In the traditional financial world, fundraising can sometimes take place in the form of IPOs, also called IPOs for Initial Public Offerings. These fundraisers consist of selling newly created shares or equity securities, which are then listed on the stock exchange. Facebook raised more than $16 billion in 2012.
However, these IPOs are highly regulated, and not all companies are lucky enough to be able to claim one. With the appearance of Bitcoin, and especially Ethereum, which makes it possible to create value exchanges programmable, this state of affairs has changed: it became possible for a young shoot to raise funds without an intermediary on the blockchain, thanks to a presale of tokens (tokens) through an autonomous contract or smart contract. This is called ICO for Initial Coin Offering, and this innovation led to the “ICO craze” of 2017 and 2018, where we saw thousands of start-ups finance themselves in this way, for better or worse.
A more recent development has been the development of IEOs or Initial Exchange Offerings which are based on the same principle as ICOs, except that the pre-sale of tokens takes place through an exchange.
The last kind of fundraising that exists in the cryptocurrency community and whose use could intensify in the future is that of STOs or Security Token Offerings. Like an ICO or an IEO, the STO consists of pre-selling a token created for the occasion, which allows the company to finance itself. However, unlike the former, which offers no guarantee on the role of the token, the STO will issue securities tokens ( security tokens ) which give the investor a legal right to the company. This is why STOs are generally much more regulated than ICOs and take place on specialized platforms.
What is an STO Fundraiser?
An STO, or Security Token Offering, is a fundraising being carried out through a presale of tokens created on a chain of blocks, which are similar to financial securities (stock, bond, share in an investment fund, etc.) The term is directly modeled on the term Initial Coin Offering (ICO), itself modeled on Initial Public Offering (IPO).
The economic model of STOs is similar to that of ICOs and IEOs, and only the nature of the tokens issued differs. To illustrate this, let’s take the example of a company that wants to finance itself to carry out a specific project. To do this, it issues tokens on a public blockchain (typically Ethereum): these tokens are securities tokens which, in our case, correspond to shares in this company. Investors buy the tokens using cryptocurrencies (bitcoin, ether, etc.) or traditional currencies (dollar, euro, etc.), hoping to make a profit.
Unlike ICOs, where pre-sale is done directly through the token’s standalone contract, and IEOs that are done through exchanges, STOs most often take place on highly regulated specialized issuance platforms due to the constraints regulations related to financial securities.
Securities tokens, or “financial tokens assimilated to financial instruments”, can constitute various financial assets. There is a test used by the SEC (Securities and Exchange Commission) to determine whether a token is a security or not: the Howey test. This test is based on a 1946 case in which the United States Supreme Court determined that the services provided by the Howey Company were “investment contracts” under US law. According to this test, a property is a financial security if:
- It represents an investment of money;
- In a common enterprise;
- With the aim of earning profits solely from the efforts of others (“with profits to come solely from the efforts of others”).
As we have seen, these tokens can be shares, that is to say, securities conferring shares of the capital of the company, management rights (vote) and an income called a dividend. For example, DigiShares issued such a token on the Ethereum chain.
In the same vein, it can also be shares in investment funds, such as in a listed real estate investment company or SIIC (called REIT in the United States for Real Estate Investment Trust ). The investment bank BTG Pactual in Brazil launched the ReitBZ token on the Tezos chain very recently.
Then another type of security token is the bond, which is relative to a debt. For example, in 2019, Kriptomat issued a bond (KRTEX) on Ethereum during its STO, entitling its holders to receive 8% of revenue and 4% of the net profits of the company.
Finally, it may be derivative securities such as Futures contracts, Swap contracts, etc.
What Do STOs Bring to the Traditional Financial World?
STOs offer a few advantages over traditional fundraising. First of all, as we have already said, fundraising by IPO is reserved for very large companies: STOs, therefore, make it possible to offer any young shoot the freedom to finance itself. These STOs facilitate traditional finance by making trading fast and inexpensive.
In addition, STOs have the merit of facilitating traditional finance by making exchanges fast, inexpensive, and above all, global. This could therefore have a positive impact on a market sclerotic by large institutions by reducing the number of intermediaries and multiplying the number of investors.
However, the main advantage that STOs provide is programmability, and in particular, the programmability of corporate governance. Since the title token is issued on a decentralized blockchain, this token could subsequently intervene in standalone contracts of organizations of all kinds. For example, a company’s stock could be issued in the form of a token that would enter into a vote taking place on the chain to determine the direction the company should take. Some companies could thus be managed entirely on the chain, which would make them what is called decentralized autonomous organizations or DAOs in English. Corporate governance would be the most relevant application of independent contract platforms like Ethereum.
What are the Differences Between ICOs and IEOs?
ICOs (and a fortiori IEOs) have the unfortunate defect of issuing utility tokens, which do not confer any right of inspection on the finished product, nor any legal guarantee: if the company decides to leave with the money and not to develop the project, it can do so. This is due to the very strict regulation of financial securities, especially in the United States, which discourages companies from tying the token to their legal infrastructure.
Conversely, STOs provide guarantees to the investor: voting rights, dividends, etc. However, this takes place at the expense of his freedom and confidentiality, as he will have to undergo identification measures (KYC/AML) beforehand.
Since they are regulated, STOs bring credibility. Indeed, the world of ICOs is often synonymous with chaos and allows various scams to emerge without too much risk. With STOs, this is made much more difficult. Another advantage of STOs is that, by opening the door to institutional investors, they allow for greater market liquidity.
Thus, STOs have strong constraints, which is quite a big step backwards regarding the freedom to invest. But this concession could open up the distributed world of the blockchain to the traditional financial world, which is very cautious when it comes to regulation. It should indeed be noted that the STO token is indeed issued and exchanged on a public blockchain, such as Ethereum or Tezos, and this could be a good transition towards a healthier economic and financial system.
How to Participate in an STO?
Within the ICO / IEO / STO trio, STOs are obviously the least accessible! ICOs often require nothing more than interaction with a standalone contract. For their part, IEOs require registration on exchange platforms, most often requiring an identification procedure, which gives them an intermediate status.
For an STO, you must submit to the KYC ( know your customer ) identification procedure, but also to the anti-money laundering procedure ( Anti-Money Laundering ). In addition, some projects restrict the number of investors to a white list that they constitute themselves.
The STO platforms that issue the tokens are very regulated platforms. Among the most used are:
- Polymath, on which had the STO of Corl, for example.
- Swarm, which notably hosted the Robinhood Equity Token (RHET) STO.
Note that there are websites that list the different STOs taking place in the crypto sphere, such as the STOscope site.