What Is STO?

Despite the rapid development of blockchain technology and the recognition of its potential, international regulators are lagging behind with the introduction of regulations for activities related to ICO – a way to raise funds through blockchain technology. 

In the absence of regulation, there is a favorable environment for the flourishing of  fraudulent schemes, which in recent years has greatly undermined investor confidence in ICOs.

At the end of 2018, a new form of investment through the blockchain called STO began to gain popularity – security token offering. The main advantage of STO lies in strict government regulation, which significantly increases the attractiveness of security tokens for investors.

Many believe that STO is intended to replace ICO, but these two tools should be considered separately from each other, since each of them is applicable to specific cases and project needs. However, the widespread use of STOs can indeed bring more transparency and order to the ICO market. 

There are several varieties of tokens in the blockchain ecosystem:

Cryptocurrencies are tokens that act as a payment instrument. Cryptocurrencies are not tied to the platform on which they were issued and are considered a universal means of payment.

Utility tokens are a means of gaining access to services within the blockchain ecosystem of the platform on which they were issued. They can be roughly compared with coupons or gift certificates.

Utility token vs security token: security tokens are a digital analogue of securities. They are certifying the owner's property right to assets (company shares, real estate, works of art, luxury goods) and related rights, which may include receiving dividends or a share of the company's profits, voting, etc. Implementation the transfer of the rights enshrined in such a digital certificate is carried out by means of an entry in the blockchain.

Utility tokens can be purchased directly from the company that created them during the ICO – the initial coin offering. ICO refers to the procedure for distributing tokens among future users of the platform by selling them in exchange for cryptocurrency. The value of a utility token is determined by the functionality of the token within the platform. Often, but not always, a limited number of tokens are issued, and then an increase in demand for a token stimulates an increase in its price.

Those who did not participate in the ICO can subsequently buy tokens on secondary markets, including cryptocurrency exchanges. Initially, the price for the token is set by the issuing company, and after the token is listed on the exchange, it is already determined by market mechanisms of supply and demand. Therefore, as a rule, people tend to have time to buy tokens at the very moment of the ICO, expecting that the price for them will go up. For blockchain projects, ICO is a quick and convenient way to raise funds that does not involve selling a stake in a company.

The main problem of the ICO market is the lack of generally accepted rules and laws, which attracts those who want quick and easy money. An ICO does not require large expenses, either from a technical or economic point of view. The whole process is carried out online, and conditionally anyone can launch their ICO, even anonymously. No official checks or audits are required for this. Relatively speaking, all that needs to be provided to potential investors is a website, a document describing the project (White Paper), and a crypto wallet address for transferring money. 

At the time of the launch of the ICO, most projects are at the conceptual stage and do not have real developments for the future product. The problem is that investors are not protected in any way from the risk that the project team will not fulfill their promises and simply will not run away with their money. In the traditional investment market, the relationship between an investor and a counterparty is subject to certain rules that set clear limits on what is permitted.

However, a utility token is not considered an investment contract, as contributors do not receive any rights associated with the acquisition of such tokens. The holder of the token does not claim either a share in the company, or a part of the profit, or even a return on the initial investment. Utility tokens are classified as a commodity, while an ICO procedure is classified as a pre-sale of a product or service.

There were cases when projects openly promised a profit to buyers of tokens, but at the same time did not register their tokens as financial instruments in the relevant state. authorities for which they were prosecuted. Therefore, projects began to take a number of measures in order not to once again attract the attention of financial regulators. This includes replacing the definition of "investor" in marketing materials with a non-binding "donor".

The lack of clear laws on the conduct of ICO leads to the fact that the market is divided into two parts. Some projects deliberately disguise their investment token as a utility token, while others try to structure their ICO in the most open and legal way in the face of uncertainty. The latter, with all their efforts, cannot completely protect themselves from risks, since the ICO remains on shaky ground until the authorities take a certain position.

Due to the fact that the regulation of the ICO market requires a completely new approach on the part of government bodies, at the moment most states adhere to the position of a passive observer of what is happening or even prohibit ICOs.There are exceptions in the form of countries whose governments are actively working to create innovative laws that provide a firmer ground for ICOs, but in general, we are seeing a lag in the development of the regulatory framework.

On the other hand, STO is gaining increasing public attention due to the fact that it is subject to existing laws that control the issuance and circulation of securities, and accordingly protects the rights of investors.

