Security Token Offering (STO) Explained in 5 Minutes or Less

Security Token Offering (STO) allows you to buy regulated digital tokens representing assets such as gold, real estate, or stocks.

Simply put, a crypto token represents a digital asset that exists on the blockchain of another cryptocurrency. These tokens can store value, buy digital assets, or pay transaction fees.

Initial Coin Offering (ICO) was considered the most preferred option to offer crypto tokens during 2017-18. However, this unregulated offering process also witnessed a rise in tokens without actual values.

A study by Satis Group LLC claimed that almost 80% of ICOs are scams. With millions of investor’s money involved in ICOs, regulation for token offering became mandatory. As a result, Security tokens were issued using Security Token Offering (STO).

A security token is a type of crypto token. Let’s understand more about it.

What Is a Security Token?

A security token acts as a digital representation of an investable asset. These assets include real estate, commodities, art, stocks, or bonds.

The main aim of an investor while buying a security token is to generate profits. For this reason, buyers tend to choose tokens with high future growth potential.

Security tokens are issued with the help of blockchain technology to make the whole process transparent and simple. You’ll also receive dividends, asset ownership, and voting rights.

The Securities and Exchange Commission approves security tokens. Moreover, governments or businesses can only issue these tokens.

What Is a Security Token Offering or STO?

Security Token Offering (STO) is a process of selling security tokens through specific exchanges. Here the token transactions are verified and stored on the blockchain network.

STOs allow investors and founders to raise digital funding for their new projects. Moreover, they will also have to follow government regulations strictly. Besides, these tokens are not available on regular crypto exchanges like Binance, Coinbase, or Kraken.

2018 saw a huge initial coin offering (ICO) based bubble burst. Between the crypto booming years of 2012 and 2018, scammers took advantage of this high market demand.

Fake projects started raising funds from people selling false hopes. As a result, ICOs raised $6,880 million in the first quarter of 2018.

However, following a series of scam ICOs, the demand for this coin offering fell drastically. Eventually, at the end of the fourth quarter of 2018, ICOs could raise only $340 million.

Following the ICO crash, government regulatory bodies started to bring more safety and security to the investor’s funds. For this reason, STOs, a more regulated version of ICOs, were born.

You might wonder how STOs differ from ICOs. Let’s get into it right away.

ICOs are easy to launch and don’t require any regulation that protects the investor’s money. In contrast, STOs are launched through strict and structured government policies and regulations.

In addition, it’s not mandatory to have a valuable asset to launch tokens using ICOs. Whereas STOs only issue asset-backed tokens.

How Do Security Token Offerings (STOs) Work?

The working of STOs can be divided into 6 phases. A project must complete all these phases to offer its security tokens.

#1. Project Preparation

The project founders and developers create business ideas and plans during this first phase. Moreover, the project appoints its team members and advisors at this stage.

The technical team prepares the whitepaper that explains all details regarding the project. These details play a crucial part in accepting a project’s token offering.

In addition, this initial stage also is used to take important decisions on:

• Selecting digital technologies and related service providers.
• Development of the investor deck.
• Calculations on the project’s capital requirement.
• Target investor identification.

#2. Design STO Structure

Projects appoint qualified corporate finance advisers to do a good structuring of STO. These advisors work with the founders and other team members to create a structure for token offerings.

In addition, legal advisors are also appointed to:

• Evaluate STO regulations.
• Determine the minimum lockup period of tokens.
• Analyze investor requirements.
• Figure out the applicable exemptions.

At this phase, an appropriate jurisdiction is selected that supports the project’s vision. This selection helps the project to incorporate and sell its token offerings.

#3. Technology Selection

STOs are powered by blockchain technology, and selecting a suitable platform is important. At this phase, the project approaches a blockchain service provider.

Security tokens are created based on the business idea, vision, and valuation. Moreover, the project develops a portal for its future investors.

Investors can use this portal to verify their anti-money laundering (AML) and know your customer (KYC) instantly. In addition, you can use this platform to connect your crypto wallets.

