A security token offering (STO) is an event during which a company offers its security tokens to investors. The term equity token offering (ETO) is used when the security tokens in question are equity tokens. STOs evolved from the need to eliminate the regulatory uncertainty surrounding initial coin offerings (ICOs) and the use of blockchain tokens as securities. STOs perform a similar function to conventional initial public offerings (IPOs) in that they provide a means by which companies can sell securities to investors to raise capital.
Advantages of investing in STOs and ETOs
- Access to low-cap investment opportunities. Conventional IPOs rely on complex systems involving numerous intermediaries. The costs associated with offering conventional shares, bonds or other securities to the public in order to raise capital are prohibitive for smaller companies. STOs, on the other hand, are largely automated, so costs are low. By using STOs, small and mid-sized companies and startups can potentially gain access to capital markets at a much lower cost. As an investor, you can access investment opportunities which are not accessible via conventional stock exchanges and over-the-counter exchanges.
- Low investment costs. Currently, security tokens are sold directly by the issuing companies – normally in collaboration with a registered bank. This means you do not need to pay brokerage fees to a stock broker.
- You hold your own tokens. Your hold the private keys for your private wallet. You do not need a custodian bank to hold the securities and your assets are fully segregated. In this way, security tokens provide many of the benefits of physical securities certificates which you can hold yourself.
- No street name securities. In many countries, including Switzerland, it is common practice for securities to be held in street name. Security tokens, on the other hand, are fully owned by you. You directly hold any rights provided by a security token, such as possible voting rights and rights to participate in annual general meetings (AGMs).
- Greater regulatory security than ICOs. STOs provide greater investment security than ICOs because issuing companies aim to meet regulatory requirements (such as know your customer regulations) when issuing their security tokens. Unlike blockchain coins which typically only have a utility value, security tokens normally represent legally binding contracts.
Disadvantages of investing in STOs
- Cryptocurrency exchange rate risks. Security tokens are typically priced in fiat currency, even if their issuer accepts cryptocurrency as payment. But you normally receive dividends (in the case of equity tokens) or coupons (in the case of bond-like security tokens) in cryptocurrency. The company may also repay the principal of bond-like security tokens in cryptocurrency when the bond matures. The values of most cryptocurrencies fluctuate heavily, and in the worst case you could lose a lot of money when converting the cryptocurrency back to fiat currency.
- Less due diligence. Most stock exchanges perform strict due diligence on companies wishing to list their stock via an IPO and have strict reporting requirements for listed companies. Security tokens are more similar to over-the-counter securities because they do not have to meet strict stock exchange criteria.
- Technical risks. Unlike securities, which are legal contracts managed by legal service providers, security tokens and equity tokens are built on blockchain systems which enable smart contracts (such as the Ethereum blockchain or the Stellar blockchain). Because of this, they may be affected by changes in blockchain systems. Developments like hard forks and 51% attacks can influence the value and functionality of tokens. The continued development of the underlying blockchain – or the absence thereof – also plays a role in the long-term security of your investment.
- Regulatory risks. Although STOs are significantly more compliant with regulatory requirements than ICOs, legislation with regards to this emerging investment vehicle is still in its fledgling stage. As new regulations are passed, individual security tokens may no longer meet regulatory requirements, which can impact their value. It is worth noting that the SIX Swiss Exchange is in the process of developing the SIX Digital Exchange, with the aim of providing a regulated security token exchange.
Conclusion
As a general rule, investing in STOs and ETOs is more secure than investing in ICOs because security tokens and equity tokens are typically linked to legal contracts between you and the issuing company. However, not all security tokens are backed by legal contracts. You must take extra care to exercise due diligence when considering investing in an STO or ETO. As with conventional securities, the legal rights which you as a token holder can legally claim from the issuer – such as dividends, coupons, voting rights or rights governing bankruptcy – are the deciding factor. The primary difference between an STO and an ICO is that security tokens should provide you with tangible legal rights.
Carefully review the STO’s prospectus and make sure that it is compliant with securities regulations in the country in which the company is domiciled. Make sure you understand how dividends or coupons are paid out and how the capital or principal can be redeemed. The guidelines for crowdinvestment and the guidelines for investing in ICOs should be applied. Many of the basic guidelines for stock investments (in the case of equity tokens) and bond investments (in the case of bond-like security tokens) apply to STOs and ETOs as well.
More on this topic:
Swiss online stock broker comparison
ICO Investment Guide
Financial products which hint at the future of finance
