STOs and Security Tokens Explained (simply)


What is an STO? Is it “the new” ICO? What’s the difference between a security token
and a utility token? Why is it even important? Well stick around, in this episode of Crypto Chiteboard Tuesday
we’ll answer these questions and more. Hi, I’m Nate Martin from 99Bitcoins.com
and welcome to Crypto Whiteboard Tuesday where we take complex cryptocurrency topics,
break them down and translate them into plain English. Before we begin
don’t forget to subscribe to the channel and click the bell
so you’ll immediately get notified when a new video comes out. Today’s topic are Security Tokens
and Security Token Offerings or STOs for short. But before we dive in,
we first need to understand what ICOs are. An Initial Coin Offering, or ICO for short, takes place when a company sells
cryptographic assets known as tokens in order to raise funds for its operations. The tokens being sold play a role
in the project and those who buy in early
are getting them at a discount, assuming the project succeeds. The company usually opens the sale of tokens
for a limited time frame until the money they need to raise is reached. A good analogy for an ICO would be selling
$1 casino chips at 80 cents a chip in order to build the new casino. If the casino comes to life
the investors made a wise investment. A good example of an actual ICO
would be Ethereum, where Ether –
the token used to power the Ethereum network – was sold to investors
before the network launched, in order to fund the project. Tokens in general
are divided into two categories – utility tokens and security tokens. Utility tokens are tokens that promise
the future use of a product or service. They aren’t meant to be an investment,
they have a utility. One example that might be considered
a utility token of sorts would be a starbucks gift card. If you buy it at a discount, you’re not really expecting to make a profit
by selling the gift card. Effectively, you’ve prepaid for,
and expect at a later date, a cup of coffee. Security tokens on the other hand, are tokens that represent
tradable financial assets, for example a share or a bond from a company. Security tokens are meant as
a form of investment, they pay dividends, share profits or pay interest in a way that promises
future profit. Put simply, utility tokens promise a product
or a service while security tokens promise profit. While ICOs started out with good intentions, people quickly started seeing
the opportunity for easy money and used this mechanism to fuel their greed. In 2017 the ICO frenzy reached its peak. Billions of dollars were invested
in so called utility tokens that had as little as a piece of paper
describing some obscure future venture. Of course the overwhelming majority
of these projects never saw the light of day
and a lot of investors lost their money. Back then the ICO field
was completely unregulated and quite the number of scams
and manipulations emerged. Investors pumped up the price of specific tokens
just to dump all of their holdings once everyone else bought in. Other cases included companies that just
completely vanished, along with the money, once the ICO ended and the money was raised. Instead of a creative way to raise capital, ICOs quickly became a workaround
to avoid regulation. Companies that wanted to avoid the long,
expensive regulatory path toward the traditional
Initial Public Offering or IPO just conducted an ICO instead. Nobody asks for permission to run an ICO, you just set up a website, some tokens
and start selling them to the general public. Also, unlike an IPO, you’re not giving away any control
over your company or profits since you’re supposedly selling tokens that only promise future use
of your currently non existing product. As things got out of hand,
public complaints increased, companies like Google and Facebook banned all ICO projects from advertising
on their platforms and regulators stepped in. The regulators wanted to investigate
whether these so called tokens shouldn’t be in fact considered as securities. And if so, are the companies behind them meeting the requirements
to allow them to sell securities. You see, in the US there’s a simple test called
the “Howey Test” that is used to decide if what someone is selling
should be considered a security. It states that a transaction is considered
a security sale, if a person invests his money
in a common enterprise and is led to expect profits solely from
the efforts of the promoter or a third party. We can break this long and confusing sentence
down to four main questions: One – Was there an investment of money? In the case of ICOs the obvious answer is yes. Two – Was this investment done
in a common entreprise? Since ICOs raise money for a company
which is considered a common enterprise the answer is also yes. Three – Was there an expectation of profit? Well, this is a very interesting question, since a company can always claim that
its tokens were meant for utility only. However, when you look at the token market you can clearly see that people
are buying tokens in the morning and then selling them in the afternoon. Meaning tokens are bought
in order to sell them for a profit. So depending on the specific case
this could be a yes or a no. And four – are the profits connected directly
to efforts of a person or entity who are not the investor? This question is a bit confusing,
so here are some other ways to look at it: “Is there a person, that isn’t the investor, who is in charge
of making this venture succeed?” You could also ask
“Is this a passive process for the investor?” In most cases the answer to these
would be a solid “Yes” as the investor’s involvement
in the project ends usually once he or she invested funds
and got tokens in return. Bitcoin, for example,
doesn’t fall under this category since there’s no one person
making the decisions. Many open source projects
