Security tokens: what are STOs and will they be the next big thing?
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security tokens explained

Security tokens: what are STOs and will they be the next big thing?

Over the last couple of years, many blockchain based startups have raised high amounts of funding through ICOs. In 2017 only, $6.2 billion was raised through token sales. However, all this glitter is not gold: according studies, 46% of last year’s ICOs already failed. Many experts consider STOs (Security Token Offerings) to be the next big thing.

Utility token VS Security tokens

Many ICOs have launched “utility tokens” to raise funds. This type of token represents the future access to a company’s product of services; there is no tangible product, service or asset behind the token. They’re designed to not be seen as investments, however investors can potentially get profit if the demand for the token increases and they sell their tokens.

Different to utility tokens, security tokens are backed by something tangible, such as assets, profits or revenue of the company, and are therefore considered as investments. Issuers of security tokens and other parties have to comply with the legal requirements for securities where the token is being issued and actively commercialized. This doesn’t only affect the initial sale, for example, after the STO, the exchanges that creates secondary markets for the referred security tokens need to comply with the financial regulation of the jurisdiction where they are based.

Utility tokens, on the other hand, are being treated differently from a legal perspective, many of them aim to not be seen as an investment so they don’t have to comply with securities laws. However, recent statements from certain financial institutions seem to indicate that most utility tokens should actually been treated as securities as well.

Will security tokens be the next big thing?

ICOs are failing, mainly due to scams, bad execution and a lack of transparency. When it comes to ICOs that have issued utility tokens, the utility is often forced within the company’s ecosystem, mainly because they did not want their token to be considered as a security due to legal uncertainty. However, this will change now that a legal framework for security tokens seem to become reality in certain jurisdictions. This means that utility tokens can finally be created for their real use case: access to a company’s service or product, and all those projects who try to force a utility to their token, can actually decide to raise funds through selling security tokens, which will be the majority of the cases.

Experts believe that security tokens will be the next big thing after ICOs, this type of tokens are more transparent and attractive for investors, due to the rights they obtain when buying a token.

Next to that, the assets that are backed by security tokens exist in the “real world”, meaning that security tokens can act like a bridge between traditional financial industry and the blockchain world.

From companies, to real estate and art: it can all be tokenized with security tokens. This tokenization of securities can play a big role in the democratization of venture capital and can make illiquid investments, such as art of real estate, a lot more liquid.

What’s the difference with an ICO?

An ICO, or Initial Coin Offering, sells tokens of a company which may be digital currency (like Ethereum), a security, a utility…: when it comes to STOs, the tokens always represent something tangible: equity, convertibles, fractional ownership, etc.

Basically, the nature of the token is what makes the difference, in the end, a STO is like an ICO but only with security tokens.

How programmable are security tokens?

Security tokens can array a variety of rights for their token holders. These rights are being stated in the smart contract that has been created for the token. These rights are programmable, those who launch the token could incorporate voting rights, fractional ownership, the right to obtain a certain percentage over the benefits of a company and many more.

How to launch a security token?

If you want to raise funds by tokenizing a company or asset, you could decide to issue a security token. You’ll first have to decide the rights the token gives to its holders such as interests or dividends (in the case of bonds or equity respectively).

Tech

You may be wondering what type of token you need to create for a security. A standard token is important to have for security tokens to expand. This because with a standard token, different parties (developers, wallets, exchanges, …) can work within the same framework.

In the same way that the ERC-20 caused the expansion of the utility token, the ERC-1400 could empower the expansion of the security tokens thanks to its interoperability. With a standard interface, security tokens can be operated and used by all relevant parties.

Regulation & security tokens

The nature of security tokens mean that they are treated very differently from a legal and regulatory point of view compared to utility tokens.

Financial regulations require the compliance with certain requirements, such as the implementation of a KYC process, a filtering of professional/accredited investors or the intervention of a Securities Agency (among others).

STO/ICO Facilitator

At Icofunding we can help you issue your own security token. We provide technical services, such as the creation of the smart contracts, strategic consulting, marketing and legal (through our partners). Click here for more information about Icofunding.

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