An STO, or Security Token Offering, refers to a public token offering within a legal and supervisory framework.
Security tokens are converted to on-chain digital assets by linking real-world financial assets and equities such as stock rights, creditor’s rights, intellectual property, real estate, trust shares, bulk commodities and other physical assets. Essentially, they bridge physical assets and equities with cryptocurrencies. It is generally believed that STOs could potentially replace asset securitization and venture capital financing.
Security token holders can be granted several benefits including ownership or bonds of a company, which can be used for profit sharing, dividend payments, and other interests.
1. Upgraded IPO
For startups, the traditional IPO is complicated, time-consuming, and can result in delays for the transferability of stock and creditor rights. An STO can help a startup, innovative company, or a high-tech SME quickly become a public company with a large number of global security token holders.
STOs can also utilize the blockchain and smart contract technologies to turn assets of low liquidity into asset-backed securities of high liquidity, achieving efficient offering and trading of asset securitization and enhancing the efficiency of the bond and equity financing process; STOs are an efficient expansion of asset securitization.
Difficulties in security token compliance are mitigated, resulting in more efficient global circulation. With regard to the KYC and AML regulations of different countries, incorporating compliance in a smart contract lowers the supervision threshold, making it easier for supervising agencies to review STO trades. The STO settlement process is also simplified, reducing trade difficulties and costs.
Compliance and high negotiability
Startups, innovative companies, and high-tech SMEs are given the opportunity to rapidly raise funds from global investors by issuing security tokens without large costs and conformance issues.
Compliance, provisions, and other content can be written in programs and contracts, automatically adding rules and supervision into the token trading system to help reduce risks for market participants. Once converted to tokens, stock rights, creditor’s rights, commodities, and other physical assets will automatically become globally negotiable using the strength of information technology.
The Ethereum ERC-20 protocol improves the convenience of token distribution, circulation, and management. Trade and wallet service providers can easily add support for security tokens so long as they use this standard. In the future, the advancement of cross-chain technologies will facilitate the compatibility among security tokens issued across various standards.
While most tangible assets have poor liquidity, STOs can accelerate the flow of global capital. In addition to improved liquidity, these assets are more easily priced and have more value.
It is obvious that trading markets worldwide impose limitations on investors. For instance, it is difficult for domestic investors (in Asia) to invest in companies, real estate, or commodities in Europe or the USA. By issuing security tokens, underlying assets can be traded and negotiated across borders by anyone at any capital scale, thus greatly enhancing the global liquidity of assets.
Lower cost of financing and trade
A token-based smart contract will reduce the number of brokers and lower the requirements for securities management, making it possible to redesign the traditional IPO in favor of startups and innovative companies with financial needs.
Traditional housing sales and trades and settlements of cross-border securities require a costly process that goes through notary, escrow, and liquidation companies. Using an on-chain process, security tokens enable buyers and sellers to achieve fast transactions and settlements without a broker, which increases the efficiency of resource allocation.
Security tokens that have been issued and listed for transactions will make it more convenient for market participants to trade and settle at a lower cost. A trade execution refers to an agreement signed between a buyer and seller to exchange a certain number of assets at a set price. Settlement means that the ownership of assets is transferred from the seller to the buyer and all documents proving payment have been completed and recorded.
Blockchain and smart contract technologies help increase the speed of securities settlement and achieve process automation. Frequent traders can trade securely and rapidly using a blockchain trading platform while infrequent traders can conduct global transactions on-chain anywhere at anytime. In this way, the need for brokers is reduced, streamlining the process and lowering costs. A transaction is closed easily by transferring funds on-chain, whereas traditional securities require a much longer settlement process.
STOs present a more flexible and cost efficient fundraising tool for traditional private equity and venture capital investment.
3. Risk warning
Although STOs present numerous benefits, they also come with their own set of challenges. A series of security token compliance standards still need to be developed and implemented, and policies across borders are still unclear, presenting barriers for global recognition.
Removing brokers from issuance, transactions, and settlements may reduce fundraising and trading costs, but security review of on-chain transactions can be difficult. The code review process for token contracts is still in its infancy and not covered by traditional compliance review mechanisms, so educating investors on blockchain security is key for the ongoing development of security tokens.
Despite these challenges, blockchain and smart contracts are promising technologies that can enable the use of security tokens, greatly improving upon traditional IPO and ICO fundraising methods.