All you Need to Know about Security Token Offerings (STO)

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Introduction#

If you are a newcomer to the world of blockchain technology, and cryptocurrency or even a seasoned veteran, the numerous acronyms can be confusing.

The fact that blockchain technology itself is in its infancy, means that many more, new terms and different products will enter the market.

With this in mind, here in GuerrillaBuzz decided to write this guide and help blockchain enthusiasts and investors like you, to understand all of the latest buzz going around the industry.

What is an STO?

To understand what a STO is, firstly, we must look at what a security is.

In terms of finance, a security is a certification or some other financial instrument, that has an intrinsic monetary value. These securities can then either be traded by exchanges, who will broker the transaction or, they can be traded directly from peer-to-peer. These securities are then broken down into two subcategories, equity, and debt securities. This is in effect, owning part of a company, without actually taking it into your possession.

Companies use these methods so that they can raise capital from investors, to fund other parts of the business, such as expansion plans. In return for their investment, the financiers are normally offered to make their money back, and make a profit through means such as: dividends, interest rates or a share on the company profits.

Security Tokens are in essence, cryptographic tokens that can pay the owner dividends, entitle them to a share of profits, pay them interest, or, they can be used to reinvest into other Security Tokens.

There is a prerequisite to qualify a crypto token as a Security Token. As a requirement, the token must pass the Howey Test, which was set out in the case of SEC vs Howey (1946) in the United States.

This means that if the token aligns with the following rules, it will be considered a security token:

1. It involves an investment of money.
2. The investment is in a common enterprise, where there is more than one investor.
3. There is an expectation of turning a profit from the works of either a third party or the promoter of the token.

Security Tokens generally garner their market value from an outside asset that is tradable. Because these class as securities, regulations apply to them and a breach in regulations will leave the offeror exposed to potential liability.

If marketed effectively, with a platform that can help advertise your business through an STO, it can be a very powerful and effective tool in raising capital. It is also widely believed that STOs will eventually outgrow traditional ICOs due to the fact that they offer more security for investors, due to the regulations in place.

Selling a Security Token is comparable to an ICO in the sense that coins are issued to the investors. However, whilst an ICO investor would seek to gain value through the unlocking of a platform, or the appreciation in value of the coin, an STO investor would seek to gain cash flow in future, potential dividends or any potential right to vote that comes with the security.

Security Tokens, as previously mentioned are backed by outside assets that give them an intrinsic monetary value as soon as they are issued. This is in contrast to the use of a regular, utility token, where the actual value is based on speculation until a platform is developed and marketed for it.

In essence, the model of using a security token makes the process of raising capital for your project, look less like a Kickstarter page and more like a professional stock that is for sale.

You can also create dedicated black and whitelists with an STO that assists with anti-money laundering and know-your-customer regulatory requirements. Through operating in the manner, an STO can cut out a lot of the stigma that has currently been generated by the usual “Wild West” approach to crowdfunding. An example of some of these are, a lack of corporate responsibility, the potential for fraud and having no way of getting anything back if the company fails.

These positives surrounding STOs seem likely to generate a massive increase, in the amount of capital invested in the blockchain industry.

Finally, there are numerous different types of token, that confer different rights and rewards to the purchaser. Let’s explore these for a moment:

Right:
By acquiring a certain token, the holder will then be granted certain rights within the platform of that token. For example, by owning DAO Coins, you could have obtained voting rights within DAO. This would have allowed you to have a say in which projects receive funding and which do not.

Value Exchange:
Tokens, in effect, create a value and monetary system within its own platform. These tokens allow buyers and sellers to trade with a real value within the confines of the platform. This can help to govern rewards when certain tasks have been completed. The ability to create and maintain value within the system is a key role of tokens.

Fees: Tokens can act as a method of entry, to be allowed to use particular functionalities within the system itself.

Function: A token doing this can allow an owner to enhance the experience of people who use that particular system. An example of this would be allowing a token holder to host advertisements within the system.

Currency: Tokens can be used as a form of currency for exchanges both inside and outside of the platform, dependent on their value at the time.

Earnings: A token with this characteristic would assist in the fair division of any profits or any other fiscal benefits that may apply to investors and token holders.

The more of these functions that a token fulfills, the higher the potential value of the token itself.

Now that we know a lot about Security Tokens, we can explore them further and we can explore why and when your business should consider an STO.

