The excitement that Initial Coin Offerings (ICOs) have created in the past few years has been marred by an onslaught of scams, hacks, and critical mistakes committed by careless investors. As it turns out, one of crypto’s biggest appeals – limited oversight and regulation – has proven to be its greatest vulnerability.
But cryptoassets are already coming of age. With the arrival of the Security Token Offering (STO), the crypto space is beginning to reach an uncharted level of legitimacy in the financial community.
The STO is the safe, secure, and sensible answer to the ICO. The word “security” in the name says a lot: Security tokens have to be backed by a tangible asset, like a company’s profits or shares. On the other hand, ICOs involve “utility coins,” which have the potential to amount to little more than a promise or a souvenir.
STOs also require licensing approved by the SEC and other regulatory bodies. In other words, security tokens have the features and protections of traditional assets, such as a share of company stock, while also leveraging the benefits of being a digital asset. And virtually any kind of physical asset – real estate, equity, etc. – can be “tokenized,” or used to back a security token.
In the short term, whilst the industry evolves, it’s likely that security token issuance will be restricted to wholesale and accredited investors. The compliance costs involved in extending such an offer to retail investors are prohibitive, whereas offers of securities to accredited investors are much less expensive – in addition to being exempted from many of the registration requirements of the U.S Securities Act. Similar regulatory exemptions for accredited or wholesale investors exist in most common law jurisdictions internationally.
Legality aside, the potential benefits to issuers of releasing Security Tokens are extensive. From a capital raising perspective, Security Token Offerings would incorporate elements of traditional IPOs – potentially giving investors a right to a share of profits, and a right to liquidation proceeds in the case of a winding up – rights that have typically not existed in earlier ICOs. Correspondingly, the issuer would be freed from the restrictions of traditional financing processes and be able to draw on a global pool of capital no matter their geographic location. The previously would have never considered an IPO on the NYSE or the FTSE will be able to reach a worldwide investing audience at a minimal cost.
Other advantages would include, borderless transferability of tokens – potentially creating a value uplift in the tokens (versus ordinary equity sold within a jurisdiction) due to the international reach and investor competition that tokens allow.
America’s most popular destination for company incorporation has updated its laws to allow for the tokenization of public or private stocks and shares and membership units.
Two-thirds of all members elected to each house in the state of Delaware have passed a number of amendments that legally allow for the use of blockchain technology to maintain corporate share registries.
In other words, any tokenized stock or share or membership units can legally be admissible in court as evidence of ownership, and any company can, in full compliance with the law, issue equity in the form of a token.
A new Ethereum based token standard, ERC-884, has already been created to allow companies to take advantage of these new capabilities
ERC-884 tokens offer a mechanism by which a Delaware corporation can maintain an official share register using an Ethereum smart-contract, hosted on the Ethereum blockchain, rather than using a traditional mechanism.
By maintaining compatibility with ERC-20 tokens, ERC-884 tokens can be traded via any cryptocurrency exchange that supports the trading of ERC-20 tokens, thus allowing the company to sidestep the use of a traditional stock exchange, share registry, or transfer agent.
Companies that wish to be fully compliant with the law, yet wish to take advantage of the new technology, can use the above standard to digitally issue shares or membership units without having to go through any intermediary.
As they would already be compliant with securities laws if they are publicly traded or otherwise have already registered with the SEC, there would be no regulatory uncertainty or gray area.
That’s because the token standard has been designed to in effect mimic a paper share or membership unit, while getting rid of the paper, so digitizing equity.
In the process, potentially removing intermediaries, reducing cost, increasing efficiency, and increasing participation to the entire global arena.