What is Security token offering?

What is Security token offering?

February 15, 2019 by Ramaa Mohan
One of the most criticized parts of the cryptocurrency market and blockchain industry is the Initial Coin Offering or the ICO. Created as a decentralised version of IPOs, the ICO is a route many startups went to fulfil their funding needs. Because going the ICO route was fast, quick and easy. And most importantly did
What is Security token offering

One of the most criticized parts of the cryptocurrency market and blockchain industry is the Initial Coin Offering or the ICO. Created as a decentralised version of IPOs, the ICO is a route many startups went to fulfil their funding needs. Because going the ICO route was fast, quick and easy. And most importantly did not involve going behind venture capitalists for funding.

The ICO method was insanely popular for a very long time and then became infamous after a couple of frauds and scams filtered their way in. And when the cryptocurrency market started to attract a lot of attention from traditional investors regarding regulation, the biggest red flag that was raised was raised by the ICO method.

The Initial Coin Offering

Initial Coin Offerings (ICO) is a decentralised version of the Initial Public Offering (IPO). The only difference being the fact that ICO’s are completely decentralised, peer-to-peer and that there is no governing body.

The Initial Coin Offering involves three steps, the project proposal, the creation of tokens and the sale of the tokens. In an ICO, investors or people who want to be a part of a project first read the proposal or whitepaper written and published by the company, decide whether they find it worth and then invest in the project by buying the platform’s native tokens.

Once the tokens are bought and the company has reached its required funding, they put that money to use for the development of the product they promised and then when the company/product/token does well, the people who invested in it do well too.

This method of raising funds for a startup became very popular because at the time there were hardly any venture capitalists that were willing to invest or back a project that involved the cryptocurrency market or was part of the blockchain industry. A major reason that this was the case was that the understanding about the technology was not too high as well and it became counter-intuitive for people in the industry to go and explain something to someone who wouldn’t understand when they could just take it to a community of people who would and are willing to invest.

But as with any method, within a couple of years, many kinks and loopholes were found and exploited. There was no documented proof or contract that could hold the company to the promises they had made and that worked in the favour of scamsters because this loophole facilitated the raising of funds and the not keeping of promises. And this became very common in the industry, people raised millions and millions under a false pretence and disappeared with the money in a couple of hours with no tangible way to track them down or hold them accountable.

In all regulation hearings and discussions of the cryptocurrency market and the blockchain industry, the ICOs became the biggest red flag and the biggest roadblock and rightly so, a lot of people had lost money.

But come 2016 and just maybe a solution was found in which investors had more say and the company was held more accountable to the promises and the milestones they were to achieve. A solution, with a bit more tweaks and turns, that could potentially dethrone ICOs.  

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The Security Token Offering

Two years ago, in 2016, another option for ICOs was created and went by the name Security Token Offering (STO). It shared many of the good and advantageous features that ICOs and IPOs had and adapted itself to match the requirement of the cryptocurrency market, industry and community.

A Security Token Offering or an STO is a new method of raising funds for startups in which the company issues security tokens to the investor instead of utility ones. These security tokens act as a legally binding smart contract between each investor and the company and chalks out the role each side is expected to play and what are their duties.

A security token is a token that is issued in a similar setting as an ICO, in the fact that it is bought from the company on a platform during a particular day. But the token is actually a legally binding agreement that ensures the company fulfils its side of the bargain while keeping the investors as involved as possible. Making it more of a responsibility for the investor rather than simply a remote investment.

Buying of a security token assures the investor the following:

  • Company shares
  • Monthly Dividends
  • Voice in Decision Making

This means that the investor is a contributing shareholder in the company. And that the company is liable to them and the goals they have promised must be achieved in the stipulated time period provided by the company itself.

The only downside to the entire STO process is the loss of decentralisation of the environment. The environment loses its decentralisation because there is a large amount of accountability and there are stakeholders and shareholders to answer to. But the other things remain the same and is actually a more scalable and secure way of investing in startups from the cryptocurrency market and blockchain industry.

Difference Between ICO and STO

Initial Coin Offerings Security Token Offerings
1) Investors buy utility tokens or loyalty points that can be redeemed later1) Investor buys a security token that acts like a share in the company
2) Investor only benefits from token and has no say in the way the company is progressing or any of the decisions made 2) Investor has a responsibility to contribute to the company’s decision making, policies and the way it chooses to proceed
3) High risk because there is no legally binding document holding the company to its word 3) Low risk because the security token bought during the sale is a legally binding contract between company and investor
4) Completely decentralised 4) Partially decentralised

Uses of Security Token Offerings

The Security Token Offering (STO) system of fund-raising is relatively new in the cryptocurrency market. It has only been around for the past two years and is yet to pick up as much steam as the ICO method did. Regardless, there have been quite a few companies that went the STO route and have seen a lot of success because of it as well.

Some of the companies in the cryptocurrency market and blockchain industry that went the STO route are:

  • tZERO: an alternative trading platform for securities released in the blockchain industry.
  • Binance: Announced opening a securities exchange after move to Malta in association with the government there
  • Republic: Used STO method to raise the first round of money for development of the product.

In conclusion, the STO is the new, more secure, more safe ICO. Investors in the cryptocurrency market that are holding back because of the number of scams that are propagated through the ICO route are in for some good news with the adoption of the STOs. STOs hold both, the company and the investor, up to their promises and makes sure that they are both equally involved and vested in the way the company moves forward and brings their products to finish. STOs could quite possibly be the next ICO, with more industry adoption.

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