Security Token Offering 101

As cryptocurrency jargon goes “STO” is rapidly becoming the sector’s buzz word du jour. Security token offerings are rapidly proving themselves to be an very effective way of raising large amounts of capital, as well as a cheaper, more viable to issue security tokens by venture capital and private equity groups the world over. By some estimates, security token offerings will grow to be a $10 trillion sector by 2020.

Whilst a Security ICO opens the possibility of raises that are orders of magnitude greater than a traditional ICO, the legal and regulatory requirements to successfully launch an STO mean that it is only justified if two or more of the below conditions are met.

You should opt for a security token offering if:

  • You are high growth company
  • You are generating $10 million or more in revenue
  • Your are an international business
  • You are looking to access institutional funding
  • You prefer issuing a transferable asset over a utility token
  • You are looking for high liquidity for your token

In layman’s terms, as security token is a cryptographic token that represents a real world asset such as stock in a company, a bond or is asset backed by real estate, art or precious metals. In the traditional financial markets when an investor purchases a security, they enter a contract. With security tokens, this contract is executed on the blockchain, with the protocol’s consensus mechanism validating the owner’s right of ownership. Security token offerings bestow on the holder the same rights as traditional securities such as share of profit, dividends, voting rights or share of revenue. You can read more about our security token models here.

Why are Security ICOs so attractive to founders?

1. Access to institutional capital

Private equity groups, funds and institutions are bound in scope to investing in regulated instruments, excluding them from the ICO market. Meaning that whilst many would have been keen on participating in an ICO, they would have been unable to do so. Security token offerings due to their regulated nature are a natural entry point for traditional capital into the blockchain sector. This funding can also be international in nature, prior to the advent of the ICO attracting foreign investment was all but impossible for startups, and limited to established companies who could undertake the costs and overhead of pursuing foreign capital. Security tokens offer a much simply route to the international financial markets, allowing a medium sized company to attract investment from family offices and VCs across the world. The combination of these two factors give security ICOs access to deeper pools of capital and instant media awareness. The borderless nature of the blockchain space means that post STO liquidity is several times larger than those limited to a single jurisdiction.

2. They offer a new way of marketing your offering

In the traditional financial markets issuing a regulated security consisted of a 7 figure legal and advisory bill and landscape of mind-bending complexity due in part to local securities laws, translations of prospectuses and passporting regulatory requirements. ICOs rapidly made mass funding available to the average startup, whilst the global reach of online advertising networks supported this dramatic growth. This reach was augmented by affiliate programs enabling issuers to reward influencers and community members to spread the word of their offering, taking on tasks such as translating copy and moderating social channels, coordinating meet-ups and evangelising the project. Whilst an security ICO requires a fair amount of legal work, STOs can still benefit from the tools that made ICOs a runaway success in the fundraising sector.

3. Low barrier to entry

Security token offerings as cryptographic tokens can be used to tokenise anything from debt to parking spaces, this flexibility permits smaller companies to raise significant amounts of funding from private capital markets at significantly lower up-front costs. Examples of cost efficiency include local legal teams, travel to negotiation meetings, local regulatory fees and ongoing due diligence costs which are negated by engaging a complaint ICO platform with integrated KYC and AML protocols administered by licensed identity verification providers.

4. More for less

Security token offerings offer issuers advantageous terms when compared to a traditional VC deal,  the primary advantage being that founders are not required to surrender board seats or voting rights. This maintenance of control prevents board politics seeping in to the company’s decision making process, and negates the short sightedness that often drives VC’s decisions looking to exit a position at the first opportunity, this peace of mind frees up founding teams to focus on the business and growing profits, and eliminates the possibility of them being ejected from their own company. The secondary advantage is the possibility for security token issuers to sell simple dividend or share of profit tokens vs preferred stock. This cements the management’s control on the company and allows founders to retain a higher percentage of the company’s ownership, whilst token holders will receive dividend rights. Security ICOs can be executed without surrendering voting rights to investors. The third advantage of security token offerings is that they generally raise higher valuations.

5. Much more than a traditional security

Due to their customisable nature, security tokens can be developed to incorporate utility functions such as preferential use of a platform, early access to features or loyalty benefits for buying and holding the tokens long term. The permissionless nature of the blockchain, together with the carte-blanche nature of security token development mean that the only limitation to a holder’s benefits is the issuer’s imagination (and legal team’s risk appetite).

What are the drawbacks?

Whilst the benefits of a security ICO are well documented above, this method of fundraising is not appropriate for every project. For starters it is a nascent market, with the history of STOs barely spanning two years. The legal landscape offers little legal precedent, relying on the regulated nature of the offering to shelter the issuer from possible legal ramifications. Moreover, longer term performance data is patently missing, and no one can predict with certainty if security token offerings will perform well in the long term.

Regulatory oversight is higher in a security ICO than a utility ICO, pushing costs in time and money in the wrong direction.

Launching a Security token in Malta

The process of launching a security token offering in Malta requires the issuer to submit an application with the MFSA for the investment vehicle classification it falls under. Prospective issuers are required to submit documentation to the Malta Financial Services Authority for approval. This documentation will describe:

  • The projects primary line of business, its current/forecasted finances, and ownership and token structure
  • The token mechanism and a description of any rights, obligations, claims to profit etc that arise from ownership thereof

How we can help

ICO Malta has developed a portfolio of security token protocols which will facilitate the development and issuance of your security token offering contact us today for detail on our turnkey STO service.