When should my Business Consider an STO?#

There may be a point when you are considering marketing your company through an STO. You might be thinking about it right now?

There are some key points to consider so that you can make sure you get good value for your STO.

Your company should only consider using an STO, if you are looking to generate a lot of capital and your company aligns with four of the following seven descriptions.

Currently turning over more than $10 Million annually: This is because, to run a successful funding round by using an STO, your business needs to generate the best valuation possible. The higher the turnover and profits of your business, the higher your company valuation will be. This will increase the amount of capital you can get for the percentages of your business.

Operating a global business: This is because, to maximize the potential of your STO, you must be able to market to a global audience, rather than being limited to being regional. This will help you to raise a lot more capital, a lot quicker.

You should be interested in a funding method that connects with your current base of customers. If you wish to issue an asset that is readily transferable, then it would be wise to consider using an STO, as these can be transferred relatively easily. You should also be a high growth company if you want to maximize the positive effects of carrying out an STO.

Furthermore, you should be willing to take a slight risk, in the sense that the regulatory position surrounding STOs can change in different places, at any time. This could potentially place your source of investment at risk. Especially, if countries with more spending power such as The United States, The United Kingdom, Germany, Russia, and South Korea, tighten their own regulations. This carries the risk of massive losses of the business. Thankfully, the risks of this happening seem to be very slight, therefore everything should be okay.

Finally, you should be desiring greater liquidity in the assets of your stakeholders. This is because, as opposed to ICOs, which do not offer that much in this sense, STOs are an incredibly liquid investment.

If your company fits in with the majority of these descriptions, then your company would be incredibly likely to gain a lot of capital and support from your fundraising efforts.

However, if your company falls short of these points, it may be worth not jumping in at the deep end. This is because a failed attempt at launching using an STO, could have dire financial implications for your business. Especially, if the amount of capital raised, is lower than the amount of money used to set up the offering.

If you are still set on using an STO, then it would be worth waiting until your business is at a point where it aligns with these descriptions a bit more closely. It will also give you more time to plan your offering.

What is the Difference Between an STO an ICO?#

Whilst STOs and Initial Coin Offerings (ICOs) are similar, in the sense that they are both used by companies to generate capital for their projects, in most other aspects, they are very different.

Firstly, due to the fact that Security Tokens are considered securities, whereas ICOs aren’t, people who invest using an STO are further protected by securities legislation. This helps to prevent fraud or to provide the investor with a type of recourse if the company they have invested in goes bankrupt. Because of this, generally speaking, STOs are currently being considered as a potentially safer purchase for investors.

Furthermore, there is a difference in the way STOs and ICOs are backed. STOs, as securities are backed by real assets that have an intrinsic, monetary value. ICOs, on the other hand, do not have their value fixed by any tangible assets and therefore do not have an intrinsic monetary value.

Also, ICOs generate their value through the technology of its platform, and the appreciation of the coins themselves, whereas STOs create their value through the operations and the climate of the business itself. Because of this, for an STO to be valuable, your company would need to be run in an efficient manner; similar to that of a publicly traded company. This, is in contrast to an ICO for your business, which would not devalue as your coins as severely due to negative events hitting your company.

Due to the fact that STOs are securities and therefore bound by securities regulations internationally, their legal situation has to be considered a lot more clearly than it would for a traditional ICO. This would involve bringing in legal experts, who can help to steer your business in the right direction when launching an STO. Whilst, you would still potentially need legal advice for an ICO, the hours of work that your lawyer would have to put in, is a lot higher for an STO, due to their regulated nature. This would involve increased costs to your business.

Due to the regulations surrounding securities, Security Tokens would be slightly more limited, in regard to the breadth of their target market. This is because, due to the unregulated nature of ICOs, there is no restriction on who can invest. Someone with $10, could invest in an ICO from anywhere in the world. This is in contrast to STOs, which, have to comply with anti-money laundering and know-your-client regulations. These regulations place certain barriers in the way of certain investors, depending on the securities legislation in their country. On the flip side, this can be seen as a good thing, due to the fact that it means that generally, STO investors would be more reputable.

An example of this is that in the United States, investors have to be accredited before they can actually make any deals of this nature. This provides a barrier to people that may have less capital however, it also helps to ensure that investments are coming from legitimate sources.

In essence, STOs are more similar to floating on the stock market, than they are to ICOs.