Written by Athravan Sett (Contributing Reporter, UK)
What is an STO?
Security Token Offerings (STOs) sit at the intersection between the blockchain and real-world assets. The space is constantly evolving, but has the potential to foster a level of legitimacy and mass adoption that many have been craving.
How does it work as a currency?
The system is very similar to the trading of established asset classes, and STOs relate directly to financial instruments that function as securities, such as bonds, shares, and real estate.
Take for example the ownership of shares in a company. In order to become a shareholder, you go online, purchase a share, and get a PDF receipt as proof of ownership that you can then trade on the market (in this case the stock exchange).
The STO functions in almost an identical way, except when the company issues their shares, they issue them as tokens instead of a standard form issue. This means that you buy the token representing shares, and then trade the token instead.
How is it different to a standard utility token?
Utility tokens often claim to generate users. Security tokens generate investors. These investors pay for a security (represented by a token) – this could be debt, equity, revenue share etc. These require regulation by the SEC and other organisations, as STOs require broker-dealers or Alternative Trading Systems to function.
The current utility crypto market has far fewer constraints, but many utility tokens are increasingly being classified by regulators as securities, and are thus losing their ability to operate without oversight. Most utility tokens are actually pre-sale tokens, predicated upon a promise of a company that may not even be operational at the time of sale. If the decentralised project is realised, there is no guarantee that it will be profitable or useful. STOs have value that is currently in existence – and could be less vulnerable to abuse as a result.
Securities are complicated, but if the answer is ‘yes’ to the Howey test (Investment? Common enterprise? Profit expectation? Profit generated by efforts of others?), then security law will likely apply.
Why is this better than the status quo? Why should I care?
- Fractional ownership – Many assets are too expensive for ordinary retail investors to purchase. This could be anything, from a Da Vinci painting that you think might increase in value, to property in New York, and anything from classic cars to a lock of Abraham Lincoln’s beard. By splitting the ownership of the asset into many different parts, the process of ownership is democratised, and the market for the good becomes more competitive and liquid. Simpler, tokenised exchange makes the process simpler, and makes demand for the asset in question a market of its own that can be expressed easily by investors of any size.
Illustration – Say the lock of Abraham Lincoln’s beard costs $1 million. That most certainly is not ‘for the people’, but if the lock is tokenised into 1 million individual tokens, then almost the entire state of Montana (for example) could own a piece of it, one dollar at a time.
Note – While this is great for diversification of retail portfolios, the democratisation discussed might be diluted if investors with deep pockets choose to buy considerable portions of shares across an even greater number of asset classes – putting upward pressure on the share prices and making it less profitable to buy a fractional share.
- Cost reduction (vs an IPO) – Tired of paying investment banks and lawyers to book-run the process of your initial public offering? An STO is a very similar way of raising share capital by offering the public a slice of the action, but has no intermediaries. This makes it cheaper and quicker to get your shares out to the public and raise the finance needed.
Note – Much of the work of intermediaries in an IPO revolves around pricing and underwriting – without which the process might be incredibly difficult, and potentially catastrophic for the business if the IPO fails. Spotify (though not an STO) did defy convention and skip the middle-men, but not every company going public will want to take that risk.
- Programmable assets – Due to the digital nature of the token, rewards and returns on token holdings can be granted easily by companies to token holders. If a company wants to broaden the commitment to its brand, its regular consumers can be incentivised to become shareholders far more easily, through offering discounts and exclusive offers to token holders.
- 24/7 trading – Every stock exchange has to close – weekends and evenings are dead time. Cryptocurrencies never sleep, and neither must investment opportunities if they operate on online markets.
Note – 24/7 trading may not come to pass, but the capability still exists.
- Regulations can be encoded into the token – As STOs are securities, they are subject to security laws. Though the landscape is rapidly evolving, STOs should make following such regulations much easier.
Illustration – If a person is blacklisted from buying shares in a company, or is under investigation etc., the token can be encoded to prevent tokens being sold to their address.
- Interoperable assets on one exchange, regardless of class – Keep your whole portfolio (be it in art or real estate) in an online and easy to manage format, just as the market for tokens facilitates online abilities to trade them. It is impossible to tell exactly what form this will take presently or what the trading interface of the future will look like, but the opportunities are exciting.