Securities Token Offering (Types and How to Use)

What is STO? STO is a blockchain fundraising tool. Companies use the STO model to raise the initial investment to start a business or to cover the operating expenses of an existing company. The procedure for creating and issuing tokens is similar to ICO in terms of its technical characteristics. The main difference between STO and ICO lies in the purpose of the issued tokens and in the specifics of the regulation of activities related to the STO.

Security tokens are the products of the fusion of traditional financial instruments with blockchain distributed ledger technology. Security tokens certify the ownership of the underlying asset or the right to participate in the profits of the company that issued the token.

Since tokens exist on the blockchain, the blockchain acts as an official registry that confirms the possession of the token and all associated rights. The fact of a change in the owner of a security token is also supported by a record in the blockchain.

By purchasing security tokens, investors expect to receive material benefits from their investment, which gives them the property of securities. The value of security tokens is determined by the value of the underlying asset they are backed by.

Security tokens are a digital analogue of securities, therefore, activities related to the issuance and circulation of such tokens fall under the control of state financial authorities. Traditionally, the approach of American regulators represented by the US Securities and Exchange Commission (SEC) is taken as a basis.

What Are Security Tokens Types?

At the moment, there are two subgroups of security tokens:

Stock tokens and bond tokens (equity tokens) are a digital analogue of the usual types of securities, that is, shares, debt instruments, etc.

Tokenized assets – such tokens allow you to acquire full or partial ownership of any asset (movable and immovable property, intellectual property, etc.). The value of each token is determined by dividing the market value of the asset by the number of issued tokens.

Why do we need security tokens when there is a financial market familiar to everyone?

The fact is that top security tokens crypto bring a range of improvements to the traditional financial market. And this is manifested in increasing the efficiency of transactions through the use of blockchain technology. 

Benefits of security tokens include: 

Elimination of financial intermediaries

In order to purchase security tokens, you only need to register on the exchange and purchase tokens for dollars or cryptocurrency there.The token and all related rights become the property of the buyer instantly, while in the traditional financial market such transactions take several days.

The fact that transactions are recorded in a public and fully audited blockchain database eliminates the need for custodians – banks that hold securities on behalf of clients. That is, investors themselves store their tokenized securities in specialized cryptocurrency wallets. The absence of intermediaries in the form of banks, auditors, lawyers, etc. reduces the cost and time of such transactions.

Creation of global markets

Cryptocurrency exchanges operate 24 hours a day, 7 days a week and provide access to the markets to people from all over the world. Thus, a Chinese citizen can acquire a stake in an American company, and vice versa.

Increasing market liquidity

Traditionally, assets such as real estate, art, luxury goods, and venture capital investments are considered illiquid because they are not easy to sell on the market in a short time without losing value. Tokens increase the liquidity of traditionally illiquid assets, as they open up opportunities for their trading on exchanges. Due to the global nature of cryptocurrency exchanges, the number of market participants increases, which affects the number and frequency of transactions, and reduces price volatility.

Lack of liquidity also affects the market value of assets and is expressed in a discount for non-liquidity, which is usually 20-30%.This is because the buyer must be compensated for the additional risks associated with the difficulty of quickly converting an illiquid asset into cash. Therefore, the increase in liquidity should eliminate the practice of price manipulation and promote the revaluation of illiquid assets.

Creation of a regulatory framework

And of course, the regulatory aspect of tokens should be noted – security tokens are regulated in the same way as traditional securities, which ensures the transparency of the STO market. Moreover, securities legislation implies special requirements for all participants in the STO market, including exchanges.

What Is STO Platforms Future?

ICO vs STO – what is the thing of the future? STO platforms and security tokens are rather a way of transforming the traditional financial system with the help of new technologies, but they do not fully reflect the revolutionary ideas and capabilities that are prescribed to the blockchain. Utility tokens create completely new possibilities that did not exist before, such as transparent voting on the blockchain or secure storage of personal data on the blockchain. 

At its core, blockchain technology is a challenge to ingrained centralized structures for managing public order: central banks, corporations, and even states, and the most active supporters of the blockchain support the idea of creating entire cities, which will be managed using this technology. So the potential of utility tokens is definitely great, it is unfair to write off the ICO phenomenon because of dubious projects that are not representative of the entire market.

And the emergence of the STO phenomenon on the horizon proves that the scope of the blockchain is becoming ever wider, and, accordingly, for successful navigation in this market, the introduction of clear and understandable rules for all is required. Therefore, STO will undoubtedly serve as a catalyst for streamlining and systematizing the blockchain industry in general and the ICO market in particular.

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