Regulation of cryptocurrency is a hot topic today not only in the USA or China, but globally, as most of supervisory authorities, including SEC, have started investigating utility tokens to find out which of them are in fact securities. As a result, blockchain companies have to prove the nature of their tokens not only to the authorities, but even to crypto exchanges. The market is fading without new solutions.
ICO’s hegemony is slowly but steadily getting replaced by more sophisticated STO mechanism, that benefits both investors and issuers. In other words, it can be considered as a fresh impetus for the crypto market that brings security and transparency to a whole new level.
What is the difference between an ICO and STO? And what a venture should consider when conducting an STO?
Utility tokens vs securities
An actual utility token represents future access rights to a company’s products or services. Meanwhile, a security token refers to a financial active that confers rights to income, assets or even dividends of a business.
The purpose of security tokens is mainly to protect investors from scam projects. In case of ICOs, participants almost have no possibility of taking legal actions against the fraudulent firm, pretty much because ICOs are unregulated fundraising events.
Note: ICOs do generally lack regulation, but not so long ago Malta and Bermuda, for example, have passed legislation, according to which ICOs will be treated as a restricted business activity which will require consent from the Minister of Finance.
An STO, in turn, is fully regulated. There is a list of limitations and restrictions that a company and potential investors shall meet. It varies depending on the location and jurisdiction. Don’t forget that the laws not only of the country of issuance but also of the territory where the investors are located must be studied in detail and be fulfilled after all. For example, some countries ask companies to file an offering prospectus to the regulator in order to be able to invite investors to purchase securities.
Note: Before conducting an STO, carefully select the country where you want to issue your securities and where you want to sell them.
Types of security tokens
Security tokens can be divided into equity, debt, derivative or even a commodity. Let’s give a definition for each of them.
- Debt Tokens represent a debt or cash generating vehicle.
- Equity Tokens represent an equity position in an underlying asset. They may give holder the right to vote or not. Also, investors purchase them as a form of anticipating future returns. If company’s profits increase than so does investors’ gains. In case company doesn’t want to share any kind of ownership with its investors, then it should be stated in the smart contract.
- Hybrid/Convertible Tokens can convert between debt and equity based on their behavior.
- Derivative Tokens represent a digital asset backed up by a physical active, such as silver, gold, car, etc.
STO pitfalls
However, neither companies nor investors should consider such strict regulations as a problem. Despite its severity, STOs offer a higher level of investors’ interests protection and an important risk mitigation for an issuer. STO focuses on professional and institutional investors, meanwhile ICO is more like a fundraising mechanism, whose characteristics don’t allow them to participate.
STO, in contrast to an ICO, gives the rights to own an equity share in a company that will be backed up by real assets. This, in turn, implies that if a company wants to issue security tokens, then local laws must be satisfied. For example, an enterprise should register the STO with the local securities regulator and give all the required information, disclosing almost every detail of the business, just like in case with IPOs, Initial Public Offerings.
Unlike ICOs with utility tokens, KYC/AML requirements for STOs are a bit stricter. For ICOs, KYC is a one-time thing, meanwhile for companies with securities it is a lifetime responsibility to know who the owner of the securities is and where they come from at each point of time. Thus, governments try to combat the money laundering, to sanction terrorists, criminals and even people who accept illegally obtained funds.
Furthermore, STO companies can’t advertise the asset publically, because it can be considered as a violation of certain laws.
Long story short, there are tens of rules that companies who plan to conduct an STO, should take into account. But how to fulfill them all? By introducing special conditions in the smart contracts. Thus, only those investors who fit the requirements will be able to purchase security tokens.
In conclusion
Despite the fact that STOs just begin to conquer the market, it has already attracted traditional stock exchanges like NASDAQ or NYSE who are looking for a gateway to list security tokens.
STO is not an easy process to pass through. And if you don’t want to lose a precious time and huge amount of money on legal procedures, appeal to professionals. In Platinum we lead an issuance of securities from the beginning till the end.
Platinum team includes over 100 professionals with 3 years experience in crypto industry and 7 years in financial markets. We have consulted over 700 projects and helped to collect $200M+.
For more information, please visit our website or follow us on Facebook.
