Unlocking the Power of Blockchain: A Comprehensive Guide to Security Token Offerings

Dive into the world of Security Token Offerings (STOs). It is a revolutionary financial instrument transforming the fundraising landscape for businesses worldwide.

Unlike their predecessor, Initial Coin Offerings (ICOs), STOs offer tangible financial securities backed by a company’s assets, revenues, or profits.

They provide legal rights such as revenue distribution or voting, making them a more secure and regulated form of investment.

This guide will guide you through the intricate world of STOs, their benefits, and real-world examples.

So, if you’re an entrepreneur or an innovator looking to leverage the power of STOs, you’re in the right place. Let’s embark on this journey together!

Understanding the Concept of Security Token Offerings

In the realm of finance, security is a certification that holds inherent financial value. It can be traded through exchanges, which broker the transaction, or directly from peer-to-peer.

These securities are primarily categorized into two main types: equity and debt.

Businesses leverage these methods to raise capital from investors, funding aspects of their operations such as expansion plans.

In return, investors are offered the opportunity to profit through interest rates, a share in the company’s profits, or dividends.

Security tokens are a type of cryptographic token that can be paid to the owner as dividends, a share of profits, or interest amounts or can be used to invest in other security tokens.

For a crypto token to be considered a security token, it must be subject to federal laws and legal regulations.

Unlike tokens launched in an Initial Coin Offering (ICO), which do not offer any obligations or rights, tokenized security offerings are financial securities backed by tangible assets, revenues of the company, or profits.

ICOs provide access to a specific platform, service, or network, whereas tokenized security offerings offer legal rights like revenue distribution or voting.

The role of a security token is akin to that of conventional security, except that it verifies ownership through blockchain and enables fractional ownership.

Governed by federal laws for securities, security tokens safeguard investors without the need for a third party, using smart contracts.

To launch a tokenized security offering in the United States, it must pass the Howey Test and comply with specific regulations.

Security tokens promise a new world of finance, offering investors the security of a regulated instrument while combining the agility and speed of blockchain.

The Dawn of a New Financial Era with Security Tokens

Recognizing the advantages of security tokens, numerous industry leaders have established platforms to trade these tokens.

These platforms provide institutional investors with a secure and straightforward way to begin investing in blockchain technology.

For instance, the founder of the NY Stock Exchange recently launched Bakkt, a platform that facilitates the buying, selling, and storing of digital assets.

Similarly, the Swiss Exchange Platform has plans to create a regulated exchange for tokenized securities.

Security tokens hold the potential to provide investors with the safety of a regulated instrument while combining the speed and agility of blockchain. Consider corporate equity as an example.

While company shares have been available for purchase since ancient Roman times, even the most advanced exchanges globally require two days to clear settlements.

With blockchain implementation, this time could be reduced to mere minutes.

However, this transformation will take work. Security tokens are more complex than ICOs or cryptocurrencies, necessitating a more profound understanding from investors. 

Security token offerings must comply with the SEC’s rules and regulations. It implies that security tokens must incorporate many more legal contracts.

The potential rewards for developing a comprehensive system for security token exchange could be enormous.

Approximately $256 trillion of real-world assets exist globally, and linking them to investors through blockchain could revolutionize financial markets.

The opportunity for crypto securities is vast, especially considering asset classes like fine art and real estate that have historically suffered due to limited liquidity and commerce.

However, security tokens can unlock the liquidity of real-world assets by connecting them to the blockchain.

The Regulatory Influence on Security Token Offerings

Security tokens are investment contracts sold to anticipate future returns and securities laws cover them. These laws can differ from country to country, so companies must meet all regulatory requirements before soliciting funds from investors.

The USA and Switzerland were pioneers in legitimizing tokens. It’s believed that 2018 was pivotal when cryptocurrencies began to mature.

Consequently, the US Securities Exchange Commission initiated investigations into crypto organizations and the nature of tokens.

In response, companies began filing the SEC’s Form D to launch an STO. According to the EDGAR database, 18 blockchains and 40 crypto-related ventures have filed Form D with the SEC since 2014.

Raising funds via STO complies with legal regulations, allowing crypto ventures to sell security tokens to large organizations.

As a federal government agency, the SEC’s role is to protect investors, maintain fair and orderly securities market functioning, and facilitate capital formation.

Under Federal Securities Law, no company can sell or issue security tokens without registering with the SEC. To be classified as a security token, it must qualify for a Howey test.

