Security Token Offering
Nowadays, it is becoming common to hear about digitizing assets, issuing tokens representing parts of a property, or simply tokenization. So, what exactly are they all talking about? This post analyzes such question, and the first step is to define what is a Security Token Offering (STO).
Similar in concept to the Initial Public Offering (IPO) where a company issues shares to be distributed among shareholders, each representing an equal share of the company, in an Security Token Offering, the security token represents a contract into an underlying investment asset, which can be used to tokenize traditional debt securities and equities, as well as tangible assets as real estate, art, gold, IP, etc. Very much in line with a share issuance in an IPO, security tokens issued in a STO, give you access to the benefits that can be obtained from exploiting the underlying asset.
What are securities?
Securities are instruments defined as fungibles, negotiable financial instruments that hold some type of monetary value and provide a right of ownership and an entitlement to a share of future profits or cash flows. For example, a security may represent partial ownership of a specific property or of a financial instrument. One of the main differences between normal securities and STOs is the use of blockchain as the underlying technology under which they occur. When dealing with securities, the ownership information of the investment product is recorded into a certificate which can take the form of a simple PDF, but with a security token, the information is stored into the blockchain and instead of a certificate being issued, a token is.
Can tokens be considered securities?
Some regulators have opted to treat security tokens as securities, since they take the view that these tokens are intended to represent a promise to a future benefit or cash flow Therefore, when this view is adopted by the regulators, security tokens become similar to traditional financial assets for which there is an extensive legislation and strict compliance is needed.
Furthermore, issuers of tokens can seek to meet the legal criteria of being considered securities, in order for the token to be qualified as a security by meeting the three main criteria under European law: transferability, negotiability and standardization.
For the time being, let us leave the legal aspect of the security token on the side, as this will be analyzed in a future post.
What is the benefit of a Security Token Offering?
One of the most crucial aspects of an STO is its direct link to [the underlying] technology, and the advantages this supposes. In this sense, an important aspect is the possibility of using smart contracts when dealing with STOs, which allow automatization of many processes, as literally the terms and conditions of the issuance can be embedded in the security token itself. For example, being able to integrate a know your customer (KYC) process in a smart contract, could mean that only the persons who were accepted can access the security tokens, but also, all the information regarding the token holder and their management can be passed to the regulators without any human interaction. The fact that STOs are born out of technology, means that it is more than likely that there is a reduction of time and costs when dealing with these types of securities, in contrast to how normal securities are offered and managed.
Furthermore, investors can find themselves in an enhanced liquid market, in contrast to the rigid and illiquid markets they are used to such as the real estate one. This is due to the fact that tokenization allows traditional assets such as a flat, a vintage car or even a famous painting to be divided into smaller portions, and allow investors to buy a tenth, a hundredth, a thousandth of the underlying asset, thus reducing the entry point to a level available to any investor, therefore adding new players to the market.
With STOs, rigid and illiquid markets can become disrupted and accessed by any kind of investor who is looking for new and interesting ownership opportunities, diversify its portfolio across markets that are completely uncorrelated to traditional ones, and which now can also become engaged in post-trading activities, 24/7, enhancing additionally the liquidity of such markets.
Is a Security Token Offering the same as an Initial Coin Offering?
In concept they might be similar, as both relate to the issuance of tokens, but in reality they are very different. An Initial Coin Offering (ICO), according to Investopedia, acts as a way for companies to raise funds, for creating any product or service. Interested investors can buy into the offering and receive a new cryptocurrency token issued by such company. This token may have some utility in using the product or service the company is offering, or it may just represent a stake in the company or project. This means that with an ICO utility tokens are issued, since such coins can be used to access the company’s product or service, and which value is established by the market by its trading.
On the other hand, in an STO, the token is backed by a real asset, making it a stable coin (cryptocurrencies that attempt to peg their market value to some external reference), where the market establishes the value of the asset being tokenized, but not on the value of the token itself. The fact that security tokens are backed, and act as stable coins, make STO investments safer than ICO and their utility coins.
What are the challenges of Security Token Offerings?
The main one is at the regulatory level. Countries and their legislators are currently scratching their heads as to how STOs must be qualified, if they fall as a security, or they are some new hybrid form of security which needs a specific regulation. The problem with uncertainty is that an increased fear as to how STOs may impact the markets, can lead to regulators placing barriers on how STOs must be issued, managed and how investors must be protected, or even limiting the entry to only a few investors that meet a qualifying criteria.
In such cases, STOs which are already technologically complex at their core, now have to deal with bigger administrative burdens, as processes may be needed to set up as to how custody of the tokens need to be performed, tracking ownership, limitation on trading activities, wider KYCs, etc.
It is going to be very interesting to see in the coming years how regulators from different countries deal with STOs, as blockchain becomes more widely adopted, and crypto currencies become more accepted. It is important to remember that STOs are backed by an underlying asset, making them a stable coin, versus other crypto currencies which are solely based on how the market values them.
What is Brickken?
Brickken is born from the idea that it is legal to issue STOs, and that the market benefits itself from removing barriers and entries to non-institutional investors. Enhancing liquidity in markets can create new investment opportunities to investors who are looking to gain benefits from assets they consider profitable, but due to entry tickets, they cannot access.
Our goal is to democratize investing, and become a bridge between assets and investors. On the road, we will reduce the interaction of some middlemen used to participating in security or financing processes. Through Brickken, asset owners and investors around the world can directly connect with each other through a platform running 24/7.
Join the new era of investment!