#4. Selecting Financial Service Providers

The founders appoint brokers to help them sell their security tokens. Besides, those transfer agents are onboarded to monitor the token issuance.

In addition, custodians are also appointed for safekeeping. Here the technical team also associates with payment providers to implement fiat payment systems. 

#5. Fundraising

The main step in fundraising involves finding potential investors. Later, the broker arranges meetings with the investors and shares the offering documents.

Besides contacting investors directly, online marketing also plays a crucial role in funding STOs. Active social media campaigns have now become a common process to promote token offerings.

#6. Security Token Listing

The last phase includes the selection of exchanges for STOs. Government regulatory bodies must approve these exchanges.

Finally, the security tokens will be available for sale. Also, it is mandatory to update the project’s developments regularly with the platforms and the regulatory authorities.

Security Token Offering (STO) Vs. Initial Public Offering (IPO)

An STO can be considered a combination of an ICO and an IPO. The major differentiator between STO and IPO includes:

• The process behind initial public offerings (IPOs) is expensive and time-consuming. On the other hand, security token offerings (STOs) are comparatively economical and require less processing time.
• The investment type acts as a major difference between STO and IPO. In the case of STO, security tokens are issued, whereas IPO is conducted for the issuance of stocks.
• IPO is limited to offering shares of private corporations. In contrast, ICO has the flexibility of representing security tokens of multiple assets. 
• IPO participants receive digital documents that confirm the ownership of company shares. In comparison, STO provides you with digital tokens as proof of ownership.  

Different Types of Security Tokens

Security tokens are further divided into three types:

#1. Asset-backed Tokens

Asset-backed security tokens represent the ownership of real-world assets such as real estate, commodities, or precious metals. These tokens can be traded based on the price of their underlying asset.

Investors can choose the type of asset depending on their risk appetite. For example, if you believe in the stability of gold, then you can invest in gold-backed security tokens.

#2. Equity Tokens

An equity token represents a stock of a publicly listed company. Your ownership information is directly stored on the blockchain network when you buy this token.

In addition, equity token holders also receive all the benefits provided to the company’s shareholders. For instance, you’ll receive the same capital gain, dividends, and voting rights.

#3. Debt Tokens

Debt tokens act like a loan the investor provides to a trusted company. As a result, this security token holder receives an interest in return. Here the interest rates vary based on the companies.

Debt tokens are of two types:

1. Stable Debt Token: This debt token rewards you with a fixed interest. Moreover, you’ll be able to calculate your overall interests before buying the tokens.
2. Variable Debt Tokens: Unlike stable debt tokens, variable debt tokens don’t come with a stable interest rate. Here the rates vary based on the interest policies of the companies. 

Top STO Platforms

STO platforms were developed to simplify the token generation process and be more accessible. Now, let’s look at some top platforms that offer STOs.

#1. Polymath

Founded in 2017, Polymath is one of the most preferred platforms for STOs. This platform operates completely based on the security token regulations and guidelines.

Polymath uses four core layers to support developers in creating and providing liquidity for their security tokens. The four layers consist of an application, protocol, exchange, and legal layer.

#2. Securitize

Securitize provides an end-to-end tool that allows companies and individuals to create security tokens. Besides, this platform offers back-end assistance for users to speed up the token offering process.

In addition, you can use this STO platform to incorporate Ethereum-based DApps. Moreover, Securitize’s Digital Securities Protocol (DSP) allows you to trade security tokens across different marketplaces.

#3. Securrency

Developed by blockchain experts in 2015, Securrency provides secured tools to issue security tokens. This platform allows users to transform assets in different forms like securities, tokens, and fiat currencies.

You can also use Securrency to trade security tokens on multiple blockchain networks. Moreover, you’ll also receive technical support after your token offerings. 

#4. Swarm

Unlike the other platforms mentioned above, Swarm provides a wide range of solutions around STOs. The features provided include token creation, fundraising, configuration, token issuance, and many more.

Swarm supports small enterprises in conducting the overall STO procedures. In addition, this platform also supports post-issuance activities like asset governance, dividend issuance, and reporting.

