The Future of ICOs? Security Token Offerings
Distributed ledger technologies (DLTs) have given rise to the initial coin offering (ICO).
An ICO is a fundraising mechanism used by DLT projects to raise capital, typically in the form of well-established crypto tokens like ether or bitcoin. In the first quarter of 2018 alone, US$6.3 billion was raised through ICOs.
Fundamental to this new paradigm of fundraising is the token, and the tokenisation of digital and physical assets. There are different types of tokens, and many projects have raised funds by selling these tokens via an ICO.
The most common tokens sold via an ICO are utility tokens, or tokens that will eventually become utility tokens once the funds raised have been used to create the infrastructure to support said tokens. A utility token has consumptive value, meaning it can be used in a real decentralised product.
Selling utility tokens is currently considered fine if the infrastructure is in place. If not, the sale is considered a token presale.
Token presales can be seen as selling securities under the US Howey Test (there is an investment of money, the investment is in a common enterprise, and buyers expect to profit from the efforts of others), which means various SEC securities restrictions, as well as registration and reporting requirements.
Selling unregistered securities can mean significant fines and prison sentences. This has led some companies incorporating outside of the US (incorporating instead in, say, Switzerland) to bypass the US market altogether.
Enter the security token offering
Off the back of regulators trying to catch up to what is a rapidly moving area field, and in the face of much uncertainty around future regulation, a new form of ICO has risen: the security token offering (STO).
In the case of a utility token, the buyer does not own anything and there is no real-world asset backing it. But with a security token, the buyer owns a piece of whatever the token represents.
In most cases, a security token is just like any normal security (such as equity, derivatives or real estate) but in digital form, making it much easier and quicker to buy and sell.
While security laws apply to these tokens, they have added benefit in terms of liquidity, accessibility and traceability, as well as decentralisation (DLTs enable all of this).
Why tokenisation holds huge promise
Any real-world asset could be tokenised as security assets - houses, paintings, or even a portfolio of houses or paintings. Assets could also be digital, like a song or some form of digital artwork.
The opportunity to tokenise things is massive. For instance, a VC firm could raise money through an STO, issuing a highly liquid and legal token, which could be traded on secondary markets, and with all transactions recorded on a DLT.
The STO is beginning to build momentum, with a $400 million real estate STO already being announced. Because of this, the infrastructure to support these projects and security tokens is also taking shape, with the rise of new projects like tZero, Polymath, BlockEx and Harbor.
Many of these projects are vying to disrupt centralised institutions that deal in securities, like stock exchanges, by creating highly efficient, transparent and decentralised substitutes, as well as enabling the tokenisation of assets that have been historically illiquid.
Tokenisation holds huge promise. In 2017, the IPO market generated US$188 billion, and that’s just a small fragment of what could be tokenised. Other obvious things include commodities and debt, but the possibilities are limitless.
Regulation is still catching up, but the concept of an STO is something we will be hearing a lot more of in 2018.