STO: Friend or Foe?

If you are part of the crypto circuit, you will be more than familiar with the term ‘ICO’ (initial coin offering) as this has been the most popular way of raising funds for Startup Blockchain projects. ICOs have been the vehicle used to raise over $5 billion dollars in the first half of 2018 alone. The purpose of an ICO is to allow companies to raise capital without giving away any of their equity or control. In exchange, a digital asset (tokens) is created that can be traded, an asset which may or may not go up in value.

ICOs have recently been receiving a lot of bad press, due to a large number of projects failing to follow their roadmaps and fulfill their promises. Some have failed to release a product or to even get their tokens listed on an exchange. Investors ended up with worthless tokens and little or no profits, contrary to what they initially anticipated. There have also been a number of ‘exit scam’ projects, which created a degree of distrust in the ICO investor community.

More recently, however, STOs have been branded as the savior of raising capital for blockchain projects. You can’t attend a crypto conference or talk about any new project without the term STO being ‘advertised’ as the new fundraising vehicle of choice and the answer to the crypto communities regulatory woes.

Firstly, STO stands for Security Token Offering. When you implement an initial public offering (IPO) or an STO, you remove the community control and the naturalized economics of the token itself. Some claim that STOs are nothing more than a play by those in the old-school finance world to take back some level of control in their funding and regulatory realm.

It seems as though many fundraisers and investors are mindlessly following this new trend without really thinking through the full benefits and drawbacks of the instrument, aside from knowing that STOs have the ‘green light’ from US regulators (for now).

STOs allow American investors to contribute to blockchain projects. However, the Regulation D requirement means that only ‘Accredited Investors’ can invest. STOs do not allow the general population and ordinary investors to participate financially in any STO.

Launching an STO means companies become wholly regulated by governments, furthering a complete centralization of public token offerings. They require disclosure of investors’ personal information, to make them subject to tax and other legal implications. An STO takes away from the decentralized nature of the blockchain, the very thing that the blockchain community regards as the holy grail of this new technology. It seems a bit regressive.

This ‘transparency’ opens companies up to much higher scrutiny, legal and underwriting costs, expanded legalities, accountability, real-time regulatory monitoring, and complete unobstructed access and power over your company being given to the regulating bodies that govern the STO processes. Blockchain experts now recommend that if you have an upcoming STO, be sure that you have a lawyer on your core team or as an advisor as you will probably need legal advice on tap.

Without a central global uniform standard or regulation, launching STOs in other countries could be quite impossible, and bring about another set of high underwriting costs per country, because remember, just because you have registered as an STO in one location does not mean you have complied with laws across the globe.

By using this new fundraising vehicle, investors are not necessarily protected from failure of projects. It doesn’t guarantee that a project will raise the amount they need to create a successful product. Nor does it guarantee that schedules will be met or promises kept. All it does seem to guarantee is that governing bodies have control and the whole process is significantly more complicated and expensive.

There are no secondary markets for Security Tokens created in a STO. Currently, securities have to be traded through licensed Brokers. These Brokers are subject to strict control laws including how much commission they can take, annual filings, KYC (Know Your Client) checks, and account maintenance. Global Security Exchanges will not be available for quite some time due to legal barriers and will no doubt be expensive for STO projects to list on once they are formed.

VCs (venture capitalists) have convinced many companies to issue security tokens rather than a strict ICO utility token; thereby, ensuring that the VC firm retains its usual ability to obtain some kind of equity passed through from the security token. Meanwhile, those who are undertaking a true ICO control all of their company.

Do STOs solve the current ICO problems?

STOs allow for US regulators to monitor the fundraising process more closely. Many will agree that we do need regulation, but others feel that maybe not to this extent. This fact can’t be ignored, that an STO is not a way of aligning itself with the general consensus of experts in the blockchain community, but that it does align with the interests of the US financial regulatory bodies.

STOs are NOT a replacement for ICOs. They are for very different types of companies and investors. They may need to co-exist until a new innovative funding vehicle is created.

In conclusion, regulation for STOs is still a work in progress; there may be weaknesses and hurdles that become apparent later on down the line. ICOs have been used to successfully raise money, although the legitimacy of some projects is questionable. As we hurtle towards this fork in the road, it is vital that for the benefit of the future of the blockchain industry and investors, that the community, the innovators, and industry experts work to advise and help build a uniform way to raise funds for blockchain projects which is fair, regulated but also accessible globally.

STO: Friend or Foe? was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.