This blog post is a series of three, taken from the Ebook we published earlier this month, The Differences Between Launching an ICO and a STO. The aim of these posts is to inform the reader, as the title suggests, on the key differences between the two offerings.
This first article focuses on the types of security tokens that can be issued and some of the benefits included. Later, we will publish two more articles, one on Compliance and one on Considering Currencies. Click here for our earlier article on The Pros and Cons of Security Token Offerings.
What’s a security token?
As regular readers of our blog will know, an ICO is a way to raise funds for a new (often tech-related) business. The company issues tokens which can be used by contributors to redeem a service or take an action on the company’s platform. As such, they are called utility tokens.
What if, as an issuer, you need to actually collect funds in order to finance your company in the form of debt or equity? What if, as an asset manager you want to issue an investment fund? What if, you want to securitise a tangible asset like a piece of art for instance? Some of this can of course be done through the issuance of traditional investment vehicles within the traditional financial infrastructure. However, you might be looking for new, innovative and more efficient ways to issue such instruments.
The answer could lie in security tokens. Tokens can be created to represent assets – such as equity, debt/loans, or investment funds. In many senses and in most regulations, these tokens are to be considered as equivalent to securities in the financial world and, as such, are known as security tokens or investment tokens. To avoid confusion, we call issuing security tokens a ‘STO’ and issuing utility tokens an ‘ICO’.
Security tokens (or investment tokens) are assets representing an expectation of (and a claim on) future cash flows (other than a simple market price increase) resulting from the activity of the issuer.
While a utility token price volatility might sometimes be difficult to explain and can be heavily influenced by speculation, a security token, representing equity for instance, is far more likely to increase in price because the company or asset itself has strong future perspectives to increase in value. A company could win a big contract or gain a licence for their new device, for example. Speculation on securities tokens can also happen, but at least valuation methods applying to traditional securities could be applied too.
But, what are the benefits of security tokens?
Here are a few we’ve identified:
- 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 fairly 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 hence facilitate the transferral of those types of securities which aren’t always technically transferrable in their ‘traditional’ form.
- The ability to divide the underlying assets into smaller units, making it more affordable for some investors and easier to transfer, allowing fractional ownership. Investing in an apartment, for example, could cost too much and be difficult to sell later. But owning a share in the whole building project could be cheaper to buy and easier to sell. Lots of development are also going on those days in order to “fractionalize” the ownership of valuable pieces of art.
- In the ‘traditional’ securities markets there are a number of intermediaries between the issuer and the final investor who charge significant fees for their services. Not only do the fees charged by those intermediaries pile-up to be paid by the end-investor, but those various levels of intermediation can often complicate communication channels with the counter-party and the investor. Through an STO, you could argue the there is a much reduced need for these middle men. Issuers offer shares directly to investors on a blockchain, making all the information transparent and publicly available.
This content is inspired by the Ebook The Differences Between Launching an ICO and a STO. Click here to download.