6 Security Token Offering Myths Explained

When a regulatory authority considers a utility token or digital asset as a security, it becomes a security token. For example, in the US, the Securities and Exchange Commission (SEC) subjects each digital asset to the Howey Test. It helps to decide if a particular digital asset is an investment contract or not.

The test has the following criteria –

• It is an investment of money.
• There is an expectation of profits from the investment.
• The investment of money is in a common enterprise.
• Any profit comes from the efforts of a promoter or third party.

If a digital asset or utility token meets these criteria, the SEC will consider it as a security token.

However, tokenized securities are traditional securities (or real-world assets) presented in a digitized form using blockchain and mart contracts. For example, using the tokenization process, you can convert the existing stocks of your company into tokenized securities.

With tokenization, you can replace physical paper with blockchain transactions. Thus, digitization helps you avoid the traditional cumbersome trading and listing process involving a lot of documentation to some extent.

Many crypto-enthusiasts believe that increasing regulation will slow down the growth of security tokens. However, they couldn’t be any further from the truth. The increasing regulation will help rebuild the credibility lost by the crypto space during the downfall of utility tokens.

Taking advantage of the unregulated nature of utility tokens, ICO exit scams over the last two years have stolen nearly $96.8 million from investors. However, as security tokens sales have to comply with regulatory frameworks (such as the Howey test in the US), the chances of security tokens turning out to be a scam are almost zero. Plus, the regulatory framework also encourages seasoned institutional and individual investors to invest in security token offerings.

The regulatory standards such as the Howey Test have offered a broader definition of what security tokens are. That’s why, contrary to popular belief, security tokens can represent a lot more than just equity in a company. They can represent real-world assets including debt, revenue shares, stocks, bonds, real estate, and even valuable artworks such as paintings and music albums.

While equity tokens represent the value of shares issued by a company, debt-based security tokens symbolize various debt instruments such as debentures, mortgages, leases or any other agreements between a lender and a borrower.

On the other hand, asset-based tokens represent ownership of a certain asset such as real estate (apartment, land, and buildings) or commodities (gold, diamonds, oil, and food grains). For example, Aspen Coins represented a fragmented equity ownership stake in the iconic St. Regis Aspen Resort.  The real-estate-based coins were offered through the crowdfunding platform Indiegogo and managed to raise $18 million.

Another benefit of security tokens often touted by crypto enthusiasts is that they will reduce the cost of the public offering. However, considering the present regulatory framework, launching a security token offering will not be cheaper.

For example, Malta has progressive STO regulations. So, you can launch your STO in Malta. However, if you want to solicit US-based investors for the same, you still have to follow KYC and AML regulations laid down by the US government. In other words, you will have to pay for making legal documents and purchase agreements, advisor fees, and tax advice in different jurisdictions depending on your STO.

You will need to pay for a variety of security token offering services including broker-dealers, asset custodians, whitepaper advisors, and marketing consultants. You will also need to hire an STO development company to tokenize your asset. As a result, launching a security token sale will not be cheaper, at least not in the foreseeable future.

Being regulated and backed by real-world assets, security tokens do offer a better alternative to utility tokens. However, that doesn’t mean each security token offering is going to be successful. Any security token offering is bound to fail for a variety of reasons including the lack of vision, management, funding and feasible business plan, and regulatory infringement as well.

However, unlike ICOs which have a 50% failure rate so far, very few STOs are likely to eventually fail. The higher rate of ICO failure is often believed to be an outcome of the lack of regulatory framework. Although regulated and legal, you must make sure to check every aspect of a security token sale before investing your hard earned money in it. Try to invest in companies with a proven track record of fundraising, realistic business models, and a viable product or service.

In theory, security tokens are supposed to facilitate global trading by eliminating the lengthy and costly paperwork as they provide compliance and ownership via smart contracts inherently. This, in turn, should create liquidity for real-world assets.

However, under the present complex regulatory framework, this potential rise in liquidity has been grossly overestimated by many crypto advocates. You may still need to comply with local laws and verify your identity to complete a transaction, which is time-consuming and tedious. This may deter investors from carrying out cross-border transactions.

Another factor is the nascent security token market. Although security tokens allow 24/7 peer-to-peer transactions, the market for tokenized assets is still young. The number of security token offering platforms and security token exchanges is small compared to crypto exchanges. As a result, the trading activity is limited at the moment, resulting in lower liquidity. However, liquidity will increase over time as the market matures.

That’s it! These are the six biggest misconceptions about security tokens and we have debunked them for you. Remember, however, some of these myths such the increased liquidity and the reduced cost of public offering may become realities over time. For now, we should accept security tokens as they are, a better but emerging alternative to utility tokens. They may not be perfect, but they do have the potential to change the global venture capital and securities market.