STO better is known as Security Token Offering represent an investment contract that is backed by an underlying investment asset, e.g. stocks, funds, bonds, and even real estate investment trusts. A Security token represents owning the information of the investment product that is recorded on the blockchain. STOs can be seen as a hybrid approach to traditional Initial Public Offerings (IPOs) and cryptocurrency ICOs since there is an overlap between the two methods of fundraising.
IEO better known as Initial Exchange Offering represents a fundraising event that is overseen by a cryptocurrency exchange. This is unlike STOs where the project team itself conducts the fundraising. Exchanges offer IEOs through various launchpads and allow users to purchase tokens directly with funds that are stored in their exchange wallets.
Brief History of STOs
ICOs reigned supreme in 2017 as the cryptocurrency market went crazy. However, the existence of many scams within the space became a major concern among investors and regulators as well. The following year in 2018, we saw the ICO bubble burst, and many investors became skeptical of the industry. Regulators also stepped up their efforts in a bid to establish some rules and protect investors.
As the ICO wave waned, another form of fundraising started to emerge. One that sought to address the shortcomings of ICOs by offering tokens that are fully regulated making it hard for scams to exist. Regulators mainly forced this switch the likes of the SEC as they sought to establish securities law to all token offerings.
This led to the birth of STOs that can simply be described as ICOs that comply with the regulator of the nation that they are offered.
According to a recent report released by InWara, a data analysis company that focuses on ICOs, there are less ICOs that are popping up as of 2019. In contrast, STOs are on the up. In Q1 of 2019 STOs have seen an increase of 135% with over 45 projects launched this year compared to the last quarter of last year.
Brief History of IEOs
ICOs haven’t only inspired the rise of STOs but also that of IEOs. A new form of fundraising where tokens are offered by exchanges and they are immediately listed on them. The first IEO took place in 2017 even though the new model didn’t attract much attention until the beginning of this year.
Binance, the world’s largest cryptocurrency exchange pioneered this new form of token sale through a new platform, the Binance Launchpad. The platform promised to support at least one token every month in 2019, and so far, it has completed three token sales which have all been highly successful. Through the launchpad, BitTorrent has managed to raise over $7 million, Fetch.Ai has raised $6 million, and Celer Network managed to raise $4 million within a few minutes.
IEOs help exchanges to inject liquidity on their platforms and the success of the Binance Launchpad has inspired other exchanges to rush to launch their own token sale platforms. So far there are over fifteen top cryptocurrency exchanges that have already begun their own launchpads. To view the full list of all exchanges that are currently offering IEOs you can check this article written by Arthur Boytsov, vice president of one of the best fundraising agency Priority Token.
STO vs IEO: Differences Between STO and IEO
IEOs are for projects that seek to launch utility tokens. Utility tokens represent units of account for the network on which they are issued on. As the network grows, the more utility is in the token since their number is fixed. As the size of the network and the number of transactions grows so does the demand for the tokens.
Utility tokens give holders of the token the right to use the network and also the right to take advantage of the network through voting.
However, these tokens have to fail the Howey test since this would qualify them as security tokens.
When Startups Should Choose an STO
Security tokens have to pass the Howey Test. The test dictates that an asset has to meet the following conditions; be an investment of money, be an investment in a common enterprise and the investors expect to profit from the work of the promoters and any other third party.
In other words, a security token represents an investment contract with legal ownership of a physical or digital asset like real estate or ETFs and many others. However, the owner has to be verified through the blockchain.
This allows security token holders to trade away their tokens for other assets, use them for collateral to access a loan and store them in different wallets.
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Advantages of STO
The number one advantage of STOs is that they are compliant with regulations. If they are to operate in the US, they have to file for exemptions with the SEC to ensure they don’t face cease and desist orders in the future like it was the case with many ICOs.
STOs provide full transparency to their investors, and this allows them to have visibility on all the tokens that have been issued, promised even those that have been discredited.
Since STOs are regulated they spur the entrance of new investors in the market without having to worry about being scammed.
Unlike utility tokens that mostly represent future access to an issuing company’s service or product, STOs usually represent the underlying interest in either profit sharing, voting rights, interest in equity, dividends and other benefits that their investors can gain.
Advantages of IEO
Raising funds quickly
Projects can raise funds quickly given all the hype that currently surrounds IEOs. Judging from the token sales that have taken place so far, an IEO is averaging a few seconds to a few minutes to meet their set hard cap.
IEOs can be trusted – since cryptocurrency exchanges conduct their due diligence by screening every project that they seek to launch on their platform, investors need not worry about the legitimacy of projects.
IEOs offer protection to both the token issuer and the investors since exchanges handle the KYC and AML process.
Projects are assured of getting their tokens listed quickly making the process easy for project issuers.
Disadvantages of STO
Just like everything security token offerings have their downsides too
Even though being on the blockchain and in tokenized form, security tokens still fall under existing securities regulations. As such, companies running an STO will still have to comply with the same regulations as they would floating an IPO. Being tokenized does help in better and swift trading, the complexity of legal regulations over multiple jurisdictions still carries risk and somewhere hinders advantages.
STO’s may be quick but issuing them is not easy. When it comes to raising capital via traditional securities, the job is slightly easier as they do not require a platform to run the capital raise exercise. But for an STO the project team needs to create its own tokens as well as a platform to manage their sale. This is the most crucial aspect of the STO and if this crucial technological part wrong and the project will end up in the financial and legal mess.
Being the latest entrant in the world of capital raise, STO’s have nothing in them that has been extensively tested in the long-term, increasing the risk for both business and investor. While subscription risk exists, the larger risk is that of unclear compliance. While there isn’t much legal precedent to rely on and regulators could change their minds at any time and bring an end to this.
Disadvantages of IEO
Safety of Exchanges
While the safety of the IEO is linked to an exchange, these exchanges are still susceptible to fraud and pump & dump schemes, especially smaller ones that are not concerned with their brand equity.
While IEO’s are considered comparatively safer for investors, Potential price manipulation by investors holding the majority of coins, the same issue we’ve experienced with ICOs
Restricting certain investors
The IEO would be limited to a certain exchange, making it annoying for some investors to participate if they do not own an account in the same exchange. This requires additional KYC procedure and account verification approval time making it very inconvenient for lots of investors.