Security Token Offering (STO): The Comprehensive Guide

The progressive world of cryptocurrencies has much more to offer than just speculative altcoins to invest in. One of the groundbreaking developments enabled by the blockchain is the security token offering (STO).

STO represents yet another way blockchain technology bridges the gap between traditional finance and securities with digital finance and crypto. As regulatory frameworks evolved and adapted to the changes, STOs became an attractive and efficient way for businesses to raise capital.

So, what exactly is a security token offering, and how does it leverage the technology brought by crypto? What are the significance and benefits of STOs compared to traditional public offerings? Are there any drawbacks?

Join us as we explore this complex term, shed light on one of the most popular capital-raising instruments in recent history, and answer all your questions. Let’s jump right in!

What Are Security Tokens?

Security tokens are digital assets that symbolize ownership of real-world assets. As their name suggests, they are tokenized securities representing valuables like stocks, bonds, and real estate integrated into a blockchain.

They are not to be confused with utility tokens, which allow users to access various networks and services, thus deriving value from their functionality and purpose. Instead, security tokens are as valuable as the external assets that they are pegged to. Moreover, unlike utility tokens, they are subject to securities regulations.

One of the biggest upsides of security tokens and their primary allure is the versatility enabled by their blockchain digitalization. Holders can effortlessly trade them on any platform that is in compliance with the regulatory environment. Furthermore, the tokenization process adds new features to securities, such as liquidity, fractionality, availability, inclusion, and more.

Then, there’s the inclusion of transparency and security, which are foundational to blockchain technology. Security tokens are clearly visible on a public ledger where anyone can verify their ownership and transaction. The addition of these components reduces the risk of fraud and streamlines all operations.

What Is a Security Token Offering (STO)?

A security token offering is one of the latest steps in the realm of fundraising. Since security tokens represent tokenized assets—like stocks—companies can use STOs to go public. Simply put, they can privately or publicly offer to sell security tokens to investors in order to raise capital. Investors can then prove their ownership of real-world assets by using blockchain.

STOs represent the evolution of ICOs, which were highly popular in the realm of cryptocurrency between 2016 and 2018. ICOs were the initial crypto-backed fundraising method that involved selling utility tokens as a means of raising capital.

While ICOs gave many startups opportunities to grow, the lack of regulation led to many issues, including fraud. On the other hand, attempts to regulate them pushed developers and investors away from ICOs, which is where security token offerings come into play.

Compared to an ICO, a security token offering adheres to regulatory standards. While that results in increased requirements and more work on the company’s end, the outcome is increased security, lowered risks, and better protection for the investors.

Security Token Offering vs. Initial Public Offering

A security token offering can be thought of as a crypto version of the initial public offering (IPO). STO combines the elements of an IPO and an ICO (initial coin offering) to create a hybrid method that brings the best of both worlds.

An initial public offering is the traditional version of a security token offering. It’s a process where a private company goes public by offering its shares to investors and ends up listed on a stock exchange. IPOs have existed for centuries since some of the earliest records date back to 1604. As a result, there’s a well-established regulatory structure surrounding it.

The first STO occurred in 2018, which makes this funding method far less established than an IPO. Still, STOs are gaining popularity, and regulatory advancements follow. Compared to IPOs, STOs are sought-after for their global accessibility, tokenization of traditionally illiquid assets, fractional ownership, and more.

How Does Security Token Offering Work?

Due to their similarities to initial coin offerings and initial public offerings, security token offerings work much like ICOs, with the goal equivalent to IPOs. They were created to make up for the shortcomings of the other two methods of raising funds.

Many startups run into barriers when trying to raise funds through IPOs. All the rules and regulations can be too difficult to overcome for small teams and companies that might not have the necessary assets and knowledge.

While there are still regulations surrounding security token offerings, they are less challenging and more friendly to inexperienced organizations. On the other hand, the presence of some regulations instills confidence in investors and increases STOs' chances of success compared to ICOs.

