ICOs vs STOs
In 2017, the Initial Coin Offering (ICO) model raised more funds than venture capital funds. This cryptocurrency crowd sale model became so popular that it even has its own definition in the Merriam-Webster dictionary.
Recently, however, a new model has emerged in the space. The Security Token Offering model (also known as Virtual Financial Asset Offering in blockchain-friendly island, Malta) has been gaining forward momentum, especially with certain regulatory bodies tightening the noose on ICO-funded projects. For the uninitiated, here’s an informative read about STOs and properties of security tokens.
Confused about the two types of coin offering models? Here are the main differences that every investor and trader should know:
Compliance
The most striking difference between the two models is regulatory compliance, or lack thereof. Traditionally, most projects that adopt the ICO model regard their ICO tokens as ‘utility tokens’ to distinguish themselves apart from a security. While it is debatable whether these utility tokens are legally classified as ‘securities’ by regulatory authorities, ICO projects, by their definition, are not compliant.
On the other hand, STO projects have to comply with regulatory frameworks and do well by their investors. Furthermore, to enforce this, compliance is encoded in security tokens via smart contracts.
Barrier to Entry
Apart from the regulatory checks, launching an STO is significantly harder than launching an ICO because of the high fees a company needs for the offering. Lawyers are needed to ensure compliance to the regulatory framework, and therefore high legal fees are a definite by-product of the STO model. In addition, exchanges licensed to facilitate security token trading might also have their internal criteria to protect users on their platform.
These factors result in STOs having a higher barrier to entry as compared to ICOs in their heydays.
Ownership Stake
Rather than purchasing (utility) tokens that only gain actual value when a company’s product or service is ready, security tokens ensure that you have ownership stake of a tangibly-backed asset. This could represent rights to a share of the company’s revenue, meaningful voting rights and more, so investors do get a slice of the proverbial pie.
Investor Protection
ICOs work on a high-risk, high-reward model, which meant that while early investors reaped large profits, later investors may not have fared as well. With most projects shying away from the term ‘security’ themselves, these projects are technically (but not necessarily legally) exempted from security regulations. Since they are not compliant, investors are not able to seek legal recourse, leaving them unprotected and vulnerable to frauds.
STOs, on the other hand, have been verified and approved by relevant competent authorities with the vested interest in investor protection. The higher barrier to entry acts as a rudimentary filter to sieve out less competent and/or potentially fraudulent projects that are trying to enter the space, while licensed exchanges that are driven to protect their users run meticulous reviews before listing STO projects.
While these measures may not necessarily eradicate all fraudulent and/or incompetent projects, investors will not be left totally vulnerable to said projects.
Liquidity
Because of the low barrier to entry, ICO projects quickly saturated the new market, resulting in a wide array of tokens and high liquidity. In addition, because ICO tokens are not compliant to regulatory frameworks for securities, the ICO market has a relatively high liquidity.
On the other hand, STOs (as well as the other players of the STO ecosystem) are governed by security laws, and therefore the number of STO projects and exchanges available are currently significantly less than that of ICOs, therefore the STO market less liquid is at the moment.
However, once the STO world works out its kinks, STOs would be set to revolutionise the traditional financial world as we know it. Security tokens, highly reminiscent of their traditional equity counterparts, would not only usher in institutional funds, but also be a potential way to tokenise everything, making security tokens extremely liquid.
Conclusion
While ICO tokens have historically been proven to be a lucrative investment, there is definitely accompanying risk. Therefore, participating in ICOs is suited for risk-oriented individuals. On the other hand, security tokens are just starting to make ripples in the space, but it is undoubtedly only a matter of time before traditional assets are tokenised and traded, generating extremely high liquidity.
All the best,
Min
