As there isn’t an official document about STOs (that I could find), I resorted to scouring the internet for data and these pieces have helped me understand this new buzzword. Here goes nothing!
Recently there has been a new buzzword in the cryptospace: Security Token Offerings (STOs).
But first, to really understand the significance of STOs, perhaps we should first understand its predecessor: ICOs.
What are ICOs?
For newcomers of the cryptospace, ICOs stand for Initial Coin Offerings, which is the fundraising model that many crypto startups use to raise funds to start their businesses. Similar to traditional crowdfunding, investing in an ICO will not entitle one to any ownership stake of the company. Instead, investors get keepsake tokens that will (hopefully) grow in monetary value as the project takes off, and the tokens become more useful to maintain the project. This is probably why most of these tokens are called ‘utility tokens’.
The ICO Explosion
Ethereum launched its own ICO in 2014. While this was not the first ICO in the space (this record was held by Mastercoin in 2013, who raised 3,700 BTC in the first 12 hours, worth approximately. 2.3 mil USD at that time), Ethereum was the catalyst that started the ICO craze.
Ethereum paved the way for businesses to start their own ICOs in two significant ways:
1. Building Blocks For ICOs
With their innovative ERC-20 protocol standard, Ethereum provided the building blocks for other companies to create their own tokens that can be supported and traded on the Ethereum network.
Without going into the nitty gritty technical details, the protocol is essentially the guideline that facilitates the integration of various coins.
This integration meant liquidity of new tokens. This gave aspiring businessmen the reassurance that their coin was going to be tradable.
2. Ethereum as a Role Model
In July 2014, Vitalik Buterin, founder of Ethereum made this announcement:
‘Ether is a product, not a security or investment offering.’
At this point, it is good to note that ‘utility’ is a term that crypto-marketers use, likely for evading the legal label of the token being a security. This is because if the product was classified as a security, it would have to be regulated under strict securities regulations. This was probably one of the reasons why Vitalik highlighted Ethereum as a product, rather than an investment offering. Other entrepreneurs saw the opportunity to avoid the red tape of said regulations and followed in Vitalik Buterin’s footsteps to create their own ICO tokens (with the help of the ERC-20 standard) and launched their own ICOs.
The Story Continues…
The new crypto market was fertile ground for companies to start businesses, and so, some companies took the leap. Like in most new markets, (and perhaps the traditional markets over a decade ago), the pioneer companies faced little competition and were able to earn outsized returns. People began to take note of the investment opportunities, which led to an influx of investors, and naturally, investor money. Other individuals also saw money-making opportunities and easily entered the barrier-less market to start their own ICOs. For a while, this market flourished.
But of course, all good things must come to an end.
The ICO Implosion
Fast-forward to 2018.
This is a brutal year where we saw (and are still seeing) our pet projects’ coins tanking and ICO projects disappearing. The infamous BitConnect closed down their lending platform in January this year, leaving the investors who lost most of their funds with no recourse. And this is but one of the many companies that appeared in the media. A report from TechCrunch found more than a thousand crypto projects deceased as of June 2018.
As the market became more saturated and competition increased, the once-insane profits dwindled. Portfolios went down. And because ICO companies are not legally obliged to account to their investors, the unprotected investors suffered the losses acutely.
Before, regulatory bodies mostly took a ‘do-no-harm’ approach, likely because the technology and market were too new and foreign to classify the ICO tokens as ‘securities’. Unfortunately, in the face of an alarming increase in fraudulent activity, crypto companies gone bust, and failed ICOs, government officials are now stepping to protect investors.
In July 2017, the SEC started clamping down on ICOs following a report that loosely proclaimed that almost every ICO token was an unregistered securities offering. This means that most, if not all, ICO companies and ICO token holders were prosecutable. The self-declared utility token label was no longer able to sidestep against legal obligations. The investigations against ICOs show no sign of stopping, which is worrisome for crypto entrepreneurs who relied heavily on ICOs to begin their businesses.
“Our Tokens Are Securities”
Amidst the carnage, the space is now proactively seeking legal clarity, declaring their tokens a security, and getting their token and fundraising licensed, or exempted.
Which leads us to now: the evolution of security token offerings.
Read on to follow the developments of security tokens and STOs in the next installment of my Hopefully Helpful series.