Crypto-securitization is another key benefit of a security token offering. The ability to store records of transactions and ownership of real-world assets, like stocks and bonds, on the blockchain is one of the main appeals of STOs.

This tokenization then allows holders to trade their securities while lowering the costs associated with any type of management or administration. Everything from the amount of paper to the work hours required is reduced—or even nonexistent—compared to regular securities.

Finally, security token offerings are used to tokenize many different assets, including:

• Real estate equity, much like REITs (Real Estate Investment Trusts)
• Company shares
• Commodities such as gold, silver, gas, oil, and more
• Equity funds

What Are the Uses of Security Tokens?

Since security tokens exist on a blockchain, they have more uses than traditional securities and offer a higher degree of flexibility.

#1. Transparency

Transparency is one of the main features of blockchain technology. At its core, blockchain is a decentralized ledger that stores every transaction ever made and presents them to all users. That means security token holders can effortlessly check their assets and verify ownership at any given moment.

All this adds a layer of trust to the concept of security token offerings. Investors are more inclined to trust the issuing companies since the risk of fraud is diminished and there’s more overall accountability.

#2. Divisibility

Divisibility is a standout feature of security tokens and one of their main benefits compared to traditional securities. It allows for fractional ownership of assets that are otherwise indivisible. For instance, ownership over a single painting can be split among as many individuals as necessary.

This approach facilitates the democratization of investing. It creates more opportunities for individuals who would otherwise be priced out of attempting to invest in costly assets. Lastly, it boosts liquidity in the market through the sheer volume of security tokens.

#3. Availability

Security tokens are available on a global scale. In addition to being accessible to investors with moderate finances, they also allow anyone to invest in them, regardless of their location.

Traditional assets can be region-locked or specific to an exchange. On the other hand, an issuer can make their security tokens available to a worldwide audience. This approach benefits both startup companies and investors eager to participate.

#4. Quick Settlement

When it comes to traditional securities, there are many intermediaries to go through and numerous systems in place that impact settlement times. Furthermore, the markets aren’t open all the time since they generally require labor, effort, and energy to run.

On the flip side, security tokens leverage the properties of blockchain and smart contracts. This results in settlement automation, and processes are almost instantaneous. Not only that, but many platforms operate 24/7, allowing investors to participate whenever they want.

Types of Security Tokens

Ever since the inception of security tokens, the need for them has been growing. As digital assets continue to develop, chances are that different types of security tokens are going to appear. There are currently three main types that we’re going to explore.

#1. Equity Tokens

Equity tokens are best compared to traditional stocks. They represent digital symbols of ownership in an entity, including shares in a company. Equity tokens can also be used similarly to stocks. Holders are entitled to receive dividends or shares in profit.

Additionally, equity tokens may give investors voting power and allow them to take part in the decision-making processes of the company in question. On the other end, equity tokens allow companies to digitize their stocks, enhance their liquidity, reach more investors by offering fractional ownership, and facilitate their trading on digital platforms.

#2. Debt Tokens

Debt tokens represent tokenized versions of debt and loans, much like the concept of bonds in traditional finance. In essence, investors who purchase debt tokens lend funds to the issuers. For that, they should receive regular interest payments for a set period of time until the debt matures, and they exchange the tokens for the original sum.

Like other security tokens, debt tokens can also be traded, which gives investors flexibility and opens up different ways to earn income on their assets.

#3. Asset-Backed Tokens

Asset-backed tokens are pegged to physical or other types of real-world assets from which they derive their value. These assets include everything from precious metals and commodities to real estate and art pieces.

Security token fractalization is one of the key benefits of asset-backed tokens. They allow issuers to vastly enhance the liquidity of otherwise illiquid assets. That makes them accessible to wider audiences and facilitates trading on digital platforms.

