There have been differing opinions about security token offerings in recent years. You could do a quick google search about what they are, and you will only settle down with articles with contrasting views. While some people are optimistic about the interests you can make by investing in them, some other people see them as a considerable risk and let-off.
So, what’s with all the confusion around security token offering, and what are they?
Follow through with us as we explore this subject and help you clarify the confusion you might have around them.
What are security token offerings (STOs)?
Security token offerings are tradable financial assets that involve offering or issuing, or issuing digital tokens to people who are willing to invest in such securities. STOs could either represent other securities or be issued directly as themselves. The most common distributed ledger technology platform leveraged by most STOs is blockchain technology. Distributed ledger technologies (DLTs) usually permit tokenization, which is the central tool used for recording in security interests.
One of the major benefits of leveraging DLTs are as follows:
- Distributed ledger technologies are more flexible;
- They are much faster than other platforms;
- They function more efficiently than other platforms;
- They are cost-effective and very easy to access;
- Most DLTs are in line with the legal conditions and regulatory obligations required for issuing securities.
Due to these advantages, STOs usually leverage DTOs to effectively raise money, provide liquidity for illiquid assets, and create a platform to bring investors together for fundraisers.
Difference Between Security Tokens and Utility Tokens
Tokens are broadly divided into two kinds, which are security tokens and utility tokens. Although they are both tokens, they have different features and functionality.
- Utility tokens are coins that are backed up by physical projects and activities; security tokens are a digital version of typical securities, and they don’t need to be attached to any utility;
- While security token investors purchase Alpha shares, utility token subscribers usually purchase coupons to access Alpha information;
- Security token investors can generate high revenues, and the company usually distributes many dividends. On the other hand, utility token subscribers can only make a one-time profit from their coupons;
- Security Tokens usually undergo security token offering (STOs) processes, while utility tokens undergo initial coin offering (ICO) procedures;
- Security token customers must pay a fee for accessing any information provided by Alpha. Utility token customers, on the other hand, are required to pay to buy tokens from the token’s ICO subscribers;
- While utility tokens are generally independent and decentralized, security tokens are usually regulated, and to a large extent, controlled by government agencies and companies.
Security tokens and utility tokens are, however, similar in terms of community development and investor liquidity. Both features are available in the two kinds of tokens.
Different Types of Security Tokens Available in the Market
There are five main types of security tokens currently trending in the market. These tokens are as follows:
Equity Security Tokens
Equity tokens are a lot like traditional company stocks as they are the shares issued by companies. The major difference between stocks and equity tokens is the platform upon which they are registered. Security tokens are usually issued via a blockchain technology platform, while stock records are saved on a database with details represented by a print certificate. Like some traditional shares, you can vote in company meetings when you possess security tokens.
Debt Security Tokens
Debt tokens are debt instruments and are very similar to mortgages and bonds. Usually, debt tokens are known to generate dividends regularly depending on how often debt instruments are paid. Sometimes, debtors may default in payments, or the value of the debt reduces due to economic forces. When such situations occur, the payment of dividends will either mitigate or be delayed.
Debt tokens are usually represented by a smart contract. The smart contracts typically include the risk factors and terms of repayment of the debt instrument in question.
Real Assets Security Tokens
A real asset security token is a type of security token that represents the ownership of some assets and physical commodities. By leveraging blockchain technology, companies issuing real asset securities can record any transaction no matter how complicated it may seem. They can track properties and commodities and also reduce the rate of fraudulent activities.
Hybrid Security Tokens
Hybrid security tokens are also known as convertible security tokens, just as the name implies. Hybrid security tokens can convert debt instruments to equity or convert equities to debt instruments. The conversions are usually done based on the market behaviors at the time of the swap.
Derivative Security Tokens
Derivative tokens have no value on their own since the value depends on the importance of other permits or assets upon which the derived tokens are based. Derivative tokens can be used in many ways after verifying the token’s ownership.
Holders of derivative tokens can trade them for different assets, they can be used as loan security, and they can be stored in a variety of wallets until the value of the underlying tokens and assets have improved in value.
Regulation of Security Token Offerings Worldwide
As a result of the legal position of security tokens as securities, the widely more taxing restrictive regimes applicable to securities can generally apply to Security token offerings. Additionally, current rules specific to issue tokens or alternative crypto assets also apply to STOs.
Unlike security token offerings, initial coin offerings are primarily established to keep away from registering or complying with financial policies and regulatory bodies. However, as stated earlier, this isn’t constantly simple, and, in numerous jurisdictions, initial coin offering issuers have succeeded in breaching innumerable securities laws.
Various approaches to regulating STOs have been pursued around the world. Regulatorscanty to adapt existing securities regulation to the unique characteristics of STOs while being able to protect investors’ interests and the financial system that underlies securities regulation.
