Security token offering
A security token offering (STO) / tokenized IPO is a type of public offering in which tokenized digital securities, known as security tokens, are sold in cryptocurrency exchanges, or security token exchanges. Tokens can be used to trade real financial assets such as equities and fixed income, and use a blockchain virtual ledger system to store and validate token transactions.
Due to tokens being classified as securities, STOs are more susceptible to regulation and thus represent a more secure investment alternative than ICOs, which have been subject to numerous fraudulent schemes. Furthermore, since ICOs are not held in traditional exchanges, they can be a less expensive funding source for small and medium-sized companies when compared to an IPO. An STO on a regulated stock exchange (referred to as a tokenized IPO) has the potential to deliver significant efficiencies and cost savings, however.
By the end of 2019, STOs have been used in multiple scenarios including the trading of Nasdaq-listed company stocks, the pre-IPO of World Chess, FIDE's official broadcasting platform, and the creation of Singapore Exchange's own STO market, backed by Japan's Tokai Tokyo Financial Holdings.
Controversy regarding ICOs
Though sharing some core concepts with ICOs and IPOs, STOs are in fact different from both, standing as an intermediary model. Similarly to ICOs, STOs are offerings that are made by selling digital tokens to the general public in cryptocurrency exchanges. The main difference stands in the fact that ICO tokens are the offered cryptocurrency's actual coins, entirely digital, and classified as utilities. New ICO currencies can be generated ad infinitum, as might in some cases their tokens. Additionally, their value is almost entirely speculative and arises from the perceived utility value buyers expect them to provide. Security tokens, on the other hand, are actual securities, like bonds or stocks, tied to a real company. In this sense, STOs are actually more similar to IPOs, with the difference being that one isn't required to be an accredited investor with a high net worth to take part in the initial offering. Just like securities obtained from IPOs, security tokens can guarantee voting rights, dividends, among other entitlements. This democratization of initial company share offerings has caused STOs to be labeled "The Everyman's IPO".
In terms of legislation, some jurisdictions do treat STOs, ICOs, and other cryptocurrency-related operations under the same legislative umbrella. In general, though, STOs are placed under securities legislation (together with traditional IPOs), and ICOs under utilities, with the differentiation being made mostly on a case-by-case basis. It is worth noting that even in countries where STOs and ICOs are under the same legislation, security tokens still require a connection to a registered company with real assets being sold.
The main debate surrounding security tokens is, thus, the legal differentiation of what can be qualified as a utility instead of a security. Generally, legislation understands that if a passive financial return is expected from the investment, then it is classified as a security. This way, even if the offering company understands their tokens are merely a utility asset with no expected return investment, if it can be proven otherwise then the ICO becomes an unregulated STO, passive of legal punishment. Moreover, this assumption of utility has been abused by some STO offering companies to sell securities without regulatory compliance (maliciously labeled as ICOs).
This legal ambiguity has led to some ICO offerers being prosecuted by the SEC as a security offering part, though their tokens were announced as utilities. Such companies include messaging apps Kik and Telegram, the former being sued by the SEC for over $100 million and the latter delaying their offering plans after similar prosecution.
One of the main selling points of cryptocurrencies such as Bitcoin has been the decentralization aspect, by which no government can influence or control the currency. By extension, a cryptocurrency is not directly affected by a specific country's jurisdiction, sociopolitical environment, or economic events (although volatility to such matters has been perceived numerous times). Such a lack of regulation has led to the rising of large-scale crypto-related criminal activity, ranging from terrorist funding to tax evasion, most of which go untracked and unpunished. Similarly, ICO scams have been an increasingly troublesome matter, causing billions of dollars in losses and damaging the cryptocurrency market's value as a whole.
Security token offerings are seen as a direct response to such matters, being tied to real, registered assets, and regulated by a specific jurisdiction while still allowing such jurisdiction to be picked by the offering party (upon legal registration and permission request). Criticism regarding this attribute includes the possibility of evading one's country's laws to digitally perform the same action somewhere else. So far, STOs have been regulated and legalized in many countries where ICOs have not, due to fitting in many already pre-existing regulations regarding securities.
|European Union||Regulated||Regulated by MiFID II. Newly issued security tokens must fulfill requirements of the Prospectus Directive.|
|Germany||Regulated||MiFID licenses are issued by BaFin.|
|United Kingdom||Regulated||Categorized by the FCA under the category of Specified Investments.|
|Switzerland||Regulated||Regulated by FINMA and subject to the same laws as traditional securities.|
|Russia||No Regulation||Regulatory hurdles have been an impediment to the development of STO technologies in the country.|
|United States||Regulated||Security tokens are subject to the SEC under the same laws as traditional securities.|
|Canada||Regulated||Must obtain approval from the CSA.|
|Brazil||Regulated||STOs must be registered and approved by the CVM.|
|Australia||Regulated||Legal under the regulation of ASIC. Traditional and tokenized securities are treated differently.|
|Israel||Regulated||Must follow the legal framework provided by the ISA and are subject to the same laws as traditional securities.|
|United Arab Emirates||No Regulation||Even with no formal regulation, remains a strong STO market.|
|Thailand||No Regulation||Legal approval of ICOs has already been made by Thailand's Securities and Exchange Commission. STO application criteria expected to be released soon.|
|Singapore||Regulated||Must receive approval from the MAS and be compliant with the Securities and Futures Act.|
|Japan||Regulated||Regulated under the FIEA.|
|Hong Kong||Regulated||Regulated under a framework provided by the SFC.|
|China||Banned||STOs and ICOs are banned and constitute illegal financial activity.|
|South Korea||Banned||Security tokens are under the same prohibition as standard ICOs.|
|Malaysia||Regulated||Must receive approval from the Securities Commission Malaysia and Labuan Fiancial Services Authority |
Examples of security token offerings
There have been various STOs globally. The article from Oxford School of Law identified 185 projects until now. The largest STO was tZERO that raised over $130 million.[dead link] The success rate of the projects lies somewhere near the 50% threshold. Ethereum is the leading blockchain platform used for issuance. Stellar comes in second position with a major German STO of the restaurant chain L'Osteria in late 2019.
Security token offering service providers
There are at least 30 confirmed security token offering service providers.
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