ICOs or Initial Coin Offerings in the last couple of years have created great excitement as a new opportunity for investment. Only in the first half of 2018 ICOs have raised $13.7 billion dollars. They provided an international investment opportunity, with promises of Bitcoin-like thousand-fold returns. Unfortunately, investors everywhere had to soon realize that there was not much substance behind the new-wave craze. Purchased tokens often give access to a platform that has not been built yet. The value of the token is solely based on speculation, without any regulation whatsoever. Eventually half of the startups fail, and only a modest 8% can be considered a real project. Even worse, some ICOs proved to be elaborate scams completely disappearing with the funds of naïve investors.

There is a necessity for a new trading tool: an STO- or security token. Security tokens are designed to solve some inherent problems in ICOs and provide a more favorable and reliable option for investors. In the following article, we are defining how ICOs and STOs differ, and explore security tokens.

The world of tokens

Tokens represent a particular asset or utility in a blockchain environment. Tokens can be anything, depending on the particular blockchain: cryptocurrency, loyalty points and commodities. It is any tradeable and fungible asset.

Tokens offered in an ICO, or initial coin offering, are utility tokens. These tokens provide access to the product or services of the blockchain platform.

STO is a security token offering. The emerging security tokens represent an investment, where investors buy tokens in anticipation of future profits in the form of dividends, revenue shares, or an increase in prices.

Utility vs. Security Tokens

After an active year for ICOs with billions raised, several scams the Securities and Exchange Commission has turned their attention to crypto-tokens.

The SEC started considering that many utility tokens may in fact be securities. The commission examines tokens from the point of view of how these are used in reality, instead of how the tokens were intended to be used.

The SEC uses the Howey-test to define whether an offering is classified as security.

Howey-test defines the following criteria:

  • there is an investment of money

  • investment in a common enterprise

  • there is an expectation of profit from the promoters

If the offering fulfills any of the 3 points, it falls under the category of securities. To put it in an easier way: if the token is being sold as an investment, or if there is a person investors can rely on, then the token is a security.

Currently many utility tokens have been purchased with anticipation of future profits by investors, which classifies these tokens as securities. These utility tokens might have to restructure or even shut down their operations. ICOs about to launch need to carefully consider their token structure and offering, and ensure compliance with SEC regulations.

Security tokens

Security tokens provide investors with an array of financial rights: equity, voting rights, dividends, buy-back rights and many others that are not offered by utility tokens.

Security tokens provide other benefits compared to traditional investment tools:

  • Cost- security tokens can be sold and bought via smart contracts, which eliminates the use of third parties, and makes the transaction more cost-effective.

  • Speed- KYC and AML checks are automatized in the buying process, making the exchange of securities faster than regular investment purchase processes.

  • Non-stop- unlike traditional stock-exchanges, crypto markets do not stop, tradings happen 24 hours a day, 7 days a week.

  • Adoption- as soon as the regulatory environment is cleared, security tokens are bound to be rapidly adopted, providing more liquidity and less administration.

  • SEC compliance- issuers and investors are both fully compliant with the law.

  • Global- the distribution of security tokens does not have to be restricted to individual countries, tokens can be traded and shared globally.

Security tokens should be subject to general security laws, which help illuminate token buyer rights, protections and expectations, and clarify the duties and obligations of the issuers.

This also means that security tokens compared to utility tokens have more restrictions on trading. There are regulations and limitations towards who, how and where can purchase them, which can greatly affect the liquidity of the token.

The Future of Security Tokens

While security tokens at the moment are lacking some regulations and widely-used exchanges, there is a very high demand from institutional investors.

Security tokens serve as an effective tool to fractionalize high-value assets and can provide better liquidity. There are multiple security token exchanges emerging, providing an effective trading environment. Security tokens bring a new revolutionary tool to the financial scene in the form of a new, fast, globally inclusive and effective investment option.

In the end it makes us wonder how much utility tokens are needed. Surely, utility tokens are not sustainable in their current format of disguising securities. It is highly likely that only a minority of utility tokens will be able to provide valuable use cases to pass the SEC probe, and be ready for mass adoption.

Barbora JuhaszovaComment