What is a Security Token Offering (STO)? Complete Guide

An overview of security tokens

A security token is a regulated digital asset lying at the intersection between traditional financial assets and digital currency. Simply put, if Bitcoin is “programmable money”, a security token is “programmable ownership”. Any type of asset that can be owned (e.g. stocks, bonds, real estate, art, private equity, or even cars) - whether tangible or not - can also be tokenized. One of the most exciting features of a security token is its intrinsic value; the mere fact that it is asset-backed, thus providing investors legal rights to ownership.

Traditional securities bought by investors are difficult to exchange into fiat without considerable effort. Security tokens are looking to solve this issue by bridging the gap between the crypto market and traditional financial markets because they serve people’s best interests. They enable easy asset trading by unlocking liquidity while also protecting investors through Blockchain technology, and the smart contract system.

Security tokens can attain an incredible degree of liquidity  because they self-execute. With smart contracts in place, actions are carried out automatically and autonomously. This feature alone provides investors with frictionless, greater freedom when looking to move and control assets.

In terms of main characteristics of a security token, the following apply:

• Automated compliance

  Abiding by a strict set of rules and regulations is one of the most challenging aspects of trading securities. This happens because regulation varies by investor type, asset type, and jurisdiction, to name a few. The programmable nature of a security token allows it to back compliance into the token. Harbor and Polymath are two legally compliant protocols that work with trading platforms such as tZERO to ease compliance and automate processes.

• Free market exposure

  Traditionally, it’s tough for Asian investors to invest in US real estate or private startups. With security tokens, owners are at liberty to market deals worldwide, and to whomever they want within specified regulatory limits. Deals can be closed on a global scale, and to any type of investor who has access to the internet. Security tokens enable international trade, democratizing and liberalizing the exchange of securities.

• Fractional ownership

  Artwork and real estate are high-priced assets worth millions of dollars. Most investors are ripped of the opportunity to invest because they cannot afford to. However, with security tokens they can benefit from fractionalized ownership. Rather than spend a fortune on a whole property, rare painting or vintage car, they can spend less by investing in fractions of that asset.

• Low fees

  Security tokens reduce fees significantly when trading digital assets because investors no longer have to deal with middlemen. With smart contracts in place, the process (e.g. wiring funds, signing papers, mailing checks) becomes programmable, with little costs involved and hassle-free.

Key takeaway: Utility tokens are tokens issued in an ICO (initial token offering) in exchange for money. Security tokens are tokens that share profits, pay dividends/interest with the purpose to generate profits for token holders, aka the investors.

What is an STO

In spite of a bearish crypto market, security token offerings (STOs) emerged in 2018 as a valuable, secure, and extremely powerful alternative to venture capital and private equity funding for many international startups. For investors, STOs provide new opportunities to buy security tokens backed by real-life assets. For startups, running an STO could help access more trustworthy funding that guarantees future success.

To better understand what is an STO, the following benefits apply:

• Access to international capital

  An STO goes beyond borders, which means companies of all sizes and shapes can better market themselves to investors. The flexibility of a security token offering provides startups with a unique opportunity to access deeper funding pools, while also increase brand awareness.

• Improved regulatory oversight

  Global regulators such as SEC (US), BaFin (Germany), or FINMA (Switzerland) strongly agree that cryptocurrency tokens should be regulated. To preserve transparency, an STO demands KYC/AML verification to protect both investors and the companies issuing an STO.

• Funding reimagined

  As opposed to raising funds from a VC, an STO can provide better terms. Startups don’t have to give up company ownership, which means management teams remain in control of their business decisions. Also, STOs don’t demand equity and startup owners can easily retain a higher ownership percentage of their business. Although dividends are granted to investors through security tokens, an STO doesn’t force a business owner to provide voting rights; this gives management teams more freedom and control.

STO use cases that go beyond hype

One cannot explain what is an STO without diving into some of its best use cases. By 2020, they are projected to reach a $10 trillion market cap. A market growth catalyst of STOs is Polymath, a platform that seeks to become “the Ethereum of security tokens” by simplifying the process of running a security token offering. With their own ST-20 token standard in place, Polymath bridges the gap between Blockchain and financial securities. tZero, a Blockchain-based innovation platform for capital markets, leverages the distributed ledger technology to revolutionize conventional Wall Street operations. The project raised an alleged amount of $134 million in an STO, and has recently completed the distribution of its security tokens to investors.

Numerous crypto exchanges have already applied to become regulated in order be able to list STOs and security tokens. Coinbase, the Gibraltar Stock Exchange, and Malta Stock Exchange are just three examples.

What the future holds for STOs

By the end of 2019, the question will no longer be ‘What is an STO’. But ‘How do I do an STO?’ With everything that happened with initial coin offerings throughout 2017, it is estimated that things will flow at a more relaxed pace with STOs this year. All startups need to raise money, although the IPO route has proven troublesome. VC funding is no longer a viable option because it takes time; not to mention that startups end up losing too much control over their companies.

STOs entered the scene following the ICO bloodbath of 2017. Armed with better rules that fully comply with securities regulations, security tokens are backed by tangible assets. With Blockchain, all tangible assets can be tokenized, whether it’s stocks, real estate, art, and more. In 2019, we should expect more startups with Silicon Valley material to turn their attention to STOs. Why? Because it could be an opportunity for them to raise money, expand their business, retain ownership, and at the same time keep investors happy. A win-win situation for all parties involved!