Security token offering: next step in crypto

According to Coinschedule, there were 600+ ICOs in the first half of 2018. New tokens have entered the market with each new campaign. They cannot even be classified in all cases. First of all because there is no universally recognized terminology for classifying assets at the moment, and second, a token often belongs to several types at the same time.

The classification proposed by the US financial regulator SEC is the most common at the moment and distinguishes three types of digital assets: utility (tokens that will provide certain advantages for product use in the future and are an integral part of the product), security (with elements of securities) and cryptocurrencies (used as a means of payment).

However, the SEC’s position toward the ICO is rather ambiguous even with this approach. On the one hand, the Commission has a strict policy towards the ICO. The SEC equated the ICO’s token shares to securities last summer, and the SEC chairman Jay Clayton claimed that almost all ICOs actually offered securities in February 2018:

«I believe every ICO I’ve seen is a security».

Of course, this affects all players one way or another — both newcomers to the market and the established players. For example, Ripple is currently involved in another legal process related to the legal classification of the XRP cryptocurrency.

On the other hand, the FINRA (Financial Industry Regulatory Authority) has approved the recent Coinbase purchase of Keystone Capital Corp., Venovate Marketplace Inc. and Digital Wealth LLC. The projects will help Coinbase to trade security tokens. Despite this, the company reports that there’s still a long haul ahead.

The lack of a clear division and legislative framework cause lots of ambiguous situations and difficulties, which, however, are minimized by using such a model of financing as the STO (Security Token Offering). Let’s review it in more detail.

Security Token Offering

Although ICO investors primarily prefer infrastructure and platform-based technology projects due to high ROI, security and stable tokens are also attracting attention: a token secured by a stable asset or a high-demand commodity is less speculative, while ensuring moderate return.

Security tokens are a natural bridge between the traditional financial sector and the cryptocurrency industry. They feature elements of securities — the right to share in the project, the right to receive dividends, the right to vote, etc., but their issuance is not associated with the difficulties that accompany the IPO (initial public offering of shares on the exchange), although it is somewhat more complicated in comparison with the release of utility or cryptocurrencies tokens.

STO (Security Token Offering) is a sale of security tokens. This model is close to the ICO in essence. However, it has its own features:

• A company that plans an STO must undergo a traditional IPO registration procedure;
• The STO provides a security token holder with the same rights as shareholders have;
• Tokens in the STO comply with the legislative standards and therefore guarantee the greatest protection to investors;
• The STO requires compliance with KYC and AML (Anti-Money Laundering) procedures;
• Circle of token buyers within the STO can be limited in accordance with the laws of a specific country — if the buyer is not entitled to purchase an investment asset by law, it will not be sold.

However, the STO initiators should remember that the ICO is no longer a fundraising mechanism with low investments — the costs for legal, marketing, consulting and technical services can amount to $500 thous. or more.

Any project planning an STO should also pay special attention to:

1. Developing a legal framework fully consistent with both the jurisdiction of business residence and the one where the STO campaign is planned;
2. Working with funds. Don’t rely solely on crowdsale, go for traditional tools such as funds, private investments and others — participation of professional venture funds and private investors is largely a key to success of the ICO;
3. Marketing and building a community around the project (especially if it is a start-up, not an ongoing business).

STO Platforms to run an STO

The analytical company CB Insights has published a study to list the main factors defining the future of blockchain. Inter alia, analysts named the increased interest of investors to security tokens and the increasing number of security tokens as a separate class of assets.

This is due to various factors. For instance, tokenization of assets (whether they are tokens of a fund or a production) increases their liquidity. Security tokens are less ambiguous from a legal standpoint compared to utility tokens of tech firms.

Besides, there are platforms specializing in supporting security tokens. Some of them are listed below:

• Harbor is the compliance platform for tokenizing private securities such as real estate, company equity, investment funds, fine art, etc. The company has raised $28M. Investors include major funds, such as Andreessen Horovitz and Pantera Capital.
• Polymath — Polymath-based issuers will be able to launch custom tokens capable of paying dividends, regulating management, voting by proxy and charging a fee. $59M of investments was raised during the ICO.
• Securitize is another platform specializing in security tokens; the Managing Partner of the SPiCE VC fund is the co-founder of the platform.
• Prometheum is a very young marketplace launched in March 2018. A combined blockchain platform allows for all types of transactions with tokenized shares and tokens according to the rules of regulators.

Many other projects are currently also supporting security tokens: a Swiss marketplace Lykke, a platform for trading tokens Templum Markets, a tokenized platform TheElephant, a cloud blockchain infrastructure Sequence, and a global crypto finance company Circle Internet Financial.

The Canadian Stock Exchange (CSE) announced the launch of a platform for processing transactions with securities built on top of the ETH blockchain in February 2018. The idea behind it is that tokens issued on the platform will fully meet the requirements of local laws.

The Moscow Stock Exchange is also going to launch its own platform for the companies’ ICOs. The holding is developing an infrastructure that will allow companies to run an initial coin offering. Particular attention is paid to preparing explanations for investors about the obligations that the token issuer undertakes, what the token is, and other details of participation in the ICO.

The Waves Platform is also developing a technology solution for Security Tokens as part of their existing client and business consulting services in this field as part of the Waves Lab Accelerator. More information will be available soon.

Conclusion

The ICO remains an efficient way to raise investments for projects of varying scale in 2018. But it is important to realize that the field of the ICO is very young and rapidly changing. What worked last year may fail this year. Increased competition, costs for the ICO, and the demands of investors and regulators are forcing companies to search for new approaches to financing.

Many experts have already come to the conclusion that the unregulated ICO will be transformed into the legally outlined STO in the future. The Security Token Offering is a sort of compromise between the interests of regulators, tech firms and traditional businesses.

This article has been prepared by Evgeny Zaykov and Juliya Bagriy.

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