Security tokens represent investments or an investment contract into an underlying investment asset, such as stocks, bonds, funds and unit trusts. A security can be defined as a “fungible, negotiable financial instrument that holds some type of monetary value,” backed by a real-world asset such as a company or property. A security token is a negotiable electronic instrument representing title of ownership, recorded on a blockchain. When you invest in traditional stocks, for example, ownership information is written on a document or recorded in a custodian account. For STOs, it’s the same process, but recorded on the blockchain as a token. STOs can also be seen as a hybrid approach between cryptocurrency and token offerings and the more traditional initial public offering (IPO) because of its intersection of both of these methods of investment fundraising.
STOs are asset-backed and comply with regulatory governance. Most ICOs, on the other hand, position their coins as a utility token that give users access to the native platform or decentralized applications. They argue, it is for usage and not for investment. As a result, ICO platforms circumvent certain legal frameworks and do not have to register or comply with the strict governance of regulatory bodies. The barrier to entry for companies to launch an ICO is, therefore, much lower.
It is much more difficult to launch an STO, as the intention is to offer an investment contract under securities law. Therefore, issuer platforms do the upfront work of making sure they comply with the relevant regulations. They would typically also only be able to raise funds from accredited investors who have themselves passed certain requirements.
Investopedia definition: https://www.investopedia.com/terms/s/security-token.asp
Crowdfunding is the strategy used by the SMEs to raise their funds for projects. The fundraising is done from a large set of people through the Internet through platforms such as Kickstarter or GoFundMe. Once the project gets enough funds, it is transferred to the project sponsors.
Usually, there are four methods of crowdfunding:
- Donation-Based Crowdfunding, where the investors have a desire to donate money to the projects.
- Reward-Based Crowdfunding, where investors contribute in return for some reward in the form of products or services offered by the enterprise.
- Equity-Based Crowdfunding, where the investor has the right to become a part of the company.
- Debt-Based Crowdfunding where the raising of the funds from the individuals is in return for interest. The latter is also known as Peer to Peer lending platforms which enable the lenders to earn better returns than from banks.
Both crowdfunding and ICO & STO strategies are attracting the investors globally! Crowdfunding is subject to national legislation this implies that crowdfunding platform cannot look for investors outside the own country of the platform.
Investopedia definition: https://www.investopedia.com/terms/i/ipo.asp
How ICO & STO vary from traditional crowdfunding methods?
Initial Coin Offering was the popular strategy to raise the funds for blockchain projects. Especially with the start-ups. This is a means of crowdfunding technique through the creation of digital coins or tokens. ICOs are the typical fundraising strategy which is used by the start-ups to showcase their ideas for funds.
Security Token Offering emerged with the motto of making the fundraising process more secure. Security Tokens has an advantage of regulations and laws which should be imposed on the project as per SEC Guidelines.
How STOs differ from Traditional Crowdfunding strategies?
Traditional Crowdfunding methods involve diverse industries. In the case of ICOs only blockchain based projects are usually done. STOs also involve diverse industries.
In Traditional Crowdfunding and Initial Coin Offerings, regulations are limited. But when it comes to Security Token Offerings, they are completely regulated in adherence to SEC Guidelines in all the countries.
All three platforms are open to a larger audience. There is no geographical restrictions imposed on them.
Therefore, these platforms have gained huge customers on social media. Added, this has helped investors to gain desirable funds for their projects. In the event of all the three, the exchange of money takes place between the investor and fundraising agent. Therefore, all three can be a bit risky in terms of money exchange. Though ICO’s are experiencing scams nowadays, STO platforms guarantee a return on investment which remains trustworthy for investors. On the other side, Traditional Crowdfunding cannot be guaranteed in terms of Return on Investment. In ICO & STO, rewards are received as a return on investment. It can be in the form of a token. These tokens can, in turn, provide access to the company’s services.
Why ICO & STO are a way better than the traditional ones?
Both Initial Coin Offering and Security Token Offering are a much better deal for investors. For example, consider you are investing $10,000 in traditional crowdfunding.
There is no liquidity guaranteed and you are locked up for a period of time. The Bulletin Board option given to crowdfunding platform is useless because transaction must be concluded outside the platform and it exposes to counterparty risk. As a consequence, illiquid shares are more similar to a bet than to an investment.
While in the case of ICO and STO, the markets offer higher liquidity with the fluctuations each day. Higher liquidity means also higher valuation of a company. With higher liquidity, the value of the cryptocurrency enhances as the business & projects start to raise. But anyhow, if your project is a non-blockchain project, until recently you had no other way than going with Traditional Crowdfunding platforms! Now STO platforms start to onboard all sorts and kind of industries.
Equity crowdfunding on the other hand is a small percent of the total crowdfunding market. This because a potential exit after 3-5 years and only in case the company got IPO-ed or acquired.
Why is then crowd-funding is still practiced and especially in the UK? The short answer is: “Crowdfunding is supported by tax reliefs.” The long answer is more convoluted, but many people view it as a hobby, nice pass-time and a betting exercise and commit only small amounts of money.
STOs are the best method. Information is provided in an offering prospectus and only facts can show up in them due to regulation restrictions. With STOs there is secondary market which provides liquidity before exit.
So do ICOs but these are more risky as not regulated and all sorts of claims and misappropriations can happen. STOs reach investors everywhere as they are blockchain powered, which also eliminates costly custodians for holdings and transfers. STOs are available and most secure part of crypto markets. As STOs are smart contract based these can be traded on decentralized exchanges with no third party risk and transfers tied up to payment as with traditional letters of credit. Crowdfunding is for small project, a prospectus cannot be deposited so deal below 8 mln in EU and legislation is different in every country (without an EU prospectus).
Hence the crowdfunding technique is for small national projects. STO can be used for big, international projects – prospectus can be deposited, and self-issuance privilege can be used Crowdfunding returns are low and it doesn’t really allow to build a diversified portfolio. The only market where it might make sense to launch a campaign is UK – rest of Europe is not significant.