6 Factors to Consider Before Launching Security Token Offering

Before launching a security token offering, issuers have several different factors to consider if they want to ensure their success. The key factors include:

1. The nature of tokenization. It’s crucial for issuers to fully familiarize themselves with security tokens and their differences compared to traditional assets and securities. That will allow them to determine the tokenization model, figure out the type of security token they want to use, their number, and more.
2. KYC and AML procedures. Due to all the regulations surrounding security token offerings, the issuers must pay attention to KYC (know your customer) and AML (anti-money laundering) measures. Implementing rigorous KYC and AML protocols also helps build confidence among investors who want to buy security tokens.
3. Regulatory compliance. Apart from KYC and AML, there are often many other rules for STOs. These rules can vary between jurisdictions, and non-compliance can lead to severe legal repercussions. That’s why it’s crucial to have legal experts who specialize in these processes to help navigate the landscape.
4. Corporate framework. The complexity of security token offerings calls for a robust corporate framework to be put in place. The issuer needs to have a clear company structure and governance models to maximize the chances of having a successful STO. This includes defining everything from decision-making processes to profit distribution.
5. Technology infrastructure. Choosing the right platform to launch a security token offering can be essential to success. It’s imperative to go with a reliable blockchain platform that supports tokenization and smart contracts. Additional options to consider are scalability, security, integration opportunities, availability of tools for investors, etc.
6. Post-STO management. Planning for the period after the STO concludes can result in better outcomes. This includes future token distribution, communication and relations with investors, project updates, financial disclosure reports, and so on.

How to Launch STO

There are four major steps in a typical security token offering process, so let’s explore each one.

Step 1 - STO Preparation

The first step in the STO launch process involves conceptualization and preparation. It involves determining which assets are going to be tokenized, as these can range from company equity to art pieces.

After that, a company that decides to raise funds through an STO should prepare a document with the purpose of informing investors about their business. This document (called a “deck”) should feature various information, including business plans, goals, and requirements.

Step 2 - Pre-STO

The pre-STO phase involves creating an offer and marketing it to the right investors. Offer creation includes the company dealing with the tokenomics of their offer. They need to specify how many security tokens they are going to issue, what the maximum circulation will be, how long the offer will last, what the value of each token is, and so on.

Along with the token structure, it helps to have a professionally written whitepaper along with enticing company achievements and strong team credentials. On top of all that, there are also legal matters relating to the offering and sale of tokens.

Next, the company should select the service provider to facilitate their STO. That involves finding a blockchain platform they plan on using to issue their security tokens. They can take into account the platform’s reputation, whether they have integrated wallets to offer to their users, what the listing requirements are, and so on.

Finally, after all the groundwork has been laid, the issuer initiates the capital-raising process. This part involves marketing campaigns, where the company targets suitable investors to share as much information with them as possible. These marketing campaigns sometimes need to be approved by a relevant authority.

Step 3 - STO Launch

An STO launch is a vital step in the entire process, as it involves running a sale of security tokens to obtain the funds that they were after in the first place.

At this point, the company lists the token on the trading platform of their choice. Depending on demand and market activities, they can also appoint market makers to boost liquidity and further facilitate the selling process.

The company should monitor the sale in real time to address any issues and concerns, such as technical glitches or investor inquiries. Depending on the length of the STO, it’s important to stay connected with the audience and maintain transparency and communication. That can be done through the website, email, forums, social media platforms, etc.

Step 4 - Post-STO

The post-STO phase of the launch revolves around delivering on the promises to investors and maintaining relations with them. After the initial token distribution, the remaining ones (if there are any) can be listed on secondary markets in a way that follows the deck and the whitepaper.

After that, the company should keep working on their project while transparently providing investors with regular updates, project milestones, financial reports, and other relevant information.

4 Top STO Platforms

STO platforms are designed to facilitate every aspect of the security token offering process, from their creation to trading and management. Choosing the right platform is crucial for the success of fundraising. Let’s explore some of the most common ones.

