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Security token offerings: benefits, challenges, examples

Alina Seredenko
Alina Seredenko Business Development Manager
9 minutes to read

Two years ago, Wesley Snipes, the protagonist of the Player, announced his intention to create a movie fund in the partnership with Liechtenstein Cryptoassets Exchange (LCX).

The fund is called ‘Daywalker Movie Fund’ (DMF) and aimed at raising money for Snipes’ upcoming movies.

For the star’s fans, it’s a chance to become co-producers of Hollywood’s movies. Just imagine, your name is in the titles of the new action movie or TV series. Wow!

Wesley, in his turn, seeks opportunities to declare himself as a serious movie producer.    

To hit the goal, he and his partner chose security token offerings (STOs) to get funding.

Why didn’t they opt for ICOs or crowdfunding? We’re explaining the reasons and the basics of big security token offerings.  

What are security tokens offerings?

Everyone is used to the fact that from time to time, something new in the cryptocurrency niche appears, then it gains traction and, finally, bursts like a bubble.

It happened with ICOs that became popular at the speed of light and appeared to be scams in most cases.

A year later, IEOs flooded the news feeds and then scared off the backers. DeFi (Decentralized Finance), invented last summer, are also experiencing a market correction.

Security Token Offerings examples
Source: PwC 6th ICO / STO Report

On the contrary, STOs (security token offerings) are blooming during the global corona crisis.

Experts consider tokenisation as a problem-solver for many industries – distribution of financial aids, fraud prevention, interruption of the value chain, and investments.

Let’s see what securitised token offering is and how it works. 

We like the explanation of this term offered by Deloitte.

Security Token Offerings (STOs) combine blockchain technology with the requirements of regulated securities markets to support the liquidity of assets and wider availability of finance. STOs are typically the issuance of digital tokens in a blockchain environment in the form of regulated securities.

In layman’s terms, STOs are somewhere in between digital assets and traditional financial products.

Digital public offerings perfectly combine the benefits of the distributed ledger technology (DLT) and transparency of physical securities.

Security Token Offerings examples 3

According to the latest data, the total security token market cap is $696m, the monthly change is +38.14%. Not bad, by the way.

A token represents the ownership of an asset or equity or debt security of the issuer. Diligence and disclosure requirements depend on the venue and jurisdiction of the listing. Certain terms of the token would be coded into the token.

Here’s the typical process of STO creation:

  1. The company issuer finds a security token attorney and blockchain firms to guarantee and set up the token structure.
  2. Then, the blockchain system for issuing securities is identified.
  3. The characteristics of the token and its underlying asset are specialised to build a smart contract.
  4. The company gets in touch with third parties such as brokers/dealers, banks, transfer agents, issuers and accountants.
  5. The actual fundraising campaign is launched.
  6. The company advertises the STO fundraising campaign through the trading platform.
  7. The issuer collects money from the investors and distributes the tokens to the investors through the assistance of the brokers.
  8. The issued token is sold to a special purpose vehicle (“SPV”) and reissued on the trading platform. 
Security Token Offerings examples 11
Source: FAS report. A Deep Dive Into Security Token Offering (click to zoom)

Benefits of security tokens

Securitised token offerings are a logical follow-up to ICOs. These new tools address the majority of issues ICOs raise.

What’s so good in the security tokens blockchain for issuers, investors, and the overall ecosystem?

National regulation, increased liquidity, and secure storage for records

The beauty of asset token offerings is that they’re legal in many countries/regions and are subject to dedicated national regulation of activities with securities.

In The US, STO projects are conducted according to Regulation D, and Regulation S. BitLicenses issued by New York State’s Department of Financial Service are an example of licenses needed for activities with virtual currency.

In the UK, virtual asset service providers should be registered by Financial Conduct Authority. FAS experts report that 5% of projects complied with the FCA (UK) regulations similar to the SEC’s Howie Test.

Germany: BaFin-Exemption is another popular filling for cryptocurrencies and other blockchain-backed tokens.

The dedicated regulation makes activities with STOs more transparent and protect the rights of parties. 

Security Token Offerings examples 9
Source: FAS report. A Deep Dive Into Security Token Offering (click to zoom)

This particular kind of tokens enables asset owners to monetise illiquid assets such as private company shares, real estate or intellectual property rights at a lower cost.

Traditionally, these types of assets are illiquid and should be often traded through an auction or agent.

Without digitalisation, you hardly can fractionalise ownership among different investors and arrange buy-sale transactions.

Also, it may be difficult to standardise the asset specs and present them in a unified form. And, finally, the cost of the asset may be astronomically high, for example, the price for artworks. With STOs, you can easily divide the asset into smaller tradable fractions.

The DLT lets issuers record all the ownership info (previous ownership distribution, transactions, issues) transparently and securely. On the one side, it helps regulators resolve conflicts. On the other hand, it eliminates the risks of fraud. 

Other merits for issuers:

  • no need for pricey third parties;
  • automated compliance;
  • asset interoperability;
  • 24/7 access to markets;
  • fast deal closing;
  • wider audience of investors.

Alternative to utility tokens, portfolio diversification, and investor protection

Unlike utility tokens that are very popular among ICOs and provide backers with access to the product/service, security tokens are considered a real financial investment.

Watchdogs oblige issuers to disclose financial records, provide the specification and valuation report of the asset embedded into the smart asset and guarantee the compensation for backers in the event of a project failure or fraud. 

Also, smart contracts bring more options for diversification, in particular through the above-mentioned fractional ownership.

Traditionally, backers invest in assets by purchasing shares of bonds. Campaigns with STO currency offer an alternative opportunity for portfolio diversification, investment, trading and even hedging.  

