What is a Security Token Offering (STO)?

This blog was originally published by TokenEx here.

Written by Anni Burchfiel, TokenEx.

An STO, also known as a Security Token Offering, is a digital token supported by blockchain technology that represents a stake in an asset. STOs enable digital funding, while still complying with government regulations. Security tokens require extensive regulations, so they are not traded on regular token exchanges. However, they are similar to ICOs (initial coin offerings) in that they are fungible tokens, meaning that they hold monetary value.

STOs function as digital representations of real-world assets, like bonds, stocks, or even gold. Because of this, security token offering services enable asset tokenization for many businesses.

STOs (security token offerings) were created in response to the ICO (initial coin offering) bubble burst in 2018. After the crypto market cap fell by over $750 billion, regulatory bodies began emphasizing more secure legislation for tokens. Some ICOs disliked the change from flexible utility tokens to securities. STOs were created as tokens that would comply with the relevant laws and regulations for securities.

Security tokens are similar to the certificates issued for stocks. For stocks, ownership information is entered into a document as an official certificate of ownership. For security tokens, similar information is recorded, the major difference being that it is recorded on the blockchain and represented by a token.

Security Token Offering vs Initial Coin Offering?

STOs are similar to ICOs (initial coin offerings) in that they are coins issued to investors to represent their investments. However, they differ in their (reported) utility.

An ICO, also known as an initial coin offering, is used as a way for entrepreneurs to raise money through digital coins. They allow users to gain access to decentralized applications, and as such, they can step around laws by claiming they are made for utility not investments. Because ICOs do not need to remain compliant with laws and regulations, ICOs offer a lower barrier to entry and are more easily available to the wider public.

ICOs emphasize their utility, though if the project they represent is successful they can also be used as a form of currency to buy a product or services. ICOs are not well-regulated, which means they are riskier but also more flexible.

STOs differ from ICOs as they represent investment contracts for investment assets like stocks, bonds, or even real estate investment trusts (REITs). STOs come with additional legal obligations as they seek to comply with security laws ICOs are not subject to.

Security Token Offering vs Initial Public Offering?

STOs (security token offerings) also have similarities with IPOs and are often regarded as a hybrid between an ICO (initial coin offering) and an IPO (initial public offering). The biggest difference between an STO and IPO is where the investment is issued, the blockchain or the traditional market.

An initial public offering is the process by which a private company first offers a share to the public. Both STOs and IPOs can represent an investment in a company, although STOs have more flexibility to represent assets beyond just company shares. With an IPO you receive a document communicating the ownership of your investment, while with an STO you receive a digital token recorded on the blockchain.

STOs are more flexible than IPOs and can be much more cost-effective due to lower fees. A company that offers an STO does not need to be completely tradable by the public, which makes it perfect for companies looking to secure investors for specific projects.

Types of Security Tokens?

There are three different types of security tokens: equity tokens, debt tokens, and asset-backed tokens.

Equity Tokens

Almost everything about an IPO and an STO equity token is the same as they both represent shares in a company. Equity token holders are similarly entitled to a company’s profit, and even have the right to vote like a shareholder. The main difference between a traditional stock and an equity token is how the ownership information is recorded. Equity tokens will be recorded on the blockchain, while traditional stocks are printed on certificates and/or stored in a database.

Asset-Backed Tokens

Asset-Backed Tokens represent real-world assets, like real estate or art. These tokens use the blockchain to securely save a record of these assets. These tokens not only provide a secure transaction record but can also retain value which means that the token can itself act as a digital asset.

Debt Tokens

Debt tokens work like short-term loans that investors give to a company. The contract created for this loan will exist on the blockchain network and act as a security for the debt. The price of the debt token will be largely dependent on the dividend model and risk involved in the loan.

What are the Benefits of STO?

STOs (secure token offerings) were created in response to the token issuers who sold tokens without considering relevant laws or regulations. STOs were created to be a secure version of ICOs (initial coin offerings) that are compliant with all laws and regulations. STOs give token holders rights similar to stockholders, like a voice in the company or dividends, while ICOs did not provide as many rights to token holders.

Providing an STO instead of an ICO can also add credibility to a token. After the crypto bubble burst in 2018, many investors were left with useless tokens. Because of this, building credibility is key for modern tokens.

Using an STO instead of an IPO (initial public offering) can add more flexibility for companies looking to offer shares without being subject to localized regulations or traditional guidelines. STOs are also easier to get into the hands of modern investors, easier to liquidate, and generally more conducive to the free market environment.

STOs are the next step for fungible digital tokens. Security tokens improve upon both ICOs and IPOs, providing the flexibility of blockchain technology while also following relevant regulations and relying on proven methods to minimize risk.