STOs can be understood as a rebranding and slightly altered version of ICOs, which remain popular despite a great deal of negative publicity.

This feature article was written exclusively for Bitrates by our frequent guest contributor Stefan Stankovic.

By now, everyone even remotely connected to the financial world has heard about the Initial Coin Offering (ICO) fundraising process. In 2017, startups managed to raise over $12.8 billion through ICOs worldwide and, if you think that’s big, you’re in for a surprise because this number has doubled in the first five months of this year alone.

The numbers might be impressive, but the crypto fundraising scene is not nearly as healthy as you might get the impression by looking solely at these numbers. According to a Statis Group report, 78% of the total number of ICOs in 2017 were identified as scams, and even though only 11% of the funding went to these ICOs - that still equates to about $1.7 billion.

The lack of clear regulations has been pinpointed by everyone in the cryptosphere as the main factor that helped pave the way for fraud and large-scale market manipulations. This, however, is soon to become history; the US SEC is changing the future of the ICO markets with guidelines and warnings, but also with scores of subpoenas. So you want to fund your crypto project through an ICO? You better “check yourself” with the SEC or wait for that knock - with a battering ram - on your door.

The New Kid on the Block

The latest catchword in the crypto fundraising industry is STO or Security Token Offering. To get a better understanding of what exactly an STO is, first, we’ll have to explain two different types of tokens issued during ICOs: utility tokens and security tokens.

Utility tokens (also known as app coins or user tokens) represent future access to a company’s network, platform or a service. These tokens do not represent a share in the company or a promise for returns on the investment in whatever form. Crypto startups fund their business endeavors by creating utility tokens and selling them as “digital coupons” for the platform, network or service they’re currently developing.

The reason why crypto businesses choose to fund via utility tokens instead of security tokens is simple: they’re unregulated and can be sold for some Ether to anyone, anywhere. Token creators usually name these crowd sales as token distribution events (TDEs) or token generation events (TGEs) to avoid the appearance of being involved in a securities offering.

Security tokens, on the other hand, are backed by something tangible such as assets, profits or revenue of the company. From the SEC’s point of view, if a token passes the Howey test, it will be regarded as a security token. As simple as that. Security tokens issued through an ICO fall under SEC’s jurisdiction and any issuer of securities is subject to federal and state securities regulations.

So, what’s the difference between a regulated ICO and an STO?

The name.

An STO is a rebranded and regulated ICO. Compliant ICOs started calling themselves STOs because ICO has become a tainted word; due to its recent appearances in mostly negative connotations, the first thing serious investors think of is fraud.

The Benefits and Drawbacks of STOs

Before we get to what all of this means for cryptocurrency investors, we must take a step back and consider the three exemptions companies can take from registering their securities with the SEC: Reg A+, Reg D 506(c), and Reg CF.

STOs registered with Reg A+ can raise up to $50 million and offer their SEC-approved securities to anyone over 18 years old globally. STOs filing for a Reg A+ need to have two years of audited financials and go through a time-consuming and costly administrative process. STOs can also file for exemption Reg D 506(c) which is much easier and faster and allows companies to raise capital without a maximum limitation; there’s one major drawback though - they can’t raise capital from unaccredited investors. Lastly, Reg CF (short for Regulation Crowdfunding) enables STOs to raise up to $1.07 million over a 12 month period from unaccredited investors.

All three exemptions have their advantages and disadvantages for the token issuers, but what do they mean for crypto investors?

STOs signify safety; an investor that acquires security tokens through an STO is protected by SEC regulatory standards. Of course, there’s a price to pay for this protection - investors must go through the KYC and AML process and, in some cases, get accredited by the SEC.

There’s no doubt that the protection of investors is long overdue in the cryptosphere, but what made ICOs so special is the fact that they gave every investor a chance to participate regardless of their finances, age, location or jurisdiction. Investors/contributors simply had to sign up to the respective platform, transfer some Ether from their wallet and receive the tokens directly. The process is risky, but also frictionless, anonymous and inclusive.

The STO market is very young (the first STO was completed less than 2 years ago,) and naturally it has some drawbacks - the compliance process in securities offerings is vastly more complex than with utility token offerings and, unlike traditional securities which already have established exchanges and brokers, STO’s require a suitable and secure platform to manage their sale. That being said, STOs are still superior to IPOs as they offer greater flexibility for business owners, attract global investors and have relatively lower barriers for entry. Moreover, digital tokens can be divisible up to 18 decimals which makes the underlying asset of the security far more liquid and affordable for some investors.

Are STOs the Future of Crypto Fundraising?

STO’s offer a compromise between the freedom of utility token offerings and the safety and legal certainty of IPOs. And honestly, it would be fallacious if we said that the crypto community values anything more than freedom and sovereignty, but, at the end of the day, we must keep it real - regulations are here to protect the investors, and investors must win if we ought to see the crypto industry grow.

If investors get constantly scammed and manipulated, they stop investing and, without this continuous pump of fresh money - the whole industry disappears. Nobody - not even the most die-hard cypherpunks, wants to see that happen. Right?

Bitrates would like to thank our frequent guest writer Stefan Stankovic for contributing this article.