security token offering

While for ICOs the way it usually works is tokens or coins are offered by companies for purchase as a form of crowdfunding, however with STOs, security token offering, it’s an upgrade whereby you can purchase tokens during the offering that you can then trade, sell, or hold. Moreover, since security tokens are actual financial securities, your tokens are backed by something tangible like the assets, profits, or revenue of the company.

Security Token Offering Key Features

Security tokens are tied to real securities, which may represent tokenized assets. In certain cases, these tokens can represent actual equity, acting as “digital shares” of a company. Although not necessarily tied to equity in all cases, they can be used to fractionalize ownership in a variety of assets ranging from real estate to fine art. In effect, they can grant token holder an array of rights.  This may mean equity ownership, periodic dividends, cash flows, debt repayments, voting rights and more. All these rights are codified by a smart contract that governs the token.

More importantly, the nature of these tokens means they are treated very differently from a legal and regulatory perspective. Because they derive their value from actual securities, security tokens are considered investments. This also means additional regulatory and reporting requirements for the issuing entity.

STOs are crypto tokens that pass the Howey Test. These tokens usually derive value from a tradable external asset and are subject to federal securities and regulations and hence deemed as Securitized tokens.

Howey Test

In 1946 the Supreme Court developed a test which is used to determine whether a certain transaction is an investment contract or not. If it is, then it will be subject to securities registration requirement.

The said transaction will be called an investment contract if it fulfills the following criteria:

  • It is an investment of money
  • The investment is in a common enterprise
  • There is an expectation of profit from the work of the promoters or the third party.

Even though the original Howey Tests used the term “money”, later cases expanded that to include other investments and assets other than money.

Are STO the new ICO?

The SEC and FINMA have broken down tokens into two broad categories:

  • Utility Tokens
  • Security Tokens

Utility Tokens

Because most of the ICOs are investment opportunities in the company itself, most tokens qualify as securities. However, if the token doesn’t qualify according to the Howey test, then it classifies as utility tokens. These tokens simply provide users with a product and/or service. Think of them like gateway tokens.

As Jeremy Epstein, the CEO of Never Stop Marketing, explains, Utility tokens can:

  • Give holders a right to use the network
  • Give holders a right to take advantage of the network by voting

Since there is an upper cap on the maximum token availability, the value of the tokens may go up because of the supply-demand equation.

Security Tokens

A crypto token that passes the Howey Test is deemed a security token. These usually derive their value from an external, tradable asset. Because the tokens are deemed a security, they are subject to federal securities and regulations. If the ICO doesn’t follow the regulations, then they could be subject to penalties.

However, if all the regulations are properly met, then these tokens have immensely powerful use-cases.

Why are Security Tokens Important?

  • Credibility

As of right now, the ICO space is a little dicey, to say the least. There is a real deficit of accountability in the space because of a lack of regulation for utility tokens. In order for the ICO space to regain some credibility, it should make sense to somehow amalgamate the crypto space and the legacy finance space together.

  • Improving Traditional Finance

Traditional financial transactions can be a little expensive because of all the fees associated with the middlemen like bankers. Security tokens remove the need for middlemen which reduces fees. In the future, smart contracts may reduce the complexity, costs, and paper works.

  • Speeding up Execution

Traditional finance institutions have a lot of middlemen involved which simply increases the execution time. By removing these middlemen, securities allow for faster execution time for successful issuance of security tokens. Because of this increased speed, the security tokens are bound to become attractive investments.

  • Exposure to Free Market

Investment transactions today are extremely localized. Well, by using security tokens, creators can market their deals to anyone on the internet. This exposure to free market helps in increasing asset valuation.

  • Huge Number of Investors

Since creators can now present their deals to anyone on the internet, the investor base increases exponentially. This is another huge incentive for creators.

  • Reducing Lawyer Service

In the future, security token projects will use smart contracts which will automate service provider functions through software. These functions are currently provided by players such as lawyers which add on to the potential middlemen involved in the project.

  • Lack of Institution Manipulation

Because the number of middlemen decreases drastically, the chances of corruption and manipulation by financial institutions decrease drastically as well and may even be removed from the investment process.

  • Easier Liquidation

Secondary trading on security tokens will be made simple through licensed security token trading platforms and it will be extremely easy for investors to liquidate security tokens.

Best Security Token Offering Platforms

Polymath

Polymath is providing the technical and legal solutions for securitizing your stocks, bonds or other assets on a blockchain. They call themselves ‘Ethereum of security tokens’ and creat a one-stop shop for all things concerning security tokens. Polymath has introduced concepts on its platform such as KYC Identity Aware tokens and liquidity for private entities, and it allows for the creation of security tokens within minutes.

They also have their own ST-20 token standard to issue new tokens and also their native smart contracts.

The Polymath team appears to be solid, with diverse experience in the tech space, crypto world & financial sector.  They have chosen a great advisory panel as well, including some very accomplished individuals in the crypto space.  On top of this, they’ve partnered with tZERO (marketplace/exchange), SelfKey (ID on blockchain) & CrowfundX (digital AI for marketing).

Advantages:

  • Active public communication – one of the largest Telegram groups
  • Securities are a $10T market which is yet to be tokenized
  • Strong team & advisors
  • SEC & CFTC seem likely to deem at least some utility tokens securities, thus increasing the need for a platform like Polymath

Disadvantages:

  • New team & new project – started in 2017
  • No publicly released roadmap of any kind
  • Outsourcing the major components: KYC validation, legal compliance, token development

Swarm

On Swarm, users can tokenize real-world assets based on their SRC20 protocol, which is a token and smart contract standard for securities issued on the platform. The protocol has put in place a set of rules issuers must adhere to before they can launch their tokenized security.

