Token Funding Models: Key Differences Every Investor and Cryptoasset Manager Needs to Know
Understanding the different types of funding models in the crypto space is important knowledge for high-performing fund managers and investors.
Raising money in the blockchain industry is a rapidly evolving process. In just under 2 years, the industry has moved on from the wild west of unregulated ICOs to regulated STOs, IEOs, and more recently, STEOs.
These acronyms may be confusing at first glance, but they’re easy to grasp — even for the non-technical among us. In this post, we’ll go over each of these crypto funding models and explain their key differences.
How Token Funding Models Have Evolved Over Time
Crowdfunding in the cryptocurrency market has quickly evolved from completely unregulated and highly speculative ICOs that raised millions in minutes to the regulated, highly transparent funding models in use today.
Initial Coin Offerings (ICOs) were first designed as a way for blockchain companies to raise money for project development. As the name suggests, ICOs work similarly to traditional IPOs used in capital markets, but without granting investors any company stock or dividends.
However, ICOs became unsustainable after a period of time due to shady companies exploiting the disadvantages of the model. This led to a dramatic market crash as regulators and governments cracked down on ICOs to prevent investor losses from scams and unstable projects.
Heavy doubts were cast on the future of many innovative blockchain projects, with most believing it to be the end of capital funding in cryptocurrency markets — that is until STOs entered the scene.
The Rise of the STO Model
Security token offerings (STO) were developed as a solution to the biggest problems with ICOs — the lack of both a legal framework and ownership rights to actual assets. STOs are rising in popularity among blockchain startups, with one study showing a staggering 130% increase in STOs in the first quarter of 2019. The same report also shows a noticeable drop in ICOs, signaling the end of the once in vogue funding model.
Unlike ICO tokens, which have nothing but potential utility backing their value, security tokens are pegged to securities. As a result, token issuers and holders are automatically obliged to follow the same regulatory requirements and federal laws related to standard securities (e.g. SEC and FINMA regulations).
This is made possible through tokenization, which tracks the ownership of real-world assets on a blockchain — similar to the traditional Direct Registration System securitization process, but using blockchain databases. This has clear advantages over using traditional securities registries.
Each token, for example, could represent a share in a company, a piece of property, or even bonds if governments adopt digital tokens. Unlike with traditional securities markets, ownership of these tokenized assets can be easily and quickly traded at any time without the need for intermediaries or specialized knowledge.
Every company issuing security tokens must provide thorough financial reports and risk disclosures, among other things, for their STO to be considered legal. This boost investor trust and protections, as they have full transparency on whether the projects they invest in are legitimate. Unlike with ICOs, it would be much more difficult for groups or individuals to simply run away with the money scot-free.
In STOs, companies place more emphasis on the investment aspect of the token rather than its utility. Since STOs are essentially securities in easily tradable digital form, they create liquidity while making markets more transparent and accessible to the average investor, especially institutional investors.
Security tokens are backed by company assets like shares, which gives token holders the right to receive dividends and/or vote on the company’s business decisions. As mentioned earlier, security token holders are also protected by existing regulations and rules designed to protect investors in the securities space.
There are three types of security tokens that can be issued in an STO:
Equity Tokens
Equity tokens are equivalent to stocks in a company. This type of token gives holders voting and dividend rights depending on how many tokens they hold. For example, an individual with more Company A tokens will have more voting power and receive higher dividends compared to individuals who own less Company A tokens.
Reserve Assets Tokens
Reserve assets tokens are usually issued by blockchain companies that work in physical industries with high-value assets like real estate. This type of token is backed by the value of the pegged asset’s reserves (e.g. gold reserves) — an attractive option for investors who prefer stable, non-volatile tokens.
Debt Token
Debt tokens work similarly to a promissory note. These tokens will be bought back by the raising company when the purchase condition is triggered, usually when the token hits a specific value.
Entering the IEO Age
Initial Exchange Offerings (IEO) are relatively new to the cryptocurrency space, but they’re already the funding model of choice for many blockchain startups.
In IEOs, tokens are sold on exchanges on behalf of companies. This provides valuable exposure to companies, as they’re promoted by the exchange to the millions of investors who engage with the platform, drastically reducing marketing costs.
In ICOs and STOs, token listings do not happen immediately since it takes a few months for exchanges to put up tokens on their markets. With IEOs, however, the listing process is almost always instant, as the exchange is involved throughout the entire lifecycle of the token sale.
How an IEO works is simple. The raising company issues its tokens and sends them to the exchange. The exchange then vets the project, structures the IEO from A to Z, and promotes the token sale to verified users.
Token holders are also protected well in terms of their investments. Exchanges are almost guaranteed to perform thorough due diligence on potential IEOs, as they don’t want to risk their reputation.
This ensures only the crème de la crème of blockchain startups are allowed to hold IEOs, which decreases the risk to investors of losing money to dubious projects.
STEO: The Next Phase in Crypto Funding
The next big thing in crypto funding is the STEO model, which combines the best of the STO and IEO models.
STEOs bolster investor security by establishing who is allowed to buy and sell tokens through KYC/AML procedures. This prevents market manipulation like pumps and dumps since unverified individuals cannot trade STEO-issued tokens.
Transparency is guaranteed, as investors are given access to all relevant data on companies raising funds through the STEO — a process further strengthened by the due diligence requirements of exchanges.
It’s clear that STEOs will be the funding model of choice for innovative blockchain companies as crypto markets mature through public adoption and more clearly-defined regulations.
How Cryptoasset Managers Can Keep Up with the Latest STOs, STEOs, and IEOs
For cryptoasset managers, nothing is more important than keeping up with the latest updates and insights into the crypto funding space. This is where the right information aggregation system comes in handy. A professional-grade, multi-channel big data platform like Blue Swan can provide everything traders need to know about the latest IEOs, STOs, and STEOs.
Blue Swan Grading can benefit managers immensely by offering a comprehensive analytical framework that aggregates essential data from a diversity of sources, offering a comprehensive market overview.
Blue Swan does everything from analyzing news and media coverage to assessing project development status. The platform also takes into account the skills and reputations of the teams behind crypto projects while keeping up with their regulatory compliance (or lack thereof). In short, the platform offers unbiased market analysis and project ratings and classifications that investors need, allowing them to make faster and smarter trading decisions.
Blue Swan Grading also offers API tools and customizable features for developers to make full use of the platform.
Be one of the first to benefit from Blue Swan Grading by signing up for our private alpha test.
Understanding the different types of funding models in the crypto space is important knowledge for high-performing fund managers and investors.
