How to launch a Security Token Offering (STO) is a series of posts taken from the ebook we published in January, Tokenized Securities. It is a straight forward and comprehensive guide that walks issuers through the main steps involved in the process of launching a Security Token Offering (STO).
In part one, we introduced the topic area and defined tokenization. We highlighted the difference between utility tokens and security tokens in part two. Compliance aware tokens was the topic of discussion in part three. However, you might still be asking why tokenization? Why replace processes that have existed for decades? In this article, we will tell you a number of benefits when comparing security tokens and finance methods that operate today. The next article will be on challenges for traditional asset tokenization.
A number of service functions that are currently carried out by middlemen can be automated through the blockchain. Currently, these various levels of intermediation often complicate communication between the issuer of a security and his investors. Each intermediary maintains its own ledger of data, and while central intermediaries maintain aggregated records, the parties’ ledgers can differ quite substantially. Every level of holding needs to perform position reconciliations with the previous ones which represents an important and costly operational process (not to mention the cost of reconciliation breaks needing to be fixed). Through a STO, the processes can be simplified and automated via smart contracts, and also by sharing the same information. Issuers offer shares directly to investors, making the information accurate, transparent and immutable.
Shared information and Transparency
Security Tokens eliminate the asymmetry of information that is present during the actual transfer of ownership of a specific security. Using the blockchain as a central source of truth, is shared by every player on the value chain. The tokenization of securities on a blockchain will also make governance and ownership more transparent and reliable than a traditional private security offering.
In the traditional securities markets, middlemen charge significant fees for their services. These fees charged by those intermediaries pile-up to be paid by the end-investor, adding another barrier to entry. By using blockchain technology and smart contracts, issuers can cut out many of the typical, low-value added, expensive, intermediaries that are needed for offerings. This in turn will re-create the links, allowing the issuers and their investors to have more direct relationship with one another.
Financial institutions currently rely on private databases. In these internal systems there are different levels of access for the users that operate the database. In the lowest form, there will be users with read-only access, who will not be able to change any data. Usually there will be at least one user with a higher level of access, such as a systems administrator, and they may be able to make amendments to existing data. Investors and regulators need to trust organisations because there is no control mechanism making the data immutable in the first place. This is where blockchains can add substantial value. Once an investor buys tokens on a blockchain, nobody can erase the history of his ownership. Once data has been written to a blockchain, i.e. after a transaction has occurred, nobody, not even a system administrator, can change it. This is highly beneficial when it comes to auditing, as you can prove your data hasn’t been altered, reducing time and costs.
Global reach and lower fees of the blockchain infrastructure allows for a new breed of investor and the potential for a worldwide investor base. The ability to divide the underlying assets into smaller units, making it more affordable for some investors and easier to transfer, allows for fractional ownership. Investing in an apartment, for example, could cost too much and might make it difficult to sell later, but owning a fractional share in the whole building could be cheaper to buy and easier to sell.
Privately issued securities are often difficult to trade and therefore have been highly illiquid. The use of blockchain allows value to circulate more easily by bringing online trust, as it prevents the “double spending” problem. The ability to fractionalize tangible assets through tokenization can also bring liquidity into these markets that have had little to no access to it. Traditionally, private securities could only be traded on secondary markets after using an extensive amount of middlemen and following strict, difficult to navigate regulations. By streamlining and automating these processes and by using a common distributed infrastructure, companies can remove the burdensome hurdles that previously restricted the liquidity of their securities. Secondary markets will also offer increased liquidity through a constant 24/7/365 trading market.
Fast digital transfer of ownership, T+0 settlement, 24/7/365: This results in increased liquidity and the opportunity for investors to transfer or sell their tokens after they’ve been issued. This is fairly commonplace for some traditional securities, in particular when they are largely distributed in the public. However, it’s far less common in other types of securities or financial instruments such as loans, real estate or private equity funds, which are generally far less liquid. Tokenizing those instruments through an STO can facilitate the transferral of these types of securities which aren’t always technically transferrable in their traditional form.
This content is inspired by the Ebook Tokenized Securities. Click here to download.