What is the difference between STO and ICO?

On the surface, both ICO and STO feature some similarities. Nevertheless, there are more differences between STO and ICO. Let's discuss these in this article.

March 26, 2019 | AtoZ Markets - Initial Coin Offerings (ICOs) have gained popularity over the past few years as the crowdfunding solution for Blockchain projects. Yet, improper regulations remain the biggest concern for investors. The massive growth of ICOs in 2017, which already has been doubled this year by $13.7 billion, proves that the market has a huge potential in the future.

What is an STO?

There is a new crowdfunding solution in the market and it is called Security Token Offerings (STOs). This new crowdfunding solution can challenge ICOs since it has better regulation, transparency, and more benefits for investors. To put it simply, an STO is an upgraded form of an ICO. The idea of STOs was presented by the blockchain startup Polymath. The concept is expected to gain more traction than ICOs, and the numbers of STOs are expected to grow in the future.

Overstock CEO Patrick Byrne quoted: "It is a very clever offering, and could represent a whole new model for American entrepreneurship."

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Security Token Offerings VS Initial Coin Offerings

Unlike ICOs, STOs are real securities which represent token assets. These tokens represent the actual equity and hold value for investors if the project performs well in the future. In other words, STOs can grant a token holder a share value for the project, similar to “shares” or “stocks” in the stock market. On the one hand, STOs provides periodic dividends, equity ownership, cash flows, voting rights, and more benefits. On the other hand, STOs are codified by a smart contract that governs the token, similar to an ICO.

Additionally, STOs allow the companies to create whitelists and blacklists, which makes it easier to comply with KYC norms and anti-money laundering requirements. The main USP of an STO remains on transparency. Therefore, STOs can change the future of crowdfunding.

Pros of security tokens

  • Low barrier for entry
  • Greater flexibility for business owners
  • Attract Global investors
  • Compliance can be hard-coded
  • Fractional ownership

Cons of security tokens

  • Complex compliances
  • Platform required to create and manage tokens

Security Token Offerings VS Initial Public Offerings

STO looks very similar to Initial Public Offer (IPO), but that is not true. Though both serve the purpose of fundraising, still when seen from a different angle they don’t share everything. STOs on one hand, offer security tokens to the investors, while IPO offers shares of the company in the form of IPO. Security tokens are underlying security while share represents a company. STO tokenizes the existing digital assets while IPO creates a new security.

As in STO tokenization takes place through which money is collected. Therefore, to bring STO, it is not necessary to incorporate a company. The exemption from being a company applies if the token issue is below the specified limits under exemption limit and the number of investors is underspecified limit. On the other hand, a share is part of a company’s capital. So, to issue shares, it is a must to incorporate a company.

The major difference between STO and IPO is the cost involved. As we know, to bring IPO, organizations not only need to meet regulations but a full-fledged working company as well. Apart from this, there are many other requirements as well as a legal opinion, documentation, banking, etc. which end up adding huge investments. While bringing an STO is a comparatively much cheaper way than an IPO as there are services available, which not only take care of the compliance but also support by providing facilities related to legal issues. Polymath is the biggest example. Also, there are no geographical limitations in the case of STOs.

One can buy security tokens being issued by a company in the US sitting in India, without being involved in a process of the international transaction. But this is not the case with IPO, they are totally dependent on the countries specified laws and regulation. In most cases, participating in foreign IPO needs a person to abide by the laws of that particular country. Even if the country allows international trading, it needs a huge amount to be incurred, the unwieldy process to be followed, and cross-country risk to be borne. On the contrary, STOs not bounded by geographical locations and are more liquid and can bring more funds than IPOs.

What are the current issues of an ICO? 

ICOs are facing high costs, in terms of marketing, product or service development, before even the start of the operations. Also, most of the ICOs fail to gather public funding. Thus, fail to complete their milestones. More than 80% of the ICOs in 2017 were scams, which resulted in the financial losses of investors.

From the financial point of view, investors are not investing in products or services, and they can not claim the rights to a token’s underlying value. The only way for an investor to make a profit is by benefitting from a token's demand and hype. This means that the ICO's fundraising efforts have no accountability, while the investors hold all the liability.

Why STOs could take over ICOs?

Nowadays, financial regulators are keeping a close eye on ICOs, due to related scams associated with ICOs in the past. Many regulators believe ICOs that sell a utility token should fall under the securities law. Hence, for new projects, issuing an STO will become more logical than launching an ICO, bearing in mind the regulatory point of view. A token sale can be conducted with little capital fund-raiser. Especially, if the startup has an innovative product that the cryptocurrency community is willing to invest in. A drawback could be that STOs will require more capital, regardless of the quality of the company’s product.

Thus, it is unlikely that ICOs will be replaced entirely by STOs. As smaller startup projects will choose to either run the risk of operating in a regulatory environment or will engage in regulatory arbitrage, whilst basing their operations in countries that have ICO-friendly regulations. That being said, Security Token Offerings can become a threat to the ICO market, as more investors start to realize the advantages of “real shares” in the future.

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