Examples of assets that can be tokenized through Swarm are real estate, renewables, agriculture, tech companies, and many more.

The WRC-20 protocol already includes features such as ownership representation, voting procedures, automated dividends, revenue streams, and regulatory compliant trading. It is expected to allow for many more features to be incorporated in the protocol, and thus in the security tokens launched through Swarm.

SRC20 security tokens can do following things but are not limited to:

  • represent ownership of part of an object or “asset”,
  • allow holders to manage that asset through voting,
  • secure a right to any revenue streams from the asset, and,
  • are tradable in a regulatory compliant manner.

And just like many other platforms Swarm has its native token called SWM to facilitate economic activities on Swarm platform.

Advantages:

  • Open-source blockchain technology;
  • The investor has a direct ownership of the SRC20 tokens released on the opportunity
  • Investing cryptocurrency into real assets and deploying traditional capital into crypto markets

Disadvantages:

  • Some feel that Swarm is “reinventing the wheel” and filecoin should just be used instead.

Tokeny

Tokeny is aiming to bring liquidity to the best investment opportunities in the form of security tokens, and the platform is designed to support clients in all aspects of launching them: sale of the tokens, full management of the tokens while they are live, and all technicalities concerning smart contracts, tokens, and regulatory compliance so the projects can focus on their core business.

The Luxembourg-based security token platform will also support the launch of utility tokens, which is a USP of the project in regards to its competitors.

The core focus of Tokeny is to bring institutional-grade solutions to the token security space. It has, for example, incorporated a bank-grade KYC procedure.

Advantages:

  • Secure end-to-end platformallowing the sale and management of tokens during and after an ICO or STO
  • Can handle high volumes of contributors simultaneously

Disadvantages:

  • A new platform launched in 2018
  • Not much publicity

Securitize

Securitize is a regulatory compliant cloud service solution for the tokenization of securities, enabling tokenization of funds, companies, or other entities.

The company provides several services including establishing the legal and regulatory readiness of the issuers and their legal team, streamlining investor registration in compliance with KYC/AML accreditation or other legal requirements, customizing smart contracts to match issuers’ unique requirements and security token data throughout the lifetime of the security. Spun out of SPiCE VC, the platform has secured commitments from companies running ICOs in aggregate of $500 million.

Securitize does this through their DS protocol that works with DS tokens. DS tokens are nothing but ERC-20 compliant tokens that also implements the additional hooks required by the DS Protocol.

Perhaps the most interesting aspect of the new protocol is its ability to integrate third-party applications running on the Ethereum blockchain. This will enable companies to build their own clients to enhance user-interface, and could open the door to third-party developers being incentivized to create new and exciting developments within the growing sector.

Additionally, the protocol will integrate several new capabilities for stakeholders. The first among these is a trust service, which would enable clients to authorize other applications or exchanges to use existing issuance protocols.

A registry service will make registration information available throughout the lifecycle of the coin, regardless of the stage of interaction.

Advantages:

  • DS protocol that works with DS tokens
  • Built-in KYC/AML
  • High security standards
  • Crypto Escrow and Custodian

Disadvantages:

  • Not much publicity

Lottery.com

Lottery.com, formerly AutoLotto, is a mobile lottery service. The company intends to utilize blockchain technology to enhance its services through instant payouts, transparency, flexibility, and expansion across international markets. The company is nearing the close of the private sale of its STO, rumored to be in the nine-figure range. This securitized token produces a financial yield to token holders based on gross raffle sales. Securitize and Cashbet have partnered with Lottery.com to help bring the offering to the market.

Through the use of Blockchain technology, the company hopes to improve its services by expanding across international markets, enabling instant payments, and increasing transparency and flexibility.

The company’s private token sale is about to come to an end, and rumor has it that the STO could be in the nine-figure range. Holders of this securitized token will receive financial yields depending on the gross raffle sales.

The company’s notable advisors include; Miko Matsamurawho (founder Evercoin), Miguel Forbes (founder Forbes.com) and Joey Krug (CIO Pantera Capital).

Advantages:

  • Famous and successful advisors

Disadvantages:

  • The results of the token sale are still unknown

Siafunds

Sia is a peer-to-peer cloud storage platform based on Blockchain technology. The platform allows hosts to lease out their storage capacity to renters.

The renters and the hosts use Siacoins, one of the tokens utilized by Sia, as a medium of exchange for execution of deals. The other token used on Sia is Siafunds.

Both the renters and the hosts pay network fees to the platform. These fees amount to about 3.9% of the total spending. Siafunds receives a proportional amount of these fees.

Out of the total 10,000 Siafunds, the operating company of Sia platform (Nebulous) is offering 750 as a reg D security token. This is an example of a dual token or “two-tier” issuance that is both a utility and security token.

Advantages:

  • Dual tokens issuance

Disadvantages:

  • Amount raising isin progress

Summary

With the arrival of the security token offering (STO), the crypto space is beginning to reach an uncharted level of legitimacy in the financial community. We are about to witness perhaps even more disruption in markets and society than we’ve been promised.

Some evangelists argue that these securities will gain so much popularity in the coming days that they will completely replace traditional stock exchanges and OTC markets.