Three STO segments emerging in 2019 in 2020
By Michael Guzik on ALTCOIN MAGAZINE
The last twelve months have proven to be the rise and fall of what I call the ICO or ITO 1.0. Numerous technology start-ups with a promising business idea in the blockchain space raised considerable funding by selling tokens (as an investment). At the same time, Security Token Offerings (STO) such as the one of Securosys emerged and placed digital representations of shares among investors to benefit from the advantages of what smart contracts and blockchain provide. As a response, forward-looking financial regulators such as FINMA categorized tokens into utility, asset/security, and payment tokens. This paves the way for a new funding mechanism for markets spanning from small- to large cap.
Although I still very much believe in the power of utility tokens, the highest probability of rapid market adoption especially in traditional capital markets will come with digital assets or so-called security tokens. This is mainly because regulators and financial market participants with “old money” can more easily enter the digital asset market if they slightly adapt their “daily business”.
2019 will be different in contrast to the hype and bust years of ICO/ITO in 2017 and 2018. The STO market will further mature and especially three segments are standing out in the primary market. I am going to explain the three in the following paragraphs.
Blue chip companies launching ventures pursue an STO
Over the last quarter I have received numerous requests from leading mandates for blue-chip companies who are not only interested in how Security Token Offerings work but also how they can actually do one. These were not only private but also publicly listed entities.
The interesting development, however, is that most of these companies have been launching new technology ventures as a parent company. These ventures usually require significant capital from the mother company, where the beneficial owner would usually hold 100% of the shares.
Security Token Offerings for these ventures are becoming a very interesting funding mechanism to not only offload investment risk to external investors but also to use an STO as a perfect marketing opportunity. Usually, valuations for early-stage ventures of blue chips are high, ultimately providing blue chips the luxury of giving out less equity. I am more than happy to announce our clients at a later stage.
A good example is the STO of tZERO a subsidiary of Overstock, listed on NASDAQ. tZERO raised USD 134m over the course of a private placement. Imagine Facebook, Tesla or WeChat launching a new venture while giving out digital representation of shares through a public placement. I believe we will see many more prominent companies going the STO route.
Companies which are financially strong but too young for an IPO
Surprisingly, Venture Capital and Private Equity funds have been approaching us to tokenize their existing portfolio companies in order to ultimately prepare them for an STO. The trend, that this time the investor side and not the issuer side is even more interested in STO should not surprise us in the end.
Venture Capital and Private Equity money is often times stuck within growth companies. The desire to exit at a way higher valuation through the course of an IPO or further capital raises is simply put the business model of most of these funds. However, the chances that most of the portfolio companies do an IPO are dwindling due to many factors externally and internally.
This is leading funds to look for alternative exit options to partially hedge their risks. STO for this will increasingly evolve as an attractive tool for issuers and later stage tech companies to exit. If you are more interested in this topic, please see my article “Three Facts Why ICO Will Become A Multi-Trillion Dollar Market”.
Early stage startups raising capital
This has been a topic I wrote about extensively so far. Obviously, the ICO/ITO market evolved from blockchain related companies pursuing a capital raise in the early stage.
However, a new trend is emerging. Technology companies receive funding from Venture Capital firms in the seed stage in order to do an STO right before Series A funding stage. This not only allows to raise significant funding from accredited/ institutional investors but also publicly through retail investors.
I believe competition and speed of growth among technology companies have significantly increased and thus capital requirements become crucial to win market leadership. Security Token Offerings subsequently allow to raise more capital over the course of a public offering.
The Downsides (Right Now): Costs and Access to Capital
However, there are still downsides in the Security Token Offering market, which makes the primary market offering a challenge if you do not know the specifics of it.
An STO is becoming increasingly expensive, however, this will change over time. This sounds like a paradox: Blockchain’s promise was to significantly decrease costs by eliminating third parties and automate processes through legal and regulatory compliant smart contracts.
Now we are stuck with increasing STO costs. The three main cost drivers are:
- Regulation: Structuring of security tokens/ digital assets according to regulatory requirements and filing in one or more countries if you pursue a public offering to retail investors
- Access to Capital: Education of traditional investors about tokens and technology (such as wallets)
- Access to Capital: Finding accredited/ institutional investors and even retail investors
As shown above regulation and access to capital are the main cost drivers when pursuing an STO. However, I predict a significant reduction of costs in the future. Cross country alignment between regulators on STOs, primary market issuance platforms and smart contract templates for securities are three main topics which will cut costs over time.
Looking ahead
Summing up, I am very bullish on Security Token Offerings in 2019 and 2020. First digital asset exchanges such as tZERO and DX.Exchange will launch in Q1 2019, providing liquidity opportunities for the primary market. The industry is finally maturing and big players are entering the market. We are currently facing challenges such as increasing STO costs and access to capital, however, these will vanish over time.
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