What Is a Security Token Offering (STO)?

2017 and 2018 were the years of ICOs (Initial Coin Offerings). ICOs first became popular in 2017, and they have since raised billions of dollars for a wide variety of crypto projects. The explosive growth of token sales helped to accelerate the adoption of Ethereum and cemented its place as a key value player in the crypto ecosystem. ICOs ultimately launched a new generation of blockchain projects that have significantly shaped the wider crypto ecosystem. However, in 2019 a more institutionalized process started to take space: the affirmation of STOs.

What Is a Security Token Offering (STO)?

A Security Token Offering (STO) is an initial public offering of tokens representing security. It can be said that an STO is a combination of an IPO (Initial Public Offering) and an ICO (Initial Coin Offering).
In traditional finance, the IPO refers to the public offering of shares of a public company to either institutional or private investors. Through the IPO process, a private company goes public and raises equity to scale up.
In the world of cryptocurrencies, the equivalent of IPO is represented by the ICO. The main difference is that ICOs are not regulated by any institution, but take place directly on the blockchain without the need to verify the investors’ identity through KYC procedure.
In a nutshell, an STO applies the benefits of blockchain to a common practice of the traditional finance world (the raising of capital to grow a business) in a way that is fully regulated and compliant with the law. When traditional stocks are purchased, ownership information is written on a document and issued as a digital certificate. In the case of STO, everything is registered on the blockchain, and therefore the security token represents the ownership information of the investment product.
In the past, several ICO projects have turned out to be scams causing numerous investors to lose money. Because of this, ICOs have been banned in many countries, and are continuously monitored by regulators in the others. Ultimately, it can be said that STOs represent an advanced and updated type of ICOs, as they must be totally compliant with the law.

How Does an STO work?

An STO is the process of selling security tokens to the public while avoiding the long exhausting process of an IPO. However, STOs are intended to be compliant with Anti Money Laundering requirements and securities law. The process of issuing an STO is still not as quick and simple as it seems, and it requires a high level of legal advice. Processes can be generalized in the following phases.

Preparation

After having carefully prepared the business plan, the issuer prepares investor information that is aimed at the target investors. This document contains information outlining the business plan, profit forecast, capital requirement, and independent valuation. The content requirements depend on the jurisdiction of targeted investors, the issuer, and the broker.

Deciding the Features of the Offering

Issuers decide the quantity of tokens, the value of each token, soft
capitalization, rights, and the duration of the offering. In this phase, it is highly recommended to appoint legal professionals to consult on legal matters.

Selection of Service Providers

In this stage, issuers select blockchain platform, technology, and financial intermediaries. Issuers should also appoint a reputable service provider to hold the underlying assets in custody, keep and facilitate the received cash flow, and market the token.

Capital Raising

With the assistance of the brokers, the issuer identifies their target investors and distributes the information to them. The brokers would then collect the funding from the investors and distribute the tokens to them.

Listing of Security

In this final stage, the issued token will be listed on the trading platform. Issuers might also conduct further marketing activities and appoint a market maker to boost liquidity, as this is often one of the significant incentives for investors. Listing rules, trading fees, minimum size of issuance of token should be clearly stated.

What Are the Advantages and Disadvantages of Dealing With STOs?

Dealing with STOs has several advantages, both from the perspective of the company and from that of the investor. A security token that represents a corporate share, benefits from the properties of the blockchain it is issued on. The most relevant advantages are listed below.

Bigger Markets for Investors

Since digital securities are easily marketed and transferred across borders, a wider audience of investors can be reached. So, from the fundraiser’s perspective, launching an STO would allow his company to reach investors from all over the world.

Divisibility

A tokenized security can be divided into several parts, thus, allowing investors to hold even just a part of a single company share. This dramatically increases accessibility, because it allows small savers to access financial instruments that are difficult to access in the world of classic finance.

Rapid Settlement

Thanks to blockchain technology, the buying and selling processes, as well as the transfer from one wallet to another, are automated and can be completed within minutes. Consequently, the mechanism turns out to be cheaper, because slow and costly administrative procedures are eliminated.

Transparency

The blockchain is a public ledger, so anyone can view the smart contracts that manage the tokens and track issuance and holdings. Moreover, STOs remove the threat of scams through the implementation of regulation and oversight. While ICOs were traded on shady and unregulated exchanges, STOs are traded on the verified ones.

Due to regulatory uncertainty, the lack of dedicated services, and often low liquidity, STOs have not yet managed to go mainstream. Due to these factors, many projects may become accessible only to a small number of investors at launch, leaving aside those who do not have sufficient capital. On top of that, the high cost of compliance may deter many investors and companies from participating in STOs.

Conclusion

These are just the early days of STOs and as we move forward, more and more companies are thinking how to ‘tokenize’ their assets in order to raise funds. At this point, STOs are mainly suited for early adopters, who are looking to invest in something new and exciting.
Many people believe that STOs can become a powerful catalyst for institutional investors, and thus, contribute to the adoption of blockchain and cryptocurrencies worldwide. There is still a long way to go on the regulatory front, as the authorities must find ways to effectively regulate the issuance and flow. Nevertheless, the security tokens represent an evolution in the world of finance.