#1. Polymath

Polymath is one of the best STO platforms that offers an all-in-one solution for those looking to raise capital. It features a purpose-built blockchain designed to facilitate every step of the STO process, including token minting, investor management, and fundraising.

Their open-source code helps with transparency and provides an additional layer of security. Moreover, Polymath offers a modular solution, so you can easily customize your offer to fit your needs and your jurisdiction’s regulatory requirements.

#2. Securitize

Securitize thoroughly vets their clients to provide investors with the best opportunities. That helps investors by reducing the time they need to spend on research. Moreover, the platform features both primary and secondary markets, so investors can continue trading after the initial STO sale has passed.

#3. Token IQ

Token IQ is a crypto-oriented STO platform that recognizes all the benefits blockchain technology brings to the fundraising space. They cater to startups and investors, as well as publicly traded companies and banks. Some of the key problems that Token IQ addresses include cross-border issues, token price volatility, and regulation compliance.

#4. Tokensoft

Tokensoft has facilitated more than $1 billion in funds raised with an STO token list of 100+ assets. Their mission is to provide a secure and scalable solution to issuers while assisting with regulatory compliance. Among many perks, Tokensoft's services include white-labeling, documentation, account management, custom blockchain integration, and much more.

Benefits of STO

Security token offerings come with several benefits compared to both IPOs and ICOs, which is why they are rapidly gaining in popularity. Some of the key advantages to using STOs to raise funds include:

• Global accessibility. Security tokens issued on the blockchain can be accessed by investors worldwide. That creates financial inclusion among people who aren’t able to participate in IPOs while simultaneously giving issuers a larger target audience.
• Reduced costs. Traditional methods of startups raising capital involve many intermediaries, such as banks and layers. All of that increases the cost for the issuer and raises the initial barrier. Blockchain-backed STOs are much cheaper since many processes are streamlined and powered by smart contracts.
• Fractional ownership. Tokenizing real-world securities adds cryptocurrency properties to that. That means issuers can “split” securities into as many security tokens as they want, lowering the barrier of entry and broadening the investor pool.
• Enhanced liquidity. Another big perk of security token offerings is enhanced liquidity, which is another feature of cryptocurrency. First off, fractionalization creates more tokens to be traded between entities. On top of that, these assets can then be traded on secondary markets and exchanges that often operate 24/7 and on a global scale.
• Increased transparency. Blockchain-backed security token offerings bring increased levels of transparency compared to traditional IPOs. Information about every asset and transaction is stored on a public ledger that anyone can access. The benefits of this approach are increased trust and reduced chances of fraud or mismanagement.

Disadvantages of STO

While STOs offer many benefits, there are still drawbacks to consider before opting for this fundraising method. Some of the key disadvantages are:

• Regulatory concerns. Security token offering regulation remains one of the biggest drawbacks of this fundraising method. While the regulatory landscape keeps evolving, there are still vast differences between jurisdictions that bring complex legal challenges and potential problems to both issuers and investors.
• Complexity. STOs combine elements of ICOs and IPOs to get the best of both worlds, but that also results in increased complexity. Issuers and investors need to be familiar with not only traditional fundraising procedures but also blockchain technology and cryptocurrency features.
• Limited investor base. Taking regulatory concerns and complexity into consideration, it should come as no surprise that there are still a reduced number of STO investors compared to traditional ones.

Key Takeaways

This marks the end of today’s lesson on security token offerings, meaning you’re all but ready to become a savvy investor. We’ve seen how they represent a step towards merging traditional financial mechanisms and revolutionary blockchain technology.

STOs benefit everyone, from small startups who are looking to raise funds and eager investors priced out or region-locked from IPOs to the realm of cryptocurrency itself. And while STOs aren’t without drawbacks and there are still challenges ahead, they are a step in the right direction toward financial inclusion and decentralization.

Whether you’re an eager entrepreneur looking to get into investing, an experienced venture capitalist, or a startup company looking to enter the market, STOs might just be the thing you are looking for!