The fintech industry has evolved at a rapid pace with new technologies and trends emerging almost every year.
Recently, security token offerings (STO) have gained widespread attention and interest from investors. But like all the other hypes and buzzwords, the security token market can be a confusing and daunting realm. Launched by tech specialists, traders, lawyers, and bankers, the technology is unified by the blockchain.
Although the security tokens are seen as the most stable of all blockchain-based investments, putting your money into it involves a certain degree of risk. Here are some of the most basic things you need to know about security token offerings.
Understanding Security Token Offering
Over the past decade, Bitcoin and other cryptos have thrust blockchain into the mainstream. Although these blockchain-based financing garnered much acceptance, it is still deemed speculative, volatile, or even a bubble. But despite this repute, the consensus is that blockchain technology and the distributed ledger technology does have immense value in the financial technology world.
We’ve seen the entry into the blockchain space of major players in the areas of finance and technology, such as Facebook, Square, JP Morgan, Silvergate Capital, and Tesla. And as the vast role of blockchain technology in digital payment systems and various digital transactions is realized, we can expect more names to join the bandwagon. The entry of major players calls for liquidity through asset tokenization or security token offerings. However, don’t confuse the term ‘tokens’ with ICOs, which was popularized in 2017 for crypto projects to raise capital.
ICO vs STO
Initial Coin Offering (ICO) follows the concept of Initial Public Offering (IPO) in publicly listed companies. In this capital-raising method, entrepreneurs and startups pool funds from interested parties. While investors in IPO get issued with securities, ICO investors are offered tokens or coins.
Unlike IPOs which are riddled with regulations, ICOs lack regulation which made the process easy. Unfortunately, this has also opened the floodgates to illegal airdrops, sham crowd sales, and outright scams. For a brief period, the 2017 ICO craze has tarnished the reputation of tokens and blockchain.
But despite the negative impact of this hype, blockchain’s revolutionary technology has been solidified its utility. To restore its reputation, the distributed ledger industry necessitated a new method of bringing investments and this is through more secured offerings. This has brought innovative tokens called “security tokens.”
Security Token Offering
A specialist at Stokr, a security token offering platform, defines a security token as a unique type of digital token that can be issued on a permissioned or permissionless blockchain. Each token represents an enterprise or external asset and serves the same purpose as bonds, stocks, and other equities. It is transferable to investors through blockchain to raise capital. Corporate entities, businesses, and governments can issue security tokens.
Unlike tokens launched in an ICO which do not come with any obligations and rights, security token offerings are secured with financial assets, such as profits, tangible assets, and company revenues. There are three different types of security tokens in the market:
· Equity tokens are akin to conventional stocks, except that they are delivered through distributed ledger technology. This token entitles investors to a portion of the company’s profit and a voting right.
· Debt tokens represent a short-term loan charged with an interest rate. A smart contract ensures repayment terms that dictate the risk factors and the dividend model of the loan.
· Asset tokens represent ownership of assets, such as commodities, real estate, carbon credits, or art. These tokens are akin to a commodity such as oil, gold, and silver.
Security token offerings provide investors with legal rights such as voting or revenue distribution, whereas ICOs provide preferential access to a service, network, or platform. Security tokens are very much similar to conventional security, except that they are carried through blockchain and also allow fractional ownership.
Furthermore, security tokens in the US are governed by federal laws on securities which ensure maximal protection of investors. But unlike conventional stocks, security tokens do not involve a third party instead it uses smart contracts.
Benefits of Security Token Offering
Aside from offering the same benefits of traditional securities, blockchain-backed security tokens provide many advantages that include: transparency, trust, instant settlement, divisibility, availability, global adoption, and new opportunities on the market.
But like any new concept, security tokens face some challenges. These include regulations, lack of familiarity with blockchain and STO, and the lack of support from external major players. Since STO is still in its infancy, it pays to be cautious and learn more about these investment opportunities.