can have the benefit of the doubt since you can’t say that there is one person
calling the shots, it’s more of a group effort and that disqualifies them
from the fourth question. So while most companies classified their token
as utility tokens in order to avoid security regulations, when they were reviewed by the authorities, almost all of them were said
to be selling securities. As a result many ICO companies
were subject to legal actions including hefty fines and even jail time. Today, most ICOs aren’t open to the public
because of the fear of regulators and are privately funded
by small groups of investors. So there you have it, on the one hand we have ICOs – A completely unregulated form of raising money
from all around the world, that’s fast and easy to execute
and is filled with scams, frauds and just plain negligence. And on the other hand IPOs – A long, expensive, exhausting road
of raising money from investors by vetted, legit companies. But today, there’s a new type of offering called
a Security Token Offering or STO. A kind of middle ground between an ICO
and an IPO. Let me explain. An STO is the process of selling
security tokens to the public while avoiding the long exhausting process
of an IPO. There are no utility tokens in STOs and everyone participating is considered
an investor. STOs are intended to be compliant with
Anti Money Laundering requirements and securities laws. You might be wondering how are STOs possible? How can you sell securities
without regulatory oversight? The answer is through exemption. In the US for example, you’re exempt from registering with the SEC
if you fall into one of three regulations. Regulation D,
Regulation Crowdfunding or regulation A. Regulation D means that STOs are exempt
from registering with the SEC if they raise money only
from accredited investors, meaning anyone with a net worth
of $1 million or more or with an annual income of $200,000 or more
in the last two years. The company can raise
an unlimited amount of money in this manner. Regulation Crowdfunding states both accredited
and non-accredited investors can participate in the offering, but there is an annual limit
to how much an STO can raise – and that’s $1,070,000 Both regulation D and regulation CrowdFunding
have a one year lockup limit. This means that investors need to wait
for one whole year before selling their security. This is done to prevent pump and dump schemes
and protect other investors. Regulation A+ means the offering
must be qualified by the SEC, sort of a mini IPO. Once it is approved, everyone can participate in the STO,
which is limited to $50,000,000. There is no lock up period
for a Regulation A+ exemption. You could buy and sell your tokens
in the same day just like you currently can
with cryptocurrencies. So, once a company falls into
any one of these regulations, it can sell security tokens as part of an STO, with no threat from the SEC coming down on it
to shut it down and throw the proprietors into jail. So are STOs a good thing? STOs have a lot of advantages. For starters, they remove the threat of scams through the implementation of regulation
and oversight. While ICOs were traded on shady
and unregulated exchanges, STOs are traded on verified exchanges. Also, STOs open up bigger markets for investors since almost every asset class type
can be tokenized. From the fundraiser’s perspective, a wider audience of investors can be reached, as digital securities are easily marketed
and transferred across borders. Of course many people think STOs are a bad thing
since in some cases, regulation D for example, they offer the investment
to accredited investors only. This seemingly excludes
the Main Street investor while allowing only the rich to benefit. On top of that, the lockup period and cost of compliance may deter many investors and companies
from participating in STOs. In the end, STOs have various pros and cons. I believe that at this point in time, they are more suited for early adopters, who are looking to invest
in something new and exciting while still subject to some oversight, which offers a certain degree
of investor protection. These are just the early days of STOs and as we move forward, more and more companies,
not just crypto related, are thinking about how they can
“tokenize” their assets in order to raise funds. Well, that’s it for today’s episode of
Crypto Whiteboard Tuesday. Hopefully by now you understand
what Security Tokens and STOs are – A way to tokenize tradable financial assets
and offer them to the public in a responsible regulated process. You may still have some questions. If so, just leave them
in the comment section below. And if you’re watching this video on YouTube,
and enjoy what you’ve seen, don’t forget to hit the like button. Then make sure to subscribe to the channel and click that bell so that you’ll be notified
as soon as we post new episodes. Thanks for joining me here at the Whiteboard. For 99bitcoins.com, I’m Nate Martin,
and I’ll see you… in a bit.

13 thoughts on “STOs and Security Tokens Explained (simply)”

  1. Nate, I was kinda shocked to read Ofir's email this morning. Does this mean you will still do your videos for 99Bitcoins?

  2. where are you located? If you are in USA i would love to meet you in person. I watched all your videos in 2 nights and got all my basic knowledge about the crytocurrency market. You are the best teacher in the whole world. Awesome!!

  3. You should check out Ownmarket #chx which is an sto issuance platform using chx as a utility token. 8 sto’s to go live this year including $50mil debt tokenisation. When the sto boom comes they will be at the forefront of them wave

  4. Hi brother.
    Recently few people promoting skyway CRU token and they are saying . It's security token. What you think? Is it good to invest In CRU

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