Security tokens represent investments or an investment contract into an underlying investment asset, such as stocks, bonds, funds and unit trusts. A security defines as a “fungible, negotiable financial instrument that holds some type of monetary value,” backed by a real-world asset like a company or property. A security token is a negotiable electronic instrument representing title of ownership, recorded on a blockchain. For example, when investing in traditional stocks, ownership information gets written on a document or recorded in a custodian account. For a security token offering, it’s the same process, but recorded on the blockchain as a token. STOs can also be seen as a hybrid approach between cryptocurrency and token offerings and the more traditional initial public offering (IPO) because of its intersection of both of these methods of investment fundraising.
STOs are asset-backed and comply with regulatory governance. Most ICOs, on the other hand, position their coins as a utility token that give users access to the native platform or decentralized applications. They argue, it is for usage and not for investment. As a result, ICO platforms circumvent certain legal frameworks and do not have to register or comply with the strict governance of regulatory bodies. The barrier to entry for companies to launch an ICO is, therefore, much lower.
It is much more difficult to launch an STO, as the intention is to offer an investment contract under securities law. Therefore, issuer platforms do the upfront work of making sure they comply with the relevant regulations. They would typically also only be able to raise funds from accredited investors who have themselves passed certain requirements.
Investopedia definition: https://www.investopedia.com/terms/s/security-token.asp
Crowdfunding is the strategy used by the SMEs to raise their funds for projects. Fundraising occurs from a large online group through platforms like Kickstarter or GoFundMe. Once the project raises enough funds, they transfer to the project sponsors.
Usually, there are four methods of crowdfunding:
- Donation-Based Crowdfunding, where the investors have a desire to donate money to the projects.
- Reward-Based Crowdfunding, where investors contribute in return for some reward in the form of products or services offered by the enterprise.
- Equity-Based Crowdfunding, where the investor has the right to become a part of the company.
- Debt-Based Crowdfunding where the raising of the funds from the individuals is in return for interest. The latter is also known as Peer to Peer lending platforms which enable the lenders to earn better returns than from banks.
Both crowdfunding and ICO & STO strategies are attracting the investors globally! Crowdfunding is subject to national legislation this implies that crowdfunding platform cannot look for investors outside the own country of the platform.
Investopedia definition: https://www.investopedia.com/terms/i/ipo.asp
How ICO & STO vary from traditional crowdfunding methods?
Initial Coin Offering was the popular strategy to raise the funds for blockchain projects. Especially with the start-ups. This is a means of crowdfunding technique through the creation of digital coins or tokens. Start-ups typically use ICOs as a fundraising strategy to showcase their ideas and raise funds.
Security Token Offering emerged with the motto of making the fundraising process more secure. Security Tokens have the advantage of regulations and laws that should impose guidelines on projects according to the SEC.
How STOs differ from Traditional Crowdfunding strategies?
Traditional Crowdfunding methods involve diverse industries. In the case of ICOs only blockchain based projects are usually done. STOs also involve diverse industries.
Traditional crowdfunding and initial coin offerings face few regulations. However, security token offerings follow SEC guidelines completely in all countries.
All three platforms are open to a larger audience. There is no geographical restrictions imposed on them.
Therefore, these platforms have gained huge customers on social media. Added, this has helped investors to gain desirable funds for their projects. In the event of all the three, the exchange of money takes place between the investor and fundraising agent. Therefore, all three can be a bit risky in terms of money exchange. Though ICO’s are experiencing scams nowadays, STO platforms guarantee a return on investment which remains trustworthy for investors. On the other hand, traditional crowdfunding offers no guarantees in terms of return on investment. In ICOs and STOs, investors receive rewards as a return on investment. It can be in the form of a token. These tokens can, in turn, provide access to the company’s services.
Why ICO & STO are a way better than the traditional ones?
Both Initial Coin Offering and Security Token Offering are a much better deal for investors. For example, consider you are investing $10,000 in traditional crowdfunding.
Liquidity does not exist as funds remain locked up for a period. Bulletin board options on crowdfunding platforms prove useless since transactions must finalize externally, exposing investors to counterparty risk. As a consequence, illiquid shares are more similar to a bet than to an investment.
While in the case of ICO and STO, the markets offer higher liquidity with the fluctuations each day. Higher liquidity means also higher valuation of a company. With higher liquidity, the value of the cryptocurrency enhances as the business & projects start to raise. But anyhow, if your project is a non-blockchain project, until recently you had no other way than going with Traditional Crowdfunding platforms! Now STO platforms start to onboard all sorts and kind of industries.
Equity crowdfunding on the other hand is a small percent of the total crowdfunding market. This because a potential exit after 3-5 years and only in case the company got IPO-ed or acquired.
Why does crowdfunding still occur, especially in the UK? The short answer is that crowdfunding receives tax relief support. The long answer is more convoluted, but many people view it as a hobby, nice pass-time and a betting exercise and commit only small amounts of money.
STOs are the best method. Information is provided in an offering prospectus and only facts can show up in them due to regulation restrictions. With STOs there is secondary market which provides liquidity before exit.
So do ICOs but these are more risky as not regulated and all sorts of claims and misappropriations can happen. STOs can reach investors globally because blockchain powers them, eliminating costly custodians for holdings and allowing transfers directly on the blockchain. STOs are available and most secure part of crypto markets. Smart contracts power STOs, allowing trade on decentralized exchanges without third party risk. Transfers tie directly to payment like traditional letters of credit. Crowdfunding works for small projects since a prospectus can’t be deposited for deals under 8 million EU. Legislation also differs in each country without a cross-EU prospectus.
Hence the crowdfunding technique is for small national projects. STOs can be used for large, global projects since issuers can deposit prospectuses and make use of self-issuance privileges. Crowdfunding returns remain modest and don’t facilitate building a diversified portfolio. The only market where it might make sense to launch a campaign is UK – rest of Europe is not significant.
Based in Zug, the platform is fully compliant with all Swiss laws related to financial intermediaries, banking, anti-money laundering, and organized trading facilities. Among its core values, there are innovative solutions through blockchain technology, which ensures security and liquidity.
EDSX is the first platform in Europe with primary and secondary markets for both institutional and retails. EDSX is a pioneering platform that employs the world’s leading technology to globally list security tokens in both primary and secondary markets, listing digital securities of real financial instruments to the public with a decentralized peer-to-peer exchange. Our goal is to fully engage every aspect of the financial revolution.
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