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It might seem like the initial coin offering (ICO) boom is over, but there have been whispers of a new kid on the block. The security token offering or STO. Some believe that ICOs are a thing of the past and all future blockchain-based fundraising will be issued as a form of security.
It’s probably high time that we get our heads around what securities are and how STOs are different from ICOs. This episode of Hard Fork Basics is going to try to answer those questions, but first, a bit of background.
What even is a security?
Before we go looking into what a security token might be, let’s take a look at what a financial security is in its own right.
Put simply, a security is a financial contract that can be traded. More specifically in the US, an asset is considered a security if money is invested, the investor expects profit, the investment is made into a business (common enterprise), and the profit generated is not directly influenced by the investor’s actions.
But here’s the thing, many financial instruments can be classed as “securities,” and specifically what is classed as a security depends on where you are in the world. It can get very confusing.
Generally speaking, in the US securities are either debt securities, like bonds, equity securities, like stocks, or derivatives, like futures contracts. In the UK though, the list is even more extensive and includes pensions, warrants, government securities, and debentures.
Despite the varied definitions of what a security is, there are some basic similarities. should have monetary value, and they should be tradable. It’s common for securities to have contractual rights attached, like shares in a company. Most of all, they should be registered with a financial authority in the country they are issued.
Decentralization is a headache
These contextual rules don’t exactly fit with the nature of cryptographic tokens and ICOs. Digital assets can be offered all over the world without formal registration, aren’t always tradable, and do not come with any legal rights for token holders attached.
But STOs promise something a little different. The “S” in STO suggests that the token follows a strict legal framework designed to protect investors and ensure complete clarity over what is being offered.
In principle, STOs should follow the legal framework that other securities have to follow, but there is still huge ambiguity over whether digital assets and tokens should be considered securities. Financial regulators still have some catching up to do.
In some cases though, like in Beijing, security tokens have already been deemed illegal. In Beijing all financial fundraising must be approved by the government, so you’re likely to get caught short if you try to run an STO as it’s basically no different from an ICO.
Not all STOs will be alike
Perhaps most importantly to note, is that not every STO will be created equally. Depending on where it is being offered and the legislation it has been subject to, it will be dramatically different in terms of risk as an investment.
In Europe, the “small offering exemption” means any security offering looking to raise less than €8 million doesn’t have to issue an approved prospectus. The prospectus is where the offering company discloses key financial details about the fundraising efforts, how they will be done, and investors liabilities.
Generally speaking, in the US securities also can only be offered to accredited investors. In short, to be an accredited investor you must either earn over $200,000 per annum, or your net worth must exceed one million dollars. So in the US at least, properly regulated STOs will be out of most people’s reach.
Before you go diving into the – still yet to be truly regulated – world of STOs ask yourself if what you’re looking at really is any different from an ICO.
Last updated February 5, 2019. 13:21UTC.
It should be noted that not all securities in the US are restricted just to accredited investors. The SEC Rule 506(b) can provide exemptions under which securities can be offered to up to 35 non-accredited investors.