Scams and Hacks Spur Industry Innovation: The Rise of Security Token Offerings (STOs)
(Part 1)
Another new craze in crypto is making the headlines — STOs or Security Token Offerings. Let’s break down the hype and see what STO’s are, why they have surfaced and what the future holds for this and other crypto asset classes.
Many traditional and non-traditional investors have been wary of getting involved into the crypto assets industry as a result of the many scams and hacks that have plagued the field particularly in regards to Initial Coin Offerings (ICO’s) a method of raising funds via a blockchain for a business. In addition to scams and hacks, the lack of regulatory clarity in the crypto industry is one of the many challenges limiting mass adoption and use of crypto assets. As a result, the crypto industry has responded with a relatively new crypto asset class — the STO.
What is an STO?
When a company issues an STO, like traditional securities, they are issuing shares in their company along with voting rights. However, with STOs, shares and voting rights are programmable on a blockchain.
Why do we need STOs?
This year the SEC (U.S. Securities and Exchange Commission) made a few notable decisions impacting the ICO industry.
In February, SEC Chair Jay Clayton said that: “I believe every ICO I’ve seen is a security” and therefore should be regulated as a security. He also went on to say that ICO’s “can be effective ways for entrepreneurs and others to raise funding, including for innovative projects.” [1]
According to the New York Times, the SEC later sent subpoenas to 80 companies and individuals involved with ICO’s. In March, the SEC warned cryptocurrency exchanges against trading “unregistered securities.” [2]
ICO’s are beneficial because they are an easy method of crowdfunding that does not involve intermediaries, such as; venture capitalists, banks and stock exchanges. It also allows retail investors to have access to a new asset class. The SEC recognizes that value. The problem is many ICO’s have promoted their tokens to investors as a way to get a return on their investment, like a security, but without legal obligations on behalf of the ICO issuer to make good on that promise.
This is why the STO idea has come to the forefront. It is a way to tokenize a business to raise funds while being compliant with securities regulations in the jurisdiction the STO is issued. In that way, it can have several benefits. STO’s allow for fractional digital equity stakes in a business and a platform for greater liquidity. Besides being backed by an actual asset — a companies profits or shares — with an STO it can register the security in a way that there is no holding period to sell the token on a secondary exchange [3]. Some argue that it would accelerate the democratization of venture capital by opening investment opportunities into private equity to retail investors [4].
Who is developing STOs?
Several blockchain events this past month have seen the STO banner raised as a funding alternative to ICO’s along with many mainstream and crypto specific news agencies. This past week Twitter sentiment analysis on STOs was positive. If we are going to take twitter sentiment as a measure, ICO sentiment was also positive this past week. While this may not give us much information we can see that the STO term is still new, and where it goes from here remains uncertain.
What is certain is to facilitate the STO process, the infrastructure for it needs to be built. One of the pioneers of the STO industry is Polymath. Polymath is creating a platform to issue ST-20 tokens, similar to the ICO ERC20 tokens issued on the ethereum platform. The founders of Polymath predict that the size of the securities market to reach $10 trillion by 2020.
The CEO of overstock.com, Patrick M. Byrne, who is also an advisor to the Polymath network claimed that STO’s are “a very clever offering, and could represent a whole new model for American entrepreneurship.” [6] Earlier this year, Overstock created an ICO for a new venture called tZERO, also a platform to issue STOs. Byrne believes tZERO and projects like it will “recreate Wall Street on the blockchain.”
Other companies such as Harbor, Securitize, Prospectus and Templum are working to develop the STO infrastructure. Many are working with notable industry names such as Merrill Lynch to create a way to issue tokens securely. All these companies will face similar challenges that ICO’s faced, getting users to want to buy their tokens and a user friendly way to make that purchase.
Will STOs be the future of tokenized fundraising?
That question is yet to be answered. The term STO is relatively new, and data on the success of STO’s is limited. One must not forget that STO’s can claim to be securities as those issuing them are centralized enterprises with a clear decision-making structure. Other cryptocurrencies such as bitcoin and ethereum were recognized by the SEC in June of this year as non-securities as a result of their decentralized structure and ecosystem [7].
The European Parliament has recently passed regulations to make ICOs more secure and accessible [8]. Such movements towards the crypto industry show that there is still more to see in the crypto fundraising world that goes well beyond STOs. Below are some of the activity taking place about STOs in the twitter community.
While STO’s grew out of the scams that plagued headlines of the crypto industry along with the rise in bitcoin adoption it is only one of many options. Scams and frauds follow innovations [9]. While there have been many scams in the ICO space, there are also very many successful ICO projects that have worked to maintain their credibility. There are many other tokenized offerings that are similar to STOs and encompass more than security assets coming out of the blockchain arena. To limit the “next-big-thing” in crypto to any one model that will rule them all would be to confine the limit of possibilities this experimental space is yet to offer.
For more on the state of ICOs and new tokenization projects read part two.
Sources:
[2] Ibid 1.
[3] Ibid 1.
[4] https://mp.weixin.qq.com/s/ppO1VFwdxt0oASmWNTgZcg
[5] https://www.csc2.ncsu.edu/faculty/healey/tweet_viz/tweet_app/
[7] https://www.cbinsights.com/research/regulation-icos-crypto/
[8] https://www.coindesk.com/the-european-parliament-wants-to-make-icos-more-accessible/
[9] https://www.forbes.com/sites/jeffreytucker/2018/08/28/beware-this-evil-crypto-scam/#3cb1c0614d89
[10] Ibid 5.
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