arguing that they were securities. This means most initial-coin offerings were likely unregistered securities and may face prosecution and fines.
By keeping the tokenized aspects of initial coin offerings, but playing by the rules, security token offerings hope to capture a similar—or greater—market demand. However, outside of the U.S., while they are more likely to attract investment from accredited investors, they may be less likely to garner support from main street due to higher minimum investments.
Companies have already started the ball rolling. A total of 18 companies—including Gab and Blockchain Capital—have raised $380 million through STOs, according to venture crypto fund Evercity and Security Token Club. The largest STO was Overstock’s tZero, which raised $134 million. Other notable STOs include Nexo—a platform for crypto-backed loans—which raised $52.4 million in its offering last April. In addition, LDCC by Lottery.com came close with an STO of $47 million. It intends to host global raffle events.
Why would you run a security token offering?
If you are thinking about creating a security token and are looking to fundraise for your project, it might be a good option for you.
Here are some of the main advantages:
- Tokens can be divided into smaller parts. This means investors are able to part-own tokens. This is the equivalent of buying a portion of a share, which you can’t do.
- They are regulatory compliant unlike ICOs which risk being classed as unregistered securities—something the SEC is already cracking down on.
- It can bring in thousands or millions of dollars worth of funding.
Should you run a security token offering?
It can be tempting to jump on the security token train hoping it will bring in millions and everything will be just dandy. But there are several potential downsides to running one. Here are some of the main disadvantages:
- It is an expensive process, and costs can range from $50,000 to more than $100,000.
- There is a lot of compliance that has to be dealt with.
- If you want to operate in the U.S., you must either register with the SEC or file an exemption, which is going to limit how you market your offering and to whom you can sell it.
- Lack of liquidity. Security token platforms are new and the sector is still growing so there may be an initial lack of investors until they really take off.
What are security token issuance platforms?
If you are looking to create a security token, you will need to offer it on a security token issuance platform. You shouldn’t issue it yourself because you run the risk of failing to be fully compliant. You also can’t offer it on regular crypto exchanges because they don’t meet the regulatory requirements, such as full KYC procedures. Several new security token exchanges have been set up to cater for this new wave of security tokens.
Security token issuance platforms will take you through the necessary steps to creating your security token. They will also help you with the necessary paperwork and let you know how to jump through the regulatory hoops. Plus they will help you decide on the right ways to make sure your token is compliant.
Please note: This article has been updated to show the cost of security token offerings are lower than originally stated.