To understand what an STO is, firstly, we must look at what a security is. (Taken from the Previous Guide).
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:
-It involves an investment of money.
-The investment is in a common enterprise, where there is more than one investor.
-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 offerer 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 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.