Is Security Token Offering (STO) The Next Big Thing?

Security Token Offering has lately been mentioned in many forums. Last year in Q4, former JP Morgan CEO of Digital Assets predicted that STOs will gain serious traction in 2019. So, what is a Security Token?

Security Token Regulations Have Been In Place For 85 Years: Much of the security law we know today is called a Howery test used still today to determine if an investment contract is a security or not.

Background of how it was defined:

In Howey, two Florida-based corporate defendants offered real estate contracts for tracts of land with citrus groves. The defendants offered buyers the option of leasing any purchased land back to them, who would then tend to the land, harvest, and market the citrus.

As most of the buyers were not farmers and did not have agricultural expertise, they were happy to lease the land back. The SEC sued the defendants over these transactions, claiming they broke the law by not filing a securities registration statement.

The Supreme Court, in issuing its decision finds that the defendants’ leaseback agreement is a form of security. It was an important case in determining the general applicability of the federal securities laws and used as a guideline till today.

The said transaction will be called an investment contract if it fulfills the following criteria:
– It is an investment of money.
– The investment is in a common enterprise.
– There is an expectation of profit from the work of the promoters or the third party.

So, how is this relevant for ICO and cryptocurrency tokens? If the token meets all the three criteria, then it is regarded as security.

To understand what a security token is, it is crucial to first understand what securities are.

Securities are financial assets offered by companies or startups to raise money. Investors are promised a return back in the form of dividends or interest or a share of the company’s profit or voting rights. When these things are done through cryptography and offered for purchase, it is called ‘Security Token Offering (STO)’ giving the holder the same rights – dividends, profit share or voting right, etc.

Traditional paper backed assets like the company’s shares or bonds had a liquidity problem, lacked transparency and had a complex manual process behind distributing profits or dividends. Blockchain and powering them with smart contracts will take care of the automatic distribution of benefits upon meeting a certain condition on a certain date, hence simplifying the whole process.

What is there for blockchain based startups

ICOs were successful fundraising strategy in much of 2018 rasing total of 20 Billion $+. Some companies like EOS and Telegram were successful in raising access to 1 Billion$+. Now towards the end of the year excitement towards ‘ICO’ faded in the minds of the crypto enthusiast.

Reasons to ICO downfall were, Startups offering tokens in ICOs presented their token as a utility, like fuel in their yet-to-be-launched platform. Giving promises that once an ecosystem is fully ready, it will be heavily utilized and due to limited supply will be largely in demand.

This has left investors only speculate on the future value of the token. Well, in reality, the hyped platform never got launched as promised. Many failed to build an ecosystem or attract users/adopters to use their services.

Unlike traditional initial public offerings (IPOs) which makes the company accountable to their shareholders, Crypto coin holders don’t have any say in the direction of startup development or decisions. And most important of all, brutal regulations from governments has brought down the industry to its knees.

How Security Token Offering (STOs) are different then?

Many argue [inlinetweet]STOs can restore trust in crypto investors.[/inlinetweet] Key benefits which STOs will bring is, it will provide regulatory clarity in most jurisdictions and make blockchain projects accountable to their investors.

Also, considering the traditional institutions who are used to buying securities from the market. Digital shares in the form of security tokens could interest institutional investors to diversify their portfolio in blockchain startups.

It’s clear that Security Token Offering could have a much broader impact on the future growth of blockchain but before STOs gain traction, there needs clarity to allow the flourishing of this new mechanism. These are:

• Proper guideline and regulatory clarity on blockchain-based security tokens, so that, service providers can start building up the necessary infrastructure. For e.g., fund-raising platforms, or advisory services to provide blockchain startups to quickly and easily launch compliant security tokens.

• There needs to be clarity on how ownership of such tokens can be exchanged and traded in the secondary market. What set of rules to be followed so that exchanges can start building necessary trading platform.

Currently, there are a couple of working exchanges, most notably ‘OpenFinanceNetwork’ & ‘tZero’ where security tokens can be traded. Also, a dozen service providers exist today who could help startups to launch STOs.

• Clarity on who can participate in the offering. One thing which made fundraising thru ICO attractive is the fact anyone from anywhere in the world could participate and can easily trade them. So does purchasers of security token have to be accredited.

• Crypto community education. Most of the ICOs in 2018, is now valued way under what was originally raised. Some are yet to release their tokens, side locking investors’ money. Many have lost interest in blockchain space or out of capital. Reigniting interest and showing them the potential of security tokens will take time.

2019 is said to be the year of security tokens, but this is only the beginning to build the foundation. Given the conditions described above, adoption may take time but Security Tokens can well be the next big trend of the blockchain revolution.