“ICO is dead, STO is the king”. This is the talk today in the distributed ledger industry.
Since the big crypto bubble burst of post-2017, people have been looking for the next big thing, and their eyes are focusing on digital security offerings. The truth, however, is that the comparison of ICOs to digital securities is fundamentally wrong.
Apart from using the same technological infrastructure (i.e. the Blockchain), digital securities and ICOs are different from all business, accounting, and legal perspectives. They are simply two different things.
You might already be familiar with some of the terms: security tokens, smart securities or tokenized assets. They are basically the same thing. I prefer to call them digital securities because for me that term most accurately distinguishes them from traditional ones.
Initial Coin Offerings
I got involved in the DLT space in early 2016 because I viewed it as an opportunity for a new, democratized internet. In 2017, we witnessed the emergence of the initial coin offering, and this unlocked a wave of innovation, forming the basis of a unique funding model which facilitates the formation and exchange of digital assets.
Due to its simplicity and lack of regulatory oversight, thousands of companies launched their own tokens, most of them based on the Ethereum ERC-20 standard. A staggering amount of approximately $12B was raised globally via ICOs in 2018 alone.
But there was a problem with the essence of the ICO model — the model was broken. From an accounting and business perspective, when a company conducts an ICO, it’s selling a product, service or access to a future network in advance. The company is selling a “utility token” which serves as a means of payment to transact within a specific network or platform.
There are two key problems with this model.
A Fragmented Utility Token Industry That Offers No Value
The first is that we don’t actually need thousands of internal payment coins to purchase products and services over the internet. It just doesn’t work in practice. So, companies forced an unpractical business model based on tokens just to raise capital.
Think about the underlying process of accessing the respective product or service via the platform’s native utility token. You’d potentially need to start the process by purchasing a major cryptocurrency such as Bitcoin or Ethereum with a debit/credit card, and then move the funds in to a third party exchange that lists your desired utility token.
You’d then need to withdraw your newly purchased utility token over to that of the project’s platform, to pay for the product of service you’re looking to obtain.
Not only would such a process be highly inefficient and time consuming, but you’d end up paying a significant amount of fees along the way. This isn’t a business model that any organization would ever have long-term success in.
Utility Tokens Afford ‘investors’ With Zero Rights
The second problem was legal. In practice, the people who bought those tokens didn’t really buy them to use for future products or services — they purchased them for speculative reasons and with the hope of unprecedented profits. Now, according to most securities laws in developed countries, such an instrument is classified as a security.
In order to bypass highly stringent securities laws, ICOs would created a dedicated section within their respective whitepaper to outline the fact that ‘investors’ were not actually ‘investors’.
Instead, token holders were merely in possession of a utility token that represented no real-world value, not did it afford holders with any rights or investor safeguards. Such unfavorable terms did not disencourage investors to part with their money, as clarified by billion of dollars raised since the ICO phenomenon began.
And so, all these problems led to the burst of the ICO bubble, and during the fourth quarter of 2018, ICOs decreased dramatically.
Utility tokens make a lot of sense for certain use cases, but they need to be separated from the fundraising element. Today, many companies have succeeded in raising capital in ICOs but pivoted from their initial plan. So now, we have token owners who don’t have any ownership rights in the companies. This is very problematic.
ICOs, with all their flaws, made a good impact, laying down the foundation for digital securities to emerge.
Security Token Offerings: A Journey With A Clear Purpose
I previously referred to a fundamental flaw with the ICO model, insofar that although utility tokens were marketed as having a clear purpose (to be used to pay for the products and services offered by the respective project), those that parted with their money rarely, if ever, partook in an ICO with this intention. On the contrary, utility tokens were speculatively purchased with the view of making a future profit in the open marketplace.
In order to ascertain the purpose of investing in an STO, think about why you would engage in a traditional IPO through a leading stock exchange such as NASDAQ. Those that purchased shares in Facebook when the company went public in 2012 did so with the believe that they would make a financial gain as the organization increased in value.
Sound familiar? Well this is where the similarities between an STO and an ICO come to a halt. While investors will no doubt inject capital into an STO with the hope of making a future profit, much like in the case of an ICO, it is only the former that can afford investors with the very same consumer protections and rights as seen in the traditional securities industry.
This will include a clear obligation from those behind the digital security in question to comply with financial and legal regulations. From the perspective of the investor, not only will they be accustomed to a stringent regulatory oversight, but they’ll also be able to obtain traditional investor perks such as periodic dividends, shares buybacks and even voting rights. These are all aspects that simply don’t, and never will, exist in the ICO arena.
However, mass adoption in the STO space will be no easy feat in the short-to-medium term. There are a significant number of challenges that needs to be addressed at a domestic, regional and international level to ensure that a clear framework is in place to facilitate a safe, secure and transparent marketplace.
If these challenges can be tackled via a unified approach by all relevant stakeholders – be it regulators, STO issuers, exchange platforms or broker/dealers (Key Players in the Digital Securities Sphere – Read More), then some really exciting opportunities lie in waiting. In fact, the growth of digital securities could pave the way for a complete sea-change in how the traditional securities industry functions (Key Benefits of Digital Securities Over Traditional Securities – Read More).