Why an STO? (Security Token Offering)

Security Token Offering

By Andrew Adcock, CEO, Crowd For Angels

In 2018, many publications mooted that ‘this was the year of the STO’. Yet for all that hype, you would be right in wondering what had actually been delivered. Unlike the ICO boom of late 2017, we did not see the flood gates open and funds pour in to projects that promised fields of greener grass, nor the epic stats promised on demand and growth. Instead, the market woke up to a realisation that in some ways maturity was coming, with companies looking to STOs instead of the more controversial ICO route.

So why are companies looking to do an STO and what benefits do they offer to investors and companies seeking funds?

For this article we assume no difference between a tokenised security (paper-native) and a security token (blockchain-native) and have assumed that the reader understands that a security token is a digital representation of an underlying security (e.g. share, bond or single asset).

To give more detail, a security token is type of cryptoasset which exists on a blockchain but with the key characteristic that it meets the UK regulatory definition of being a “Specified Investment”, like shares or a debt instrument. Security tokens are classed as securities because they grant certain rights to holders associated with traditional securities, like ownership of a company/asset, voting rights or rights to a share of the profits. STOs see the initial issuing of a security token and are becoming increasingly popular as token issuers want to avoid the associated risk of issuing an unregulated instrument (like in ICOs).

Let’s look into the companies

First of all, digital assets are expected to be easier to transfer and at a lower cost than traditional paper based assets. While you might not cut out the middle man (such as a stockbroker) altogether when transferring a security token, the administration and custody work undertaken is expected to be cut significantly. Blockchain based assets benefit from public accessibility, allowing systems viewing these assets to automatically record and report changes without the need for human intervention or the time required to complete forms.

Let’s look at an example.

Currently, once a year in the UK, all companies need to provide a ‘confirmation statement’ to Companies House, declaring its shareholders and holdings. This form is filled in online and requires a person from the company to agree the current shareholdings and declare this by completing the form. This might take an hour for a small simple business, to weeks for a large complex company.

With the blockchain we can alleviate this manual submission.

In an ideal would, the company’s cap table would be digitised, tracking a blockchain token that represents the company’s equity. This cap table would be represented by a fluid number of token holders, but with the underlying assurance that those holders are known, ID wise, following the rules and automatically reporting back to the authorities.

This removes an administrative burden from companies, giving them more time to get on with the daily tasks at hand and not worry about who their shareholders are. This will also mean that capital raising and the cost of capital should be reduced by optimisation.

This could also lead to other benefits such as personal financing for the company, as more data is available for assessment. However, with greater transparency and ‘sight’, lenders & investors, have access to more deals and more competition.

Another benefit being mentioned is the ability to access a larger pool of capital as digital assets can be accessed globally. It is true that as a company you are able to open more doors and access audiences who are not the traditional affluent ‘middle class male’. That doesn’t automatically mean you will be funded. Yes, your project can be viewed on a larger stage, but you still need to abide by local laws sounding a financial offer. This might make accepting finance from ‘abroad’ less desirable, as the checks can often be more difficult.

What about investors?

While it is true that a digital asset should be easier to transfer and the potential pool of buyers is greater, this doesn’t mean that there will be greater liquidity in the market. In truth, the lack of information a small private business provides will generally limit demand for its shares  and not make the company any more appetising to an exchange (decentralised or not). However, it will allow for stock transfers to be completed at greater speed and at a fraction of the price, giving you as an investor greater comfort to manage your portfolio dependant on your requirements and needs.

For larger firms which do have an established cap table and many investors, 24/7 trading is possible. We could write a whole article on why it’s not smart to trade at 2am on a Saturday morning but that would miss the point. The point is not to focus on what the market does or does not do, but to realise the shift in technology, and that this technology can facilitate, communicate and report changes without human interference, at any time, anywhere in the world. You just need to watch it (and keep the occasional back up) .

Reporting is where I believe the greatest strength of digitisation really lays for investors. Because new data streams will allow not only smaller investors to have greater transparency about their investments, but institutions too, we will be able to analyse smaller companies better. This hopefully will allow investors to access much smaller players than they are used to, ultimately diversifying their own risk and creating new financial products.

And let’s not forget the Government

In the UK, there has been a real push to ‘digitise’ services and deliver information via the web, importantly where the payment of taxes is due. With the evolution of digitised securities, we will see a greater expectation of autonomous reporting and dynamic taxes catering for individuals business. I hope that this automation and transparency will lead to businesses being able to get on with the job, as coined by many politicians, and not get bogged down or disheartened by administration and red tape.

Conclusion

Time will tell if these innovative products will deliver the promises many hope they will. But in the meantime, remember one key thing. Should it not work out, you still have ownership of an underlying paper share, possibly in a great business that you wanted to back in the first place.

If you are interested in finding out more about STOs (Security Token Offerings) then make sure you check out, Learn about tokens: “https://crowdforangels.com/learn-about-tokens”

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