The Fintech revolution in recent years has resulted in a significant rise in the popularity of and demand for Decentralized Finance. However, the supply-side has not managed to stay abreast, though not for want of trying; case in point, the less than stellar performance of most of the Initial Coin Offerings (ICOs) between late 2017 and early 2018.
This anticlimactic show, coupled with tighter legal and regulatory requirements, created a void of sorts, which has now been filled by a new kid on the block — the Security Token Offering, or STO in short, and the last few quarters have been quite promising!
ICOs offer digital tokens that are meant to be used for specific utilitarian purposes and do not offer investment rights, ownership, or a stake in the company. However, unlike ICOs, STOs are regulated offerings that provide investors with blockchain-based, smart-contract powered investment rights in underlying assets such as stocks, bonds, funds, works-of art, real estate, etc.
Essentially, any asset that is likely to generate positive returns in the future, can be tokenised and fractional ownership in the same can be offered to investors by the company owning the asset.
In addition to being asset-backed, STOs are required to comply with relevant regulatory frameworks and security laws, thus provisioning all the essential safety features of traditional IPOs, while still providing the flexibility offered by new technologies and decentralized finance.
While this hybridization between IPOs and ICOs results in greater flexibility and safety for the consumers, for businesses looking to issue STOs in lieu of ICOs, it has resulted in increased red tape and has limited the avenues for liquidity and funding.
Not only do such businesses now need to ensure that they are compliant with the relevant securities laws in their particular jurisdiction, but they are also restricted to raise capital from investors who have undergone certain accreditation themselves.
However, it is still considerably cheaper to raise capital via an STO than via a traditional IPO, making it particularly accessible and interesting for small businesses and early-stage startups with modest growth forecasts and business interests across multiple markets around the globe, who otherwise had no alternatives beyond the traditional Venture Capital & Private Equity world.
That said, while entrepreneurs and investors around the world are warming up to the idea of an STO, an overwhelming majority of the governments have still not fully legalized the model yet.
For example, though the US government allows companies to offer investment opportunities to US citizens, the offering company is required to be compliant with SEC regulations as laid out under Regulation D, A+, or S.
- Regulation D requires that the offer be compliant with Section 506C, which means that the company cannot publish advertisements in newspapers, magazines, public websites, television, radio, etc., nor can the company conduct public seminars to solicit investment.
- Regulation A+ provides exemption from “general solicitation” clause for investment up to $50 million, but is way too time-consuming and expensive.
- Regulation S necessitates that the company not be listed in the US, thus making it impossible for local businesses to seek exemption from “general solicitation” clause under this regulation.
This dilemma of having to choose between a very limited base of accredited investors and spending a lot of time, effort, and resources seeking an exemption has largely alienated businesses and forced them to look for alternatives outside of the US.
Other countries have seized this opportunity and have adopted an STO-friendly stance, but these jurisdictions are only a handful. Chief among them are Switzerland, Germany, Malta, Estonia, Lithuania, Malaysia, Mauritius, Hong Kong, Singapore and Canada. While each one of these countries has established some kind of a legal framework for STO’s, so far Malta appears to be the most STO-friendly.
In terms of exchanges, the traditional stock exchanges and a large majority of the crypto-exchanges are still not equipped to handle STOs, but there are others that have surfaced over the last year or so, which are designed specifically for STOs — Polymath, tZero, Harbor, Securitize, and STO Global-X to name a few.
Having said that, even among these, there are still very few which actually offer secondary trading facilities for the issued security tokens. STO-Global -X is probably the only institutional-grade, compliant and secure STO platform that offers both primary digital asset issuance as well as secondary trading for the issued security tokens, and they have done well to collaborate and extend their secondary trading platform for security tokens issued on other platforms like GSX, Polymath and Securitize.
This kind of cross-collaboration is the need of the hour and will go a long way in creating and enabling a robust and liquid market for Security Tokens.
All this however does not imply that IPOs are on a decline and are not relevant anymore! In-fact, 2017 saw ICOs and STOs raising a combined total of approximately $5.6 billion in capital investment, whereas IPOs raised more than $36 billion in the US alone.
While ICOs and STOs offer a new, viable and promising alternative for businesses looking to raise capital, they are not designed or evolved enough (yet) to be applicable across-the-board for businesses of all sizes and shapes, who are at various stages in their growth cycle.
It is more important, now more than ever, for startups as well as established businesses to select the right instrument for raising capital; one that aligns well with their vision, market, business model, and stage of idea execution.