#5. Tokensoft

Tokensoft offers tools to create security tokens on popular blockchain networks. The supported networks include Arbitrum, Ethereum, Polygon, Celo, Avalanche, and Optimism.

Moreover, this platform provides KYC/AML compliance for over 50 jurisdictions. Besides that, Tokensoft provides distribution support, token trading, and token issuance features.

Advantages of STO

#1. Low Risk

STOs are regulated using government laws and regulations. This strict governance procedure limits the token offerings of fraudulent projects.

In addition, the security token issued has an underlying asset that is less likely to lose all its value. Moreover, token buyers can also choose low-volatile assets to safeguard their investments.

#2. Presence of Real-world Asset

STOs allow you to own company shares and physical assets such as oil, silver, gold, and more.

You can also evaluate the security tokens based on the price of the token’s real-world asset. This pricing will ensure you receive a fair market price on your investments.

#3. High Liquidity

With the implementation of STOs, you’ll be able to buy a part of an expensive asset. For example, if a popular real estate in New York costs $100 million and is distributed as 1 million tokens; In this case, you can buy a token for $100 and gain ownership for a portion.

This asset tokenization increases the liquidity of security tokens as it is more affordable for a larger population. As a result, you’ll always find buyers to sell your tokens.

Also read: Real Estate Tokenization Explained in 5 Minutes or Less

#4. High Efficiency

Buying assets from the traditional investment market is complex and highly time-consuming. In contrast, STOs, with the efficiency of blockchain technology, simplify the whole security market.

Security tokens automate the verification procedures like KYC and AML and simplify auditing and accounting procedures. In addition, the elimination of banks reduces transaction speed and cost.

Disadvantages of STO

Along with the advantages mentioned above, STOs also comes with a few disadvantages:

• High Volatility: The high liquidity mentioned as an advantage can also result in a highly volatile market. In this case, the price of tokens can quickly change with time. 
• New Technology: Blockchain technology is in its early stages. As a result, traditional companies might find it difficult to adopt this new technology.
• Limited Investor Participation: The regulation and policies restrict the number of potential investors from issuing security tokens.

Are you interested to learn more about STOs? If so, I would like to recommend great books to you!

Learning Resources

#1. Assets on Blockchain

In this book, Assets on Blockchain, Max Kops teaches about tokenizing and digitizing assets to create security tokens.

This book also covers the following:

• Revolutionizing traditional assets using security tokens.
• Importance of tokens, blockchains, and STOs in transforming the financial industry.
• The detailed process involved in STO.
• Information regarding security tokens and laws related to it.
• Advantages and disadvantages of blockchain-based assets.
• IPOs vs. STOs.
• Tokenized finance and its relevance for investment bankers, investors, companies, and asset managers.
• Overview of various regulatory standpoints across the world.
• Practical and simple case studies.

#2. STOs – Security Token Offerings for Beginners

STOs – Security Token Offerings for Beginners by Alex Anderson answers all beginner’s doubts related to security tokens, STOs, ICOs, and IPOs.

In addition, you’ll also learn about topics such as:

• Working of STOs.
• Steps to consider before investing in STOs.
• Different varieties of assets-based security tokens.
• Tax and regulatory aspects.
• The process to evaluate the best STOs.

#3. The STO Financial Revolution

The STO Financial Revolution, written by Alex Nascimento, aims to provide detailed information on security tokens and their offering process.

This book’s main target readers include entrepreneurs, investors, financial professionals, and blockchain enthusiasts.

The major features of this STO-based book consist of the following:

• STO applications for companies.
• Steps to use blockchain technology to tokenize an asset.
• Principles for organizing, managing, and planning security tokens.
• STO case studies. 

Final Words

Security Token Offering (STO) is crucial in eliminating scam projects that widely existed in the ICO period. With security tokens, you can own digital tokens of real-world assets.

STOs solve the majority of issues related to regulations and project verification. However, security tokens also come with risks based on their underlying assets. So, it’s always better to conduct proper research before investing in any tokens.

You might also be interested in the top crypto trading courses.