The Security Token Offering (STO) framework emerged in late 2018 to mixed reactions. Some readily embraced it, while others were reasonably skeptical over the then-new system. However, in just a year after its introduction, STOs have been used in various settings. In particular, they have been adopted in the trading of stocks listed on Nasdaq. The Singapore Stock Exchange also invested in an STO platform, apparently acknowledging the potential of digitized securities.
Also known as tokenized IPO, STO enables the public offering of security tokens in on exchanges. These tokens are classified as securities, which means that they are usually subjected to regulation. As such, STO has a higher likelihood of getting mainstream adoption as it provides the combined advantages of decentralization and the protection of regulatory intervention.
The discussion on STO in the context of decentralized fundraising makes more sense when with Initial Coin Offering (ICO). They have similarities, but the former presents notable advantages that make it more appealing to businesses and regulatory bodies.
ICO is essentially a crowdfunding method that uses cryptocurrencies. Under this framework, a certain amount of crypto assets is sold to investors or speculators in the form of tokens. These tokens become functional units of currency once the funding goal is reached and the project or venture proceeds.
STO also uses cryptocurrencies but under a different scheme. As mentioned earlier, it involves tokenized digital securities. These are sold in cryptocurrency exchanges, which can then be used to trade financial assets such as equities. Blockchain is employed to keep and validate token transactions.
ICOs have the advantage of being cheaper to undertake since they are usually not processed through traditional exchanges. In contrast, STOs rely on established platforms. They are also generally receptive to regulation. As such, they are perceived to be more trustworthy and dependable.
“Unlike ICOs, STOs represent a fully compliant alternative to capital growth and asset liquidity. They are securities (financial assets) stored on blockchain/decentralized ledgers, supported by an underlying asset that holds monetary value in the real world,” says Luisa Fernanda Agudelo, Marketing & Communications Manager at Micobo GmbH.
With platforms like Kickstarter, Indiegogo, and Seedrs, crowdfunding has snowballed over the past few years. It is estimated to grow into a US$28.8 billion market by 2025, nearly thrice its estimated US$10.2 billion value in 2018.
The rise of the security token offering is set further to drive crowdfunding growth with the infusion of decentralization. Currently, most crowdfunding platforms rely on traditional financial systems to handle the inflow of funds pledged by donors or investors. Crowdfunding campaigns are supposed to reach international audiences, but the number of possible funders or investors can be restrained by regulatory policies in different countries and financial transaction inconveniences.
“Security tokens which tokenize tangible and intangible assets, such as corporate equity and debt, will revolutionize capital raising via Security Token Offering (STO). Investing in projects and secondary trading of security tokens will break-down the jurisdictional barrier on a global basis,” argues Aaron Tsai, Founder and Chief Capitalist of MASEx, a global exchange that trades security tokens in multiple asset categories.
Tsai also believes that “the crypto and security tokens will also integrate the unbanked into the global security token investment.” Not everyone can easily get bank accounts, online wallets, or other fintech payment systems because of various requirements. It’s not the case with cryptocurrencies. Anyone can quickly get a crypto wallet and start using digital currencies.
The lack of access to banking or financial services is one of the major impediments in online crowdfunding regardless of whether it is decentralized or not. By allowing the use of cryptocurrency exchanges to offer tokenized securities, individuals who don’t have access to or prefer to avoid banking services can engage in stock trading or invest in publicly traded companies. Looking at it from another perspective, this means that companies can raise capital from unbanked potential investors.
Decentralization may be regarded as an advantage for crowdfunding. However, many also see the lack of regulation as an obstacle to mainstream adoption. This idea is shared by Cathy Mulligan, co-director of Imperial College London’s Center for Cryptocurrency Research and Engineering. Mulligan says Bitcoin startups encounter setbacks because of the absence of regulatory frameworks.
Regulation takes away the stigma or negative associations with cryptocurrency. It also helps address trust issues. With STO, tokens are tied to real and registered financial instruments or assets regulated by established institutions and relevant laws in certain jurisdictions. This means that holders of such tokens do not have to rely blindly on an unfamiliar “trustless” system. The tokens they buy and trade have real value.
STOs are already regulated in Hong Kong, Japan, and Singapore. Thailand has a no-regulation policy, but ICOs already have legal standing in the country, so it will not be long before STO gets the same treatment.
STOs advance the mainstream adoption of decentralized fundraising and investment by addressing the weaknesses of ICOs and other similar approaches. The Initial Coin Offering framework is a good idea of bringing cryptocurrency and blockchain into the crowdfunding setup, but it is riddled with issues and susceptibility to abuse. STOs offer something more palatable to investors, companies, and regulatory agencies. They strike a perfect balance of decentralization, financial inclusiveness, and reliability.
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