Understanding Security Token Offerings (STOs)

Businesses and start-ups around the world always look for financial resources to fund their new projects or organizational expansions. In the traditional form of fundraising, the board of the company or the start-up founders launch an IPO which is short for Initial Public Offering, to list the company shares for investors to buy. In that way, investors buy shares in hope for dividends and price growth, while the company or start-up receives financial resources to kick start their projects. 

Like other markets, Blockchain is making significant changes to financial markets in general and fundraising markets in particular. ICO and STO which stand for Initial Coin Offering and Security Token Offering are emerging as applications of the Blockchain technology. Unlike the ICO that is heavily criticized due to its unregulated and risky nature, STOs are rising in popularity in recent years. Let’s now dive deep inside and see what STO means.

What is Security Token Offering

STO which is short for Security Token Offering is basically a fundraising method within the blockchain network. It is similar to IPO which is short for Initial Public Offering, where start-ups and companies issue company shares for investors to invest in their new or expansion projects. STOs are regulated and must be issued in compliance with Security regulations of the country where they are issued. Security tokens represent a tangible asset or a share of a tangible asset in the blockchain network. It can be public or private sector bonds, shares, real estate or commodities. The process of converting a real world asset to tokens, making the project in compliance with the securities and commodities regulations of the country where it is conducted and listing it for sale to raise funds in exchange of a fractional ownership on a tangible asset, is called Security Token Offering or STO.

How does STO work?

The process of STO involves multiple steps as below:

1- Asset Tokenization

STO is tokens that represent a real world asset in the blockchain network. Hence, as the first step, you must tokenize an asset to start the Security Token Offering process. The asset can be a real estate property, governmental bond, company share and a lot more.

2- Regulation Compliance

STO must comply with the government regulations on security and stocks. Actually, this is the most important advantage of STO in comparison with unregulated ICO. You may read our article about UAE regulation on asset tokenization for further information.

3- Smart Contracts Development 

One of the most important parts of STO or any blockchain-based project is developing appropriate smart contracts. Self-executed blockchain programs that administer all terms and conditions and execute the whole STO process are called smart contracts. This will include token owners’ right, dividend entitlements, ownership registration and a lot more. 

4- AML and KYC compliance

STOs should not only be created under security and stocks law, but also must comply with AML(Anti Money Laundering) and KYC( Know Your Customer) laws and regulation for the sake of preventing misuse of tokens. 

5- Initial Offering

Once all requirements are in place, the initial offer will be executed and investors receive tokens in exchange of fiat or crypto currency. By receiving tokens in their wallet, investors own the rights and entitlements that are tied to the underlying asset. 

6- Secondary Trading

Security tokens that are bought by investors through the initial STO can be traded within exchanges and trading platforms. Those platforms and exchanges must also comply with governmental regulations.

7- Dividends and Incomes

As going forward, the underlying asset might generate profit or income. For instance, a real estate property generates rental income, so it must be distributed between the investors who are basically the token holders. Investing in STOs is a great way for making passive income in crypto. Besides, smart contracts take care of calculating and distributing the income to investors with no human interference which makes it cost efficient.

Final Words

STO comes with lots of advantages such as regulatory compliance, better liquidity, global access to investors and a lot more. However, there are some risks that you must consider, before making the decision to invest in STO. Regulatory differences between different countries, specifically tax regulations might cause difficulties for investors. Besides, ensuring about a STO project compliance with local regulations, where it is launched is another risk for investors. Furthermore, STOs potential for fraud and vulnerable activities is another concern that investors must be careful about.

Finally, we would like to recommend investing in projects, where you are confident about regulation compliance and legitimacy. You must be careful for the sake of safeguarding your money against potential threats and more importantly, STO regulatory and standardization discrepancies and conflicts.