There is currently an intense debate raging within the crypto community. This debate is centered around the emergence of a new method of raising money for blockchain projects, this method is called a Security Token Offering (STO).
Some people believe that STOs, will eventually completely replace the original Initial Coin Offerings (ICOs). Others believe that STOs in their current form actually take away from a lot of the original positives that crowdfunding through an ICO provided.
In this guide, we will explore the key differences between ICOs and STOs, so that you can be clued up on the new fundraising method in the world of crypto.
What is an ICO?
Firstly, we will start by briefly explaining what an ICO is.
An ICO is very similar to an IPO in the world of traditional investments. ICOs themselves are a method of fundraising where a company who is looking to establish a new product or service will look for outside investment to help fund their venture. The company running the ICO will do this through various forms of marketing.
In exchange for their investment, the investor will receive a certain number of cryptocurrency tokens that are unique to the ICO. Investors can either use traditional, fiat currency or other tokens.
Investors buy into the project with the hope that the value of the token will increase from the base price. They will then hope to trade the token later on for a profit.
Companies will mainly use an ICO to avoid the strict regulatory procedures (which are expensive and time-consuming) involved with normal fundraising methods.
There are also a number of different ways in which an ICO can be structured. Each token can be given a normal, flat price that will not change during the ICO, or, the value of an individual token may raise during the ICO, based on how much money has been received in that funding round.
It is very simple for a business to launch an ICO, as there are a number of different platforms that are willing to host your ICO launch for some sort of consideration.
The ease and freedom provided by an ICO have led to a boom in the blockchain industry, in 2017, money raised through ICOs topped $6.2 Billion.
Like with anything, there is always a catch. Due to the unregulated nature of ICOs, they are very susceptible to fraudulent activity and a large number of investors have been left out of pocket by shark-like businesses who will create an ICO, then take the money and run. Furthermore, due to there being no regulation for ICOs, stolen money can almost never be recovered.
The statistics make for fairly damning reading. According to a study produced by Satis Group LLC ,81% of ICOs that they analyzed had been found to be scams. Further to this, 6% had actually failed, 5% had gone dark and only 8% went to trade on an exchange. This doesn’t make for very good odds for investors.
This is one of the reasons that a large number of investors have been hesitant to invest in ICOs. They feel that the risk of being scammed is so high, that it does not warrant the potential returns that could be made.
What is an STO?
Now, we will briefly go into detail about what an STO is.
Whenever explaining what an STO is, it is always important to explain what a security is.
“In terms of finance, a security is a certification or some other financial instrument, that has an intrinsic monetary value. These securities can then either be traded by exchanges, who will broker the transaction or, they can be traded directly from peer-to-peer. These securities are then broken down into two subcategories, equity, and debt securities. This is in effect, owning part of a company, without actually taking it into your possession.”
Companies use this as a way of offering part of their business to investors, in return for a short-term cash injection that can help them to realize their latest goals and plans. Investors can also be entitled to profits, dividends and interest rates.
So, a Security Token is a crypto token which can entitle the owner to either a share of the profits of the business, a stake within the business itself or some other form of reward in exchange for their own money.
Security Tokens also have to fulfill the requirements of the Howey Test to be considered as a security. The requirements were established in the case SEC vs W.J. Howey Co. 1946.
The requirements are as below:
- It involves an investment of money.
- There is an expectation of profit from the investment.
- The investment of the money is in a common enterprise.
- The profits are derived from a promoter or a third-party.
STOs are always backed by some form of tangible asset, which helps to prevent investors from falling prey to fraudulent business practices.
Due to the fact that STOs are classed as securities, they are also subject to securities regulations for the country they are launched in and for the countries of their investors. For example, if you were launching an STO in the United States and you have an investor from the United Kingdom, you will have to comply with both the American Securities and Exchange Commission (SEC) and the British Financial Conduct Authority.
In the US, you will need to register with the SEC, meaning you will need to provide them with the following information:
- A description of your company’s property and business purpose.
- A description of the security you are offering.
- Information on your management structure.
- Your companies financial statements, confirmed by an independent accountant.
This means that when launching an STO, you would need to enlist legal support to help you properly understand the required regulatory practices.
All of this legal red tape can be expensive, however, it also provides protection for businesses who are looking for investment. Due to the fact that investors in an STO, have to be identified, there is less chance of an investor using your business for illegal monetary activities. This can help to preserve the image of your business and can prevent you from falling into any legal trouble.
The legal ramifications of STOs mean that there is a slight barrier for entry for investors. In the United States, when registering your STO with the SEC, you will need to apply for an exemption to seek investment. At the moment, all STOs are registered under a Regulation D exemption. This means that in the US, only accredited investors will be able to put money into your business.
Despite this, offering your business to investors through an STO is still more cost effective than the traditional method of making an Initial Public Offering on your country’s stock market. There is a lot less expensive administration involved and the number of regulatory hoops that you need to jump through, are still lesser than the traditional method.
Also, when you have the correct set-up and you have marketed your STO correctly, Security Tokens can be traded incredibly easily on your chosen exchange. They are a lot less cumbersome than traditional company stocks and more secure than ICOs.
STOs have also helped to provide a better reputation for the crypto world. This is because currently, as we mentioned before, ICOs have a reputation for being a hotbed for fraudsters. Due to the more regulated nature of STOs, they have made it so that token offerings are seen as more credible to investors. This is predicted to help the token offering movement to scale up even more in future.
These factors have led to many predicting that STOs will replace ICOs in the coming years. Others argue that they defeat the original purpose of ICOs due to the fact that they are subject to regulations and red-tape.
STOs have already resulted in some big moves for businesses. For example, crypto-exchange LXDX offered out 10% of their business, which could be bought through 5 million Security Tokens. They offered these tokens for one Euro per token, which led to an earning of $5 Million for them. As time goes on, we will see STOs that are a lot bigger than this and time will tell, if they’ll be able to surpass the money raised by filecoin.
The Differences Between ICOs and STOs:
Now that you have read to this point, you probably realize that there are a lot of differences between ICOs and STOs, despite their similarities. So, we have composed an easy to understand table, which will clearly display the similarities and differences between the two funding methods.