Fundraising in the modern world is in a constant state of evolution. While legitimate avenues for projects to receive funding were once few and far between, the advent of blockchain technology introduced new fundraising methods for businesses and startups.

Currently, projects often utilize blockchain technology in the form of Initial Coin Offerings (ICOs). Despite existing since as far back as 2013, ICOs have become extremely prominent in the last couple of years, raising an estimated $4.9 billion USD in 2017.

While ICOs have proven to be an extremely disruptive tool for projects to utilize, contemporary thinkers are continually developing new fundraising models. Security Token Offerings (STOs) represent a fundraising model that is becoming increasingly popular. These offerings attempt to utilize the effectiveness of ICOs while remaining compliant with modern financial regulation.

Why STOs are important, and how they differ from ICOs

Security Token Offerings (STO) are similar to ICOs in many ways, but have some key differences when it comes to operating within the confines of financial regulation.

By their very nature, Initial Coin Offerings are a disruptive fundraising method that is able to eliminate many of the barriers to entry that exist in the traditional fundraising process. While this has largely contributed to the popularity of ICOs, it is not without some major oversights.

In fact, as a result of the open nature of the ICO market, many malicious actors have entered the landscape. The issue of malicious actors and fraud in the ICO landscape is so prevalent that Canada’s Better Business Bureau called cryptocurrency-related scams the 5th most prevalent in the country.

According to the Bureau, scams operating in the cryptocurrency industry accounted for at least $1.7 million CAD in reported losses in 2017 alone. This figure is believed to be much higher as the Bureau believes only 5% of victims actually come forward to report financial crimes.

In addition, blockchain technology is still a relatively new arrival to the world of finance, and regulators are still attempting to contextualize the industry and create clear regulatory guidelines. As a result of the lack of clarity, many ICOs find themselves operating with ‘very little regulatory clarity,’ and often unintentionally operate outside of the law.

In many ways, STOs are a solution to the woes of the ICO market. Rather than operate in a currently unclear area of the law, they operate directly within the purview of regulators. Unlike ICOs, STOs require licenses approved by regulatory bodies in order to operate.

Another key difference between the two fundraising models is that security tokens sold in STOs must be backed by something tangible, allowing them to operate in a similar way as shares. While ICOs often do not entitle investors to anything more than the purchased token, STO investors own a profit share or asset from the company in which they are investing.

This grants STOs not only the protections of traditional asset investments, but also the benefits that come with leveraging blockchain technology. There is seemingly no limit on physical assets that could serve as the basis for a security token, and offerings can be equipped with extra features such as allowing investors to participate in a project’s governance and decision making.

Regulation is a major factor in the evolving blockchain landscape

Since their advent, ICOs and other blockchain-related financial avenues have created a challenge for regulators. In only a short amount of time, the blockchain industry has grown to account for billions of dollars in investments, leaving regulatory bodies playing catch-up in order to protect investors and ensure that projects are operating legally.

In the U.S., even the industry’s largest projects have been under scrutiny from regulators. Ethereum is currently the second most popular cryptocurrency in terms of market value yet faced recent scrutiny from the U.S. Securities and Exchange Commission (SEC) regarding the original sale of its Ether token.

The long standing debate over whether or not Ether should be considered a security gained a lot of attention due to broader issues in the industry as a whole. There are certain regulatory criteria that must be met when attempting to legally sell securities, and many projects in the ICO landscape circumvent these obligations due to the lack of regulatory clarity.

For now, the SEC said that Ether is not a security, but clarified that the classification does not apply to many of the market’s offerings, which it believes are in fact securities. In March 2018, the SEC suggested that most ICOs are securities, regardless of how they are branded.

Security Token Offerings attempt to circumvent this confusing issue altogether. They require licensing approved by the SEC and/or other applicable regulatory bodies.

In countries like Canada, regulators have continually stated that they do not want to cripple the blockchain industry or its innovation, with the Ontario Securities Commission vowing to create innovative regulation in the near future.

Proponents of STOs believe that they are able to adapt to financial regulation and help mature the industry as a whole. As an added benefit, they can also provide greater investment protection, reduce the risk of scams, and remove uncertainty in order to ensure that businesses are operating legally.

Recent examples show that the STO trend may become favorable for many companies

As the STO industry begins to rise alongside the ICO industry, 2018 observed new examples of companies leveraging Security Token Offerings in order to secure funding.

tZERO, a subsidiary of Overstock, concluded an STO which reportedly raised $134 million USD for a securities trading platform.

“The ICO craze of last year created a toxic waste dump of financial assets,” said Overstock.com CEO, Patrick Byrne in a conversation with CNBC. “To me, that world of ICOs is a Superfund site. What we’re developing is a mechanism so that there will be a legal way to go forward and not create any new toxic waste.”

Another example of a recent STO endeavor is Spin, a scooter startup which announced a $125 million USD fundraising effort. As Business Insider reported, Spin’s STO was launched to raise money in exchange for its own native tokens, which are backed by equity in the company.

Similarly, an Australian project operating in compliance with the country’s financial regulatory body raised $3 million to create digital tokens tied to real estate. The project is called Konkrete Distributed Registries, and token sales are attached to shares in the company and regulated by the Australian Securities and Investments Commission.

Ultimately, proponents believe that STOs serve as an evolution of the ICO industry that could help combine the benefits of blockchain technology with the financial security and regulatory compliance of traditional public offerings.

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