In 2017, the need for more compliant, regulated approaches to digital assets resulted in Security Token offerings or investment contracts based on blockchain contracts. After all, 2017 was “the year of the ICO” and the capital increases were largely non-regulated, overcoming angel and venture capital.
Legal Issues With ICOs
These surprised authorities, like the SEC, have been frustrated by the potentially deceptive deals and celebrities from Alex Tapscott to DJ Khaled and Floyd Mayweather. The SEC has even investigated businesses outside of the United States, such as Kik (based in Canada).
The market has seen the advantages of a blockchain capital increase, which allows anyone to invest any sum anywhere in the world no matter how small. Through eliminating intermediaries, several ventures ignored KYC / AML and opened investments to everyone with capital. ICOs raised over $20 billion between 2017 and the end of 2018. STOs, or Safety Token Offers, were paled between 2017 and 2018 compared.
STOs Are Replacements For ICOs And IEOs
In 2017, there were only 5 STOs and BlockState notes that so far only around one billion dollars have been obtained (in early 2020). The winds change, however, when ICOs are replaced by STOs. STOs raised around 450 million dollars in 2019 and ICOs raised just 370 million dollars during the same year. Also, in 2020, ICOs are expected to practically disappear, while STOs continue to expand.
As it says, “follow the money” and because businesses turn to ICOs, it is obvious that security tokens win in the blockchain at least.
STOs Must Substitute For IPOs
Most importantly, STO’s are an entirely viable option for raising capital outside the blockchain region. For example, IPOs or Initial Public Offers cost over $4.2 million to be carried out, in addition to 4-7%, according to PwC. ChainPlus puts the expense of an STO at about $100,000.
Many would argue at this time that IPOs are capable of raising far larger sums than STOs, although the fact is that the global accessibility of STOs means that there is no limit to the amount that you may raise (with the note that there can be legal limits on the jurisdiction). For example, tZERO raised some $134 million, around $100 million higher than a US IPO’s median offer.
Unless you collect $100 million, spending more than $4 million on fees is a serious margin hit. This is not to mention things like the expense of KYC, which, according to Refinitiv, is around $616 per client. The ability to digitally record and check the identity of the investor via the blockchain will reduce KYC costs significantly.
According to a FENERGO survey, enforcement is a major concern because about $26 billion in KYC / AML non-compliance fines were imposed in the last ten years. Security Tokens can provide a simpler enforcement solution by incorporating specifications for compliance into the token.
Security Tokens Can Be A Better Solution For Enforcement
Let’s compare the most common token protocol used for an ICO, ERC-20 with the tokens used for STOs in greater detail. ERC-20 is a protocol that only specifies a few basic functions:
- Token name (e.g. ETH)
- Token decimal number (e.g. 18)
- Transferring tokens
- Inquiring the balance of tokens at a certain address
- Total supply of tokens
You note that you do not have such roles as limiting transfer, banning investors from certain jurisdictions, enforcing a lock-up period, or preventing transfers to a minor or someone on a watch list.
These tokens lack a lot of what is necessary for a securities offer. You don’t want to sell the securities to a minor or someone in a jurisdiction in which you are not controlled by mistake, for example, but with an ERC-20 token, you can’t control it.
Nonetheless, you can control this behavior with a safety token that allows you to program enforcement into your token.
Security Tokens will allow everything from admin to forced transfers, and more: Security Tokens
- Code / Reference Link
- Get number of holders function
- Token sender hook
- Token receiver hook
- Data parameter in transfer functions
- Get the administrator address
- Transfer administrator function
- Transfer administrator event
- Get metadata of an address
- Static checks
- Dynamic checks
The list may continue, as security tokens are highly complex programmatically. Several possible criteria can be used, possibly the most famous being ERC-1400. The very sophistication of the protocol is a possible limitation because you will have to find the blockchain talent that can navigate it without adding security vulnerabilities.
ERC-1404, properly known as the “Simple Restricted Token Standard” has a much simpler version that merely adds two basic functions to the ERC-20 standard:
Such functions allow you to apply certain of the above-mentioned transfer limitations, for example about the age of jurisdiction of an investor. Considering that there are hundreds of thousands of ERC-20 smart contracts and more than 1,000 Ethereum developers, discovering expertise that can manage the ERC-20 protocol is relatively easy (not to say it will be cheap).
From there it is an easy process to understand the added features of ERC-1404 and build your protection token.
Security tokens would likely fundamentally revolutionize compliance, as security tokens can reflect any financial asset, whether it is equity, debt, or real assets, and therefore allow compliance with any asset to be enhanced.
