Security Token Offering (STO)

A security token offering (STO) is a public offering of tokenized digital securities.

Security Token Offering (STO)

STOs enable digital financing while complying with regulatory laws. Since security tokens are subject to strict rules, they are not traded on regular token exchanges. They are, however, comparable to ICOs in that they are fungible tokens, meaning they have monetary value.

After the ICO bubble burst in 2018, the STO was introduced. After the cryptocurrency market cap fell by more than $700 billion, regulatory agencies started pushing for more secure token laws. While some ICOs have resisted the transition from flexible utility tokens to securities, STOs have nonetheless been established as tokens that comply with securities laws and regulations.

Major banking institutions, such as JP Morgan, have already entered the blockchain space. More names will emerge as blockchain continues to play an increasingly important role in payment systems, including CBDCs (Central bank digital currencies) and stablecoins, as well as in the context of liquidity, via the tokenization of assets through security token offerings.

Security tokens are comparable to stock certificates, where ownership information is entered into the document as an official certificate of ownership. The key distinction is that the STO is held on the blockchain and represented by a token.

Types of Security Tokens

    Stocks, bonds, options and futures can be tokenized and then used as a security token. The tokens thus obtained can be roughly divided into 3 forms:

  • Asset-Backed Tokens - Asset-backed tokens are backed by physical assets such as gold, stocks, real estate, etc. These tokens use the blockchain to maintain a secure ledger of these assets, and retain their value as well as provide an accurate audit record of transactions, allowing them to serve as digital assets. An example of the asset-backed token is the WCRU security token.
  • Equity Tokens - An IPO and an STO token are very similar in that they both represent company shares. Equity token holders have the same voting rights and the same share of profits as a company's shareholders.
  • Debt Tokens - Debt tokens work similar to the short-term cash that investors provide to a company. As collateral for the loan, a ledger entry will be kept on the blockchain. The payment method and loan risk affect the price of the token.

Security tokens could be a viable alternative and competitor to stocks and other traditional assets in the near future.

Security Tokens vs Utility Tokens

Security tokens are distinct from other digital assets such as cryptocurrencies and utility tokens in that they must comply with regulatory requirements. Any investment in a Security Token must comply with applicable securities legislation. Security tokens are also typically backed by physical assets, providing investors with better liquidity, transparency, and security than other digital assets.

A security token differs from a utility token in that it is an investment contract that represents ownership of an underlying asset. A utility token, on the other hand, is meant to allow access to a specific service or platform. Security tokens typically grant holders a portion of earnings, voting rights, and dividends, while utility tokens provide access to services and products.

Security Token Offering vs Initial Public Offering (IPO)

Security token offerings are similar to IPOs and are sometimes seen as a mix between an ICO and an IPO. The primary distinction between a STO and an IPO is whether the investment is issued on the blockchain or in the traditional market.

An IPO is the process by which a private company initially offers a share to the general public. STOs and IPOs can both reflect an investment in a company, but STOs offer additional flexibility in representing assets other than company shares. An IPO provides you with a paper confirming ownership of your investment, whereas a STO provides you with a digital token recorded on the blockchain.

STOs are more adaptable than IPOs and, due to lower fees, can be significantly more cost-effective. An STO does not have to be totally tradable by the public, making it ideal for businesses wanting to recruit investors for specific projects.

Benefits of Security Token Offering

STOs were designed to be a secure form of ICO adhering to all rules and regulations. STOs give token holders shareholder-like privileges, such as a vote in the company or dividends, while ICOs, for example, don't give token holders as many rights.

Using an STO instead of an IPO can offer more freedom to companies wishing to offer shares without being bound by local legislation or traditional guidelines. STOs are also easier for modern investors to obtain, easier to sell, and overall more conducive to a free market environment.

STOs are the next stage in the evolution of fungible digital tokens. Security tokens outperform both ICOs and IPOs by offering the flexibility of blockchain technology while complying with relevant regulations and relying on proven methods to reduce risk.

Disadvantages of a Security Token Offering

One of the main advantages of STOs is also one of its main challenges: regulation. STOs are subject to stringent regulation and compliance, which slows down the security token process. Platforms issuing STOs must always be up-to-date on new and existing Anti-money Laundering, Know Your Customer and other regulations.

Investor restrictions in some countries also limit who can engage in STOs. This reduces the investor pool for the STO and the opportunities available to potential investors. STOs can also be costly due to the administrative checks required before the security token is issued.

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