Many companies, including AmaZix, ICOBench, Blockchangers, Argon Group, and Bitcoin Suisse, have raised funds through security token offerings (STOs) and initial coin offerings (ICOs).
In this article, we discuss STOs, how they work, and their benefits to the public and the companies that set them up.
What is a Security Token Offering (STO)?
A Security Token Offering (STO) is a way for companies to raise money by issuing digital tokens that represent ownership in real assets like stocks, real estate, or bonds. These tokens are created using blockchain technology, which is a secure and transparent way to record transactions. Unlike traditional shares, security tokens are digital and can be easily traded on online platforms.
Security tokens can be an attractive investment because they combine the benefits of traditional securities with the advantages of blockchain technology. For instance, transactions can be completed quickly and efficiently, and ownership records are transparent and hard to tamper with.
As of 2023, the Tokenized Securities Market was valued at $202 Billion, and it's expected to grow significantly, reaching $301 billion in 2030, as more companies and investors recognise their potential.
How Do STOs Work?
Step 1. Preparation and Planning:
Before launching an STO, a company needs to plan carefully. This involves determining the type of security token to issue, whether it’s equity (shares of the company), debt (similar to bonds), or asset-backed tokens (linked to tangible assets like real estate). The company also needs to comply with the relevant regulations in its jurisdiction, which means legal consultation is required.
Step 2. Regulatory Compliance:
Unlike ICOs, STOs must adhere to strict regulations set by financial authorities. This involves thorough documentation, including a prospectus that details the offering, the company’s financials, and the rights of the token holders. These documents are then submitted to regulatory bodies such as the U.S. Securities and Exchange Commission (SEC) for approval.
Step 3. Token Creation:
Once the legal groundwork is laid, the company creates the security tokens using blockchain technology. These tokens are typically created on platforms like Ethereum, which support smart contracts. Each token is a digital representation of the ownership or investment stake and is encoded with the relevant legal and financial rights.
Step 4. Marketing and Promotion:
With the tokens created and regulatory approval in place, the company begins marketing the STO to potential investors. This is done through various channels, including online campaigns, social media, and investment forums. The goal is to attract accredited investors who meet the legal requirements for participating in the STO.
Step 5. Token Sale:
During the token sale, investors purchase the security tokens using fiat currency or cryptocurrencies. The sale can be conducted through the company’s website or a partnering exchange platform that specialises in STOs. The process is transparent, with the terms of the sale and investor rights clearly outlined.
Step 6. Post-Sale and Token Management:
After the token sale, the company uses the raised funds for its stated purpose, whether developing a new product, expanding operations, or other business activities. Investors hold their tokens, which can often be traded on secondary markets. Token holders may receive dividends, interest, or other returns based on the performance of the underlying asset or company.
Step 7. Ongoing Compliance and Reporting:
Even after the STO, the company must maintain compliance with regulatory requirements. This includes regular reporting to financial authorities and keeping investors informed about the company’s performance. This ongoing transparency helps build trust and ensures the security of the investment.
Features of STOs
1. Regulatory Compliance:
STOs comply with financial regulations, which means they follow strict rules set by regulatory bodies like the SEC in the United States. This compliance helps protect investors from fraud and ensures that the companies issuing the tokens are legitimate. For example, all information about the company and the investment opportunity must be fully disclosed, similar to traditional securities.
2. Asset-Backed Tokens:
One of the defining features of STOs is that the tokens are backed by real assets. This could be shares in a company, real estate, or other tangible items. This backing gives the tokens fundamental value, unlike many ICOs, where the tokens' value is often speculative.
3. Investor Protection:
Because STOs are regulated, investors have legal recourse if something goes wrong. This added layer of security makes STOs a safer investment compared to ICOs. Also, STOs often require investor accreditation, meaning only those who meet certain financial criteria can invest, further ensuring that investors are knowledgeable and capable.