No safety token project appears to have forfeited the use for compliance with another KYC / AML team. Insecurities laws it’s always “better safe than sorry,” but it can happen that one day all KYC / AML steps will be converted into digital assets, thereby negating the obligation of an additional group.
One of the most prominent security benefits is increased liquidity. After all, the blockchain does not only operate during trading hours such as NYSE or NASDAQ. Safety tokens can instead be exchanged 24/7/365. However, they are not restricted geographically, so that an investor can buy and sell them at any time on any market.
In secondary private markets, low liquidity is a major problem, particularly for physical, costly assets like collectibles and certain commodities such as gold. It makes these assets particularly suitable for tokenization.
That said, security tokens pledge greater durability, not now, in the future. There is currently a serious lack of secondary market infrastructure for security tokens and there is not enough infrastructure to buy and sell over traditional markets to build adequate volumes for superior liquidity.
However, if you believe in safety tokens, which means that best technologies are eventually gained, buyers and sellers will naturally fill those markets in time to create the liquidity premium for security tokens.
In reality, conventional exchanges initially faced the same challenges. For example, the London Stock Exchange may trace its history more than 300 years ago. Perhaps investors predicted low liquidity centuries ago, with the sum and quantity of investors marginal compared to the current one.
Slowly but surely, traditional markets have seen momentum and volume rise that has contributed to liquidity. Today, the market cap on the London Stock Exchange is more than $26 billion, considerably less than bonds like NYSE. In any event, the security token market is far from rising, but more liquidity is followed by more issuers, investors and regulatory approvals.
The Future of the Security Token Market
In other words, the potential security tokens market is immense. Or put it simply: Security Tokens ‘ potential market is the stock market.
This global market contains practically any asset you can think of, whether collectibles such as watches and supercars, luxury goods such as diamonds and gold, alternative assets such as properties or conventional assets such as stocks.
Yes, each of these properties is already tokenized or already sold. You may purchase tokens to acquire fractional ownership in CurioInvest Supercars or invest in Aurus tokens in gold or invest in real-life tokens (disclaimer: the author does not support such ventures, this is only for informative use).
Again, the sector is just beginning, but things are moving in the right direction for mass adoption.
Security Token Regulations
Regulators around the world are warming up to security tokens and their related ICOs in stark contrast to utility tokens. Wikipedia also provides the most comprehensive overview of global security token regulations:
As you can see, only two jurisdictions have unambiguously forbidden security tokens. China is shocked, and the South Korean authorities are more than likely to learn how to differentiate between ICOs and STOs and then change their rushed regulations.
The largest financial markets in the world, from the US to the EU and the UAE, have all reacted favorably to the security token. When regulators expand their spatial awareness, more jurisdictions should follow suit.
Why Will It Not Take Place Overnight?
The future of the safety token industry is bright. The proposals switch from ICOs and IEOs to STOs and the regulators warm up. However, there are many obstacles ahead of us.
For starters, there are several separate areas in which the industry is confused, such as security token protocols and securities regulations. As noted, ERC-20 tokens can not manage the requisite compliance complexities. You will, however, find hundreds of articles, comments, and corporate pages in Google “erc20 security token” or “ERC-20 security token” indicating that a certain token is a security token while using the ERC-20 protocol.
These are essentially incompatible. Although ERC-20 can legally be categorized as a security token, it does not realize the benefits of safety tokens that are primarily in increasing the operational and enforcement capacity of securities.
The so-called”ERC-20 security tokens” are subject to the same technical limitations as tokens like the inability to restrict transactions and are not appropriate for the digitalization of securities.
Regulations are another source of uncertainty that correlates with the contradictions of the procedure. Most issuers fail to recognize that the US security regulators, such as the SEC, are internationally available, and that you are subject to US securities regulations wherever you are located in your security token sales are open to US investors.
It makes it even more important to use the right protocol, because the right protocol, such as the ERC-1404, would allow you to take action like restricting US investors if you’re not controlled in the US.
Real security tokens are, after all, the only way to represent securities on the blockchain by using security token protocols. The blockchain securities, both in terms of issuance, transfer or compliance, are far more effective than off-chain securities and in a conventional paper-based system. Logically, therefore, securities will slowly but surely transition to security tokens.
Only in the last few years were security token protocols first proposed, it was thought that many years would take before blockchain-based securities became real. There are still many naying today, so it is important to simply remain aware and concentrate on change in the industry rather than on hype or anti-hype.