The Current State of Security Token Offerings (STOs)
STOs have been gaining momentum since the end of the ICO boom of 2017 and are believed by many to become the iteration of capital raising.
In this article, we will explore the legal standing of STOs, the general sentiment expressed towards this new fundraising model and how the STO landscape may look in the future.
ICOs Versus STOs
In March 2019, consultancy firm PwC published a study in which they delve into the state of blockchain-backed fundraising models. In the paper, tilted 4th ICO/STO Report, PwC detailed a number of findings pertaining to the STO and ICO fundraising models.
While ICOs and STOs may appear to be similar to the untrained eye because of their blockchain-backed nature, there are a number of fundamental differences which provide STOs with an upper hand in terms of investor protections.
The study notes this characteristic stating: “Security Token Offerings (STO’s) are not fundamentally different from ICO’s, but a more mature and regulated form, as the underlying tokens provide different financial rights, including dividends or shares.”
The name STOs (Security Token Offerings) comes from the fact that the digital assets being purchased by investors are financial securities. As a result, they fall under the jurisdiction of regulators. In contrast, typical ICOs involve investors purchasing digital assets which they believe will grow in value. The decision to invest in an ICO is driven by the potential for future profits if/when the digital asset grows in value.
While STOs provide investors with greater control, which can include ownership rights, they also come with the features which were introduced by their predecessor, the ICO. The ICO model was groundbreaking because it allowed regular people to participate in investment opportunities which would be out of reach in the traditional financial sector due to regulatory constraints. In the same vein, while STOs are more regulated, they are still more accessible for regular investors as opposed to many traditional investment opportunities.
For many, STOs represent the logical evolution of the ICO model. In the ICO craze of 2017, investors were defrauded of their money in the millions. Unscrupulous parties took advantage of the attention the model was receiving in mainstream media as well as the largely unregulated nature of the sector to swindle people, especially those who were new to the cryptocurrency and blockchain sector.
The Head of Blockchain EMEA at PwC Strategy, Daniel Diemers, encapsulates the general sentiment of the sector as well as would be investors towards a model with more protections in place. Diemers said: “The trend demonstrates that from an investment strategy perspective, ICOs or STOs remain attractive to investors for venture capital financing. However, there is a process of rethinking in favor of more security and transparency for investors.”
The Facts And Figures
The first STOs were seen in 2017, following increased SEC scrutiny on the sector. According to PwC, the first two STOs cumulatively raised about $22 million. In the next year, 2018, STOs grew in popularity for startups looking to fund their endeavors while staying within the bounds of the law as 28 STOs were offered. The 28 projects raised $442 million cumulatively.
An important note to point out is that the biggest STO to date also ranks in the top ICOs of all time. A subsidiary of Overstock.com, the tZero STO raised $134 million in 2018 and is among the top 15 ICOs.
PwC believes that the STO model is likely to witness further growth with time stating: “In 2019 and 2020, further growth is expected, as the adaption of funding methods will increase.”
The Regulatory Environment Across the World
In Switzerland, a global leader in financial markets, the regulatory body FINMA has defined digital assets and classified them into three classes. These are asset tokens, utility tokens, and payment tokens. Therefore, any project with an asset token is considered an STO and must fulfill the requirements set forth by the regulator.
Similarly, Estonia also classifies digital assets into three types. The regulatory body, (EFSA), provides three categories namely: donations, utility tokens, and finally security tokens. If an investor receives ownership rights in the issuing company or the token is connected to any profits made by the project, the digital asset is considered a security.
In the United States of America, the Securities & Exchange Commission (SEC) considers most digital assets floated in ICOs to be securities, with the exception of cryptocurrencies. Furthermore, the SEC chairman has said that all digital assets except bitcoin and ether are securities.
The European nation of Liechtenstein has also enacted regulations to govern blockchain-backed fundraising. In its Blockchain Law, launched early 2019 the nation’s authority on financial matters, the FMA, will provide guidance to startups holding token based crowd sales. According to PwC, FMA “is said to closely interact with companies planning an STO.”
Lastly, BaFin, the financial regulator in Germany generally considers digital currencies as financial instruments. BaFin approved the country’s first STO in early 2019.
For many, the rise of STOs is a move in the right direction as it is likely to influence the growth of the sector by attracting a significant number of investors to the industry, especially since there are rights protected by the law.
Managing Director and founder of the Gibraltar Stock Exchange (GSX) Group, Nick Cowan, reiterates this sentiment stating:
“The report [PwC] highlights the increase in the tokenization of assets […] and also illustrates the steadily evolving global regulatory landscape, developments that will advance the mainstream adoption of digital assets.”