4. Transparency:
Companies must provide detailed information about their business, financials, and the specific rights that the tokens confer. This level of detail helps investors make informed decisions. For example, an STO might include audited financial statements and clear descriptions of how the raised funds will be used.
5. Global Accessibility:
STOs offer global accessibility, allowing investors from different parts of the world to participate. This broad access helps companies reach a larger pool of potential investors, increasing the likelihood of successfully raising capital. However, companies must also ensure they comply with the regulations of each country in which they accept investments.
6. Lower Costs:
Compared to traditional fundraising methods, STOs can be more cost-effective. They often involve fewer intermediaries, such as brokers or banks, reducing the costs associated with raising capital. This efficiency can make STOs an attractive option for startups and smaller companies looking to reduce expenses.
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7. Liquidity:
Since security tokens can be traded on secondary markets, investors have the ability to sell their tokens relatively easily compared to traditional securities. This feature can be particularly appealing to investors looking for flexibility.
8. Fractional Ownership:
By tokenizing assets, STOs allow investors to own a fraction of an asset, such as a piece of real estate or a percentage of a company. This feature makes investing more accessible to people who might not have the capital to buy entire assets outright.
Pros of STOs
1. Regulation and Compliance:
STOs are regulated by financial authorities, which means they must comply with existing securities laws. This provides a level of security and trust for investors, as they are protected by the same regulations that govern traditional securities.
2. Investor Protection:
Because STOs are subject to strict regulations, there is a higher level of investor protection. This reduces the risk of fraud and provides legal recourse if something goes wrong, making them a safer investment than ICOs.
3. Access to Global Markets:
STOs allow companies to reach a global pool of investors. This can be particularly beneficial for startups and smaller companies looking to access international capital without the constraints of traditional financial markets.
4. Transparency:
The regulatory requirements for STOs ensure a high level of transparency. Companies must provide detailed information about their business, financial health, and the terms of the token offering. This transparency helps investors make better-informed decisions.
5. Liquidity:
Security tokens can be traded on secondary markets, providing liquidity for investors. This means that investors can buy and sell their tokens relatively easily, compared to traditional investments that may be harder to sell quickly.
Cons of STOs
1. Regulatory Hurdles:
The same regulations that protect investors can also be a hurdle for companies. Complying with securities laws can be costly and time-consuming, especially for startups with limited resources. This can slow down the fundraising process and increase overall costs.
2. Limited Investor Base:
Due to regulatory requirements, STOs often restrict who can invest. In many cases, only accredited or institutional investors are allowed to participate, limiting the potential investor base and excluding many retail investors.
3. Complexity:
The process of launching an STO is complex. Companies need to navigate a maze of legal, technical, and financial requirements, which can be daunting and require specialised knowledge and expertise. This complexity can discourage some companies from pursuing an STO.
4. Market Volatility:
Like all investments, security tokens are subject to market fluctuations. While they offer more stability than ICOs, they can still be volatile. Investors need to be aware that the value of their investment can go up or down.
5. Technological Risks:
STOs rely on blockchain technology, which, while secure, is not immune to technical issues. Problems like smart contract bugs or hacking can pose risks to both companies and investors.
To Round up, here are five frequently asked questions about STOs and their answers Q. Can anyone invest in an STO?
A. Not always. Due to regulatory requirements, STOs often restrict investments to accredited or institutional investors.
Q. Do STOs pay dividends?
A. Some STOs offer dividends or other profit-sharing mechanisms similar to traditional stocks.
Q. Why are STOs considered safer than ICOs?
A. STOs are considered safer because they are regulated, which reduces the risk of fraud and provides more transparency and investor protection.
Q. Can STOs offer high returns like ICOs?
A. Yes, STOs can offer high returns, but they are generally considered to be more stable investments due to regulatory oversight.
Q. How can I invest in an ICO or STO?
A. To invest in an STO, you may need to go through a regulated platform and meet certain investor criteria.