Regulation of Security Token Offerings in Europe
There are no unified globally acceptable STO laws or European taxonomy that categorizes or defines crypto assets. At the European Union level, STOs are currently not regulated. However, there is a draft regulation proposal on crypto-asset markets. The draft has been published in September 2020 and is aimed to achieve harmonization in the European Security token offering market.
As is currently the case, the regulation of STOs only applies to security tokens to a small extent. However, security tokens do not fall under EU financial services law. The only exception to this is when the tokens also qualify as electronic money tokens. Subsequently, many STOs would soon fall under the applicable service law on markets in financial instruments directives (MiFID).
If that is the case, security token offerings will not fall within the scope of the new proposal. It is then likely that the Member States will be forced to take measures as part of the harmonization plans to ensure that there is coherence between European Union legal systems between STOs regulated by the law and STOs with value regulated by MiFID and other regulatory bodies. However, it is expected to take several months for the draft regulation to be approved and come into force.
A small number of European regulations are currently applicable to the issuance of transferable securities. Some of these regulations include STO prospectuses and their transparency. Negotiation and market abuse, however usually hinders a degree of harmonization to the European regulatory framework.
However, despite the framework, the STO regulations still vary considerably from jurisdiction to jurisdiction. In some jurisdictions, STOs do not meet the requirements to be legally classified as securities, causing a lot of discrepancies in the framework. In some situations, some countries have started to implement specific legislation such as governing the use of DLT which may directly affect STOs. Some of such countries include France, Germany, Italy, Luxembourg, the Netherlands, Romania, Spain, and the United Kingdom.
On the other hand, some countries have lower chances of implementing STO regulations. This is because there are currently no regulations guiding STOs in such countries. Those countries include the Czech Republic, Poland, and the Slovak Republic. Although STOs are not governed by set laws, they are still affected by some of the laws that govern all intangible assets and property laws in some of the countries.
Advantages and Disadvantages of Security Token Offerings
There are many contrasting opinions about STOs by scholars, investors, cryptocurrency enthusiasts, and government agencies and organizations. Although most of the arguments for and against security token offerings are reasonable, it is fair to understand STOs the positive and negative perspectives. This will enable you to have a better understanding of STOs. Below are some of the advantages and disadvantages of STOs.
Advantages of Security Token Offerings
Safe and Trustworthy
One of the most significant benefits of security tokens is that they are safe and trustworthy. STO investors don’t have to worry about data loss or mutations. This is because security tokens are stored in a blockchain platform and cannot be tampered with. Once they are transferred into a blockchain-based system, investors can trace the token as it is being exchanged, and they can keep an eye on the token for as many years as possible.
Unlike some stocks and shares with underlying issues and uncertainties, STO owners have full rights and control over their investments. They can access the tokens whenever they wish, add more tokens, or sell existing tokens. STOs are relatively stable due to their transparent nature and background.
A great thing about security tokens is that investors can own them in fractions instead of whole units like traditional stocks. For instance, an individual can own 0.00005 tokens of an STO, while another person may own five tokens of the same coin. Millions of people around the world can own these tokens due to their divisibility features. The advantage of fractional ownership of tokens is that investors don’t need large amounts of money to hold them, yet they enjoy the profits and increase in value. The feature also gives security tokens an edge over traditional stocks since it can reunite multitudes of people from around the world.
Instead of using centralized exchanges, security token offerings utilize the decentralization offered by blockchain technologies. Security tokens are safer than the usual stocks, as there is a lower risk of failure. Hence, security token offerings are great for people who want insecurities they can easily control and trust.
Security token offerings have been adopted worldwide, which means investors can own the tokens regardless of their country of origin. STOs can be accessed from different platforms if they are adequately implemented. The only barrier to security tokens’ global acceptability is a harsh jurisdiction law in a particular country. Investors can trade security token offerings on a worldwide network, irrespective of distance or time zone.
Operates in an Open Market
One of the primary reasons why security token offerings are transparent is because they are operated in the open market. Unlike typical stocks where a single entity such as banks or any other financial institutions control the day-to-day running of the market. The level of control of traditional stocks gives them an undertone of a monopolistic or an oligopolistic atmosphere. In the case of STOs, almost any legal entity can issue security tokens to the public, and the price of the tokens is fully controlled by the forces of demand and supply. The competition is usually very healthy for developing the token’s value.
Fast and Efficient Clearing and Security
Since all STO transactions are carried out on a blockchain, investors don’t have to worry about the kinds of delays and long processes associated with centralized securities. There is no need for the involvement of third parties or the provisions of costly infrastructural facilities. STO clearings are very fast, straightforward, and efficient, which makes them more convenient for most investors around the world.
Straightforward Post-offering Administration
Since they are blockchain-based, the management of security token offerings are pretty easy to achieve. All post-offering activities such as the payment of dividends or distribution of profits are done automatically with the aid of smart contracts.