The SEC, FCA and other regulators are very concerned about investor protection; that’s why many asset token offerings are open only for accredited backers who are well-versed in investment risks. 

In addition, STOs gravitate more to projects at early development stages with an exit door opened, which offers a certain degree of investor protection.

Security Token Offerings examples 5
Source: FAS report. A Deep Dive Into Security Token Offering (click to zoom)

Other advantaged for backers:

  • full picture of the actual value of assets;
  • more liquidity for financial instruments;
  • no manipulation by issuers and financial authorities.

Challenges of securitised token offerings

What features of digital public offerings can scare players?

Lack of financial literacy 

Experts from the Cambridge Centre of Alternative Finance found out that lack of knowledge and clear understanding of security tokens blockchain is what distracts people and companies from entering this field.

Now there’s a variety of terms used, often interchangeably and without a clear definition. Even the term ‘crypto-asset’ lacks a specific definition.

Explaining the basics of cryptocurrency and tokenisation should be a platform’s priority.

Gaps in regulation

Yes, we’ve just said that the beauty of STOs is the legislative framework, but there are still unregulated activities. 

P2P exchange services and decentralised exchange services remain a shady niche where backers can experience considerable risks and losses.

Also, only some governments have developed a solid base of laws and rules for STO activities. Among the best countries to launch STO are: Lithuania, Malta, Canada, the US, Switzerland.

Security Token Offerings examples 7
Source: PwC 6th ICO / STO Report

Additional costs and liabilities

Despite reducing administrative costs, the launch of STOs is often associated with bureaucracy, which by default, entails legal charges for other services.

Hiring external professionals is essential as they guarantee the smooth launch of the project. In this case, asset token offerings are more suitable for businesses at later stages of development (Round A and further ones).

There’s another drawback. When the third party doesn’t take part in the launch of STO, its responsibilities are transferred to the buyer and the seller. 

The company prepares marketing materials, attracts investors, complies with regulatory requirements and closes the deal.   

Without professional help, it may be a pain in the neck.

Other limitations of digital public offerings:

  • the lack of legal protection for crypto assets;
  • difficulties in asset valuation and accounting;
  • failure in meeting AML/KYC requirements;
  • high costs for issuers;
  • paper-based processes in some countries/regions.

3 top security token offerings

Here are recent use cases showing how companies deploy STO blockchain.

The DBS Digital Bond

At the end of May, Multinational Singapore-based bank DBS issued $11.3 million digital bonds in its first security token offering (STO).

The bond issued through Digital Exchange (DDEx) expires in six months and comes with a coupon of 0.6% per annum.

The bond will be traded in lots of $10,000 to provide DBS clients with access to the bank’s infrastructure.

DBS says that the bond complies with the regulatory framework and offers the same investor protection as traditional bonds.

The bank expects that clients will embrace tokenisation and deploy this method for fundraising purposes.

Security Token Offerings examples 1
DBS Bank

INX’s security token and equity offering

INX, a Gibraltar-based crypto trading platform, shared its intention to raise $125m through the first-ever initial public offering of security tokens

According to INX, it has already raised $7.5 million through a closed private token sale. The company mainly operates in the USA and in August launched its first security token IPO for both retail and institutional investors approved by the SEC.

The co-founder of INX mentions that regulated tokens can open the path for legal fundraising and trading in the US and beyond.

Security Token Offerings examples 12
INX

Blockchain-based security tokens by SBI Securities

In March, SBI Securities from Japan said that it’s legally compliant to get involved with security token offerings.

The company will offer blockchain-based STOs to its clients and handle over-the-counter transactions for the secondary trading of tokens.

This campaign is only a part of the global SBI’s plan. The company wants to set a digital assets joint venture with the Swiss stock exchange SIX and establish a digital securities exchange in association with SMB.

SBI Securities adheres to the Settlement of Funds and Financial Instruments and Exchange Acts enabling STOs.

Consider JustCoded as your trusted fintech software development partner

JustCoded creates web and mobiles solutions for tech startups and established businesses in online investment, crowdfunding, real estate, travel, and art sectors.

Our key clients are Expedia, FxPro, ADS Securities, Printed.com, GSMA, The Office Group, CapitalRise, The Intern Group.

What we build for FinTech:

  • investment platformsWe elevate platforms from scratch or integrate existing websites with third-party services, improve user experience and enhance usability, put processes and tasks on the pilot;

    Security Token Offerings examples 2
    Forus — the first Saudi Arabian P2P lending platform
  • crowdfunding and p2p lending portals. We offer crowdfunding software for regulated investment businesses LenderKit to kickstart any online crowdfunding business – p2p loans, equity crowdfunding, donation-based and reward-based websites. Sectors we cover are real estate, SME funding, green energy.
    Security Token Offerings examples 8CapitalRise
  • impact investing. Projects that deliver sustainability and make an impact have a special place in our strategy and heart. We’ve already built solutions for several impact investing platforms specialised in solar power plants, photovoltaic parks, off-grid systems.

    Security Token Offerings examples 4
    Charm Impact

The takeaway

Investopedia called 2021 the year of the Security Token Offerings STO, which are the most beneficial case of blockchain technology to date.

The combo of blockchain, tokenisation, and digital public offerings creates an optimum environment for a new kind of fundraising scheme.

This scheme unites the fast and easy fundraising through ICOs with legal requirements imposed for IPOs.   

Security Token Offerings aren’t ideal, they still have many challenges and seem to be a risky adventure. But they are bloody effective if done right.

Before launching an STO campaign, get familiar with the STO regulation in your country and best practices.

If you are looking to implement tokenisation in your crowdfunding platform or other business, we'd be glad to suggest you a possible solution.
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