October 20, 2020

What is Security Token Offering (STOs)?

Security Token Offerings (STOs) represent a new and innovative way of raising capital for start-ups. STOs cut out intermediaries, use blockchain technology, and are highly regulated, which makes them an affordable and efficient way for start-ups to raise the necessary capital directly from the market.

A fintech trend that is picking up speed is the security token offering, STO for short. Security tokens are an upgraded and highly regulated digital version of traditional securities. For entrepreneurs, STOs are an easy and relatively inexpensive way to raise capital. For investors, STOs offer a secure and transparent direct investment in a company.

Let’s look at why STOs revolutionise the way capital is raised.

Security tokens are financial instruments, and they represent a share of a company or an asset, such as property, fine art or investment funds.

Security tokens show the ownership information on the blockchain, which protects the tokens against fraud and misuse and makes the STOs faster, more accessible and less expensive. 

But before we focus on the benefits, let’s look at the different security tokens. 

There are three types of security tokens: equity tokens, debt tokens, and asset-backed tokens. The main difference between the three is what the tokens represent.

Equity tokens are similar to traditional shares: They represent the shares issued by a company – but they are recorded on the blockchain. Owners of equity tokens are entitled to a share of the company’s profits and voting rights. 

Debt tokens are debt instruments that include real estate mortgages and corporate bonds. Debt tokens represent capital raised through debt, and they can be compared to a loan to the issuer. Owners of debt tokens are generally entitled to the repayment of principal and periodic interest. 

Asset-backed tokens, and especially the subgroup of commodity-backed tokens, represent the ownership of a specific asset such as real estate or commodities, including oil, gold or crops. The blockchain technology is particularly important for the commodities supply chain because it helps to simplify transactions, reduces fraud and makes it easier to track and monitor the asset ownership.  

There is a reason why Security Token Offerings are becoming more popular with companies and investors. Actually, there are five reasons. 

Companies that want to raise money through an STO have to comply with regulations and disclose important information about their business by publishing a prospectus or a private placement memorandum. This increases transparency and accountability and reduces risks.

Smart contracts and blockchain technology ensure that the processes are transparent, secure, efficient and fast.

Security tokens are backed by real-life assets, which makes it easier to assess their valuation.

STOs use fewer middlemen, such as lawyers, brokers and banks. This reduces costs, makes the processes more efficient and minimises the sources of error.

Security tokens offer fractional ownership, which opens up the market to smaller investors and brings additional liquidity. Because the tokens can be traded 24/7 and with mobile apps, trading gets simpler and more convenient. 

However, the concept of STOs is still in its infancy. Security tokens are essentially a different medium representing the same traditional financial instruments, but the legislation in this area is still developing. It is important to note that even though STOs are a great method to invest, you should always research the companies and projects you want to invest in. Because the basic risks for investors are still there – if the company fails, the investment also fails.

Yet, STOs are an ideal way for many start-ups to raise capital. Instead of relying on expensive venture capital funding or angel investors, companies can use Security Token Offerings to easily and securely access the capital market for a fraction of the traditional cost. This means that even small investors have the opportunity to invest in up-and-coming companies – and benefit from their potentially significant increase in value.

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