The Howey Test and Regulatory Compliance for STOs

The Howey Test, established by the US Supreme Court, is a criterion to determine whether a transaction qualifies as an investment contract. A transaction must meet the following conditions to be considered an investment contract:

1. It involves an investment of money.
2. Profits are expected from the investment.
3. The acquisition of money is in a joint enterprise.
4. From the promoter or third party’s effort, the profit comes.

Federal courts define a common enterprise as an organization where investors pool assets or money to invest in a project.

In addition to the Howey Test, several other legal regulations must be adhered to when launching a security token.

Security tokens are compliant from the outset as they are subject to specific federal security regulations. In the USA, security tokens need to comply with the following rules:

1. Regulation D: This SEC regulation allows startups or smaller companies to raise funds through debt securities or the sale of equity without registering securities with the SEC. Companies are required to file a Form D, which includes the names and addresses of their directors and executives, along with some details related to the offering.
2. Regulation S: This regulation offers an SEC-compliant method for non-US and US companies to raise funds outside the USA. An offering subject to this regulation can issue both debt and equity securities. The creators must follow the security regulations of the country where they will be executed.
3. Regulation A+: This regulation allows the creator to provide SEC-approved security to non-accredited investors via a general solicitation for up to an investment of $50 million. With Regulation A+, US or Canadian companies can combine public funding with private funds from venture capitalists to create a large fundraising round.

The Rationale Behind Security Token Offerings

1. Enhanced Access to Digitized Real-World Assets: STOs introduce a novel way to make assets, which were previously challenging to trade quickly and easily, accessible for trading.

With $256 trillion of real-world assets globally, asset classes like fine arts and real estate, which have historically suffered due to limited liquidity, now have many opportunities.

2. Reduction in Costs: Launching an Initial Public Offering (IPO) can be costly. In contrast, companies can facilitate investment through tokenization with an STO. Significantly it reduces legal and administrative costs while maintaining transparency.

Trading restrictions can be embedded into a token with smart contracts, reducing the costs associated with IPOs or other securities trading.

3. Continuous Trading: While the world is moving towards digital trading, traditional markets are only open for trade during restricted working hours due to their reliance on human maintenance. With the advent of blockchain and cryptocurrencies, trading can occur 24/7.
4. Fractional Ownership: Industries like real estate, collectables, and fine arts have attracted investors’ interest over the years due to their uncorrelated nature. The value of these assets does not fluctuate as much as other assets.

Security tokens allow investors to buy fractions of fine arts or collectables, enabling people to diversify their portfolios without needing much money.

5. Increased Liquidity: Liquidity depends on the number of traders (sellers and buyers) in a specific market.

Accelerating transactions and fractional ownership through asset tokenization can enhance liquidity by allowing more individuals to enter the investment space and buy/sell at higher volumes.

The Upside Of Security Token Offerings

Security Token Offerings (STOs) present a multitude of advantages. Primarily, they simplify the process of businesses reaching out to the public.

This is because potential investors are spared from exchange fees, broker charges, and due diligence costs.

Moreover, STOs enable dividing underlying assets into smaller units, promoting fractional ownership. This makes the offerings more accessible to investors and simplifies token transfers in secondary markets.

When Is The Right Time For Your Business To Launch An STO?

Your business should contemplate initiating an STO if it aims to raise substantial capital and aligns with specific criteria:

• Annual turnover exceeding $10 million
• Operating on a global scale
• Readiness to accept minor risks
• A funding approach that appeals to your existing customer base

If your business doesn’t meet these prerequisites, venturing into STOs might not be beneficial. An unsuccessful STO launch could have financial repercussions.

Practical Instances of Security Token Offerings

LXDX

LXDX was among the pioneers of leveraging STOs for issuing their stocks. The security tokens offered by LXDX granted direct exchange ownership to the buyers. Priced at one Euro per token, LXDX raised $57 million in the financing round.

Preflogic

Preflogic is launching a security token with smart contracts, facilitating Regulations D, S, and CF. Their STO Wizard platform empowers anyone to issue securities, bypassing the hefty legal expenses constraining the STO sector.

Final Thoughts

In conclusion, Security Token Offerings (STOs) are not just a trend but a significant shift in the way businesses raise capital.

They offer a more secure, regulated, and efficient alternative to traditional fundraising methods.As we continue to explore the potential of STOs, it’s clear that they will shape the future of fundraising.

So, whether you’re a business looking to launch an STO or an investor seeking to understand the landscape, now is the time to dive in.

Don’t miss out on the opportunity to be part of this financial revolution. Explore the world of STOs today!