With all the buzz around Security Tokens and Security Token Offerings, potential investors might have a simple and obvious question: what makes this type of investment stand out? We believe that the investment market will see a serious shift with the development of an STO because Security Token Offerings open the window for everyone to an easier, affordable, and secure way to invest in companies that they want. Let’s take a look at some of the benefits that Security Token Offerings bring for investors.
Since security tokens are created on a blockchain, it is quite common to get them mixed up with utility tokens. In fact, those two have almost nothing in common. In most cases, utility tokens are designed solely to provide access to a service or product that exists on a blockchain platform. They have no other value in their own right, while security tokens are actual financial instruments which designate token assets. Just like any existing traditional market instruments, security tokens may grant rights in:
● Virtual or physical assets ownership;
● Financial commitments;
● Dividend payments;
● Direct or indirect participation in the management of the company.
STOs are usually called “the new version of ICO” which is completely wrong. Initial Coin Offering is a fundraising method via the use of cryptocurrency, which can be a source of capital for startup companies. Basically, ICO is a token distribution event where investors invest in BTC or ETH in return for the native tokens of the particular project and this token can represent a number of things such as pre-sold rights to access the service when the product is ready or they could be a part of a product’s ecosystem with a certain role in the work of a product.
The main issue with ICOs and the major issue for the whole crypto market is a lack of regulation, hence no investor protection mechanism is in place. Lack of regulation already resulted in billions of dollars lost by investors. It includes both fraudulent ICOs and assets stolen from centralized crypto exchanges.
The case with Security Token Offerings is completely different since security tokens are treated as “Tokenized Securities” by most of the regulators that have some form of crypto regulation in place. Thus same traditional securities laws apply for security tokens. This means that a company that issues security tokens has to fully comply with all applicable securities regulations.
With traditional securities, regulations can vary by asset type and buyer/seller/issuer jurisdictions, the same goes for security tokens. But when securities are tokenized, compliance becomes automated meaning that security tokens may then be traded anywhere where they are deemed as being compliant. Blockchain technology and smart contracts make it possible to include ownership and regulation directly into a token meaning that the smart contract will be able to execute, regulate and govern the token. For example, a Security Tokens can be programmed to verify who can buy them and therefore restrict Security Token holders from transferring (i.e. buying or selling) them to a non-eligible counterparty.
When you purchase a share of a company on a financial market, you’re entrusting the stock issuer, as well as a long list of third-parties who help facilitate the process: Brokers, Transfer Agents, Registrars, Clearing Firms, Custodians. With security tokens, there are only two entities you’d have to trust: the issuer and the issuance platform. Because the number of intermediaries is significantly decreased, chances of corruption and manipulation by third-parties are reduced to a minimum as well.
Another problematic process when dealing with traditional securities is the settlement: traditional securities take at least 2 business days to settle. Exchanges like the Nasdaq and NYSE can execute trades very quickly, but settling asset transfers takes time. Currently, settlement cycles for most broker-dealer transactions are T+2, meaning it takes 2 more days after a trade has been executed to transfer ownership rights.
Security tokens are built using blockchain technology that allows transactions to be executed much faster. Trades on a blockchain settle in a matter of minutes rather than days. Improved settlement and reduction of excessive third-parties are not the only benefits of technology that security tokens are built upon. Along with that, blockchain helps to:
- Simplify accounting and auditing processes;
- Lower issuance fees by removing the middleman (banks) from the investment process. Lower issuance fees for issuers means that the initial price of the token will be lower for investors as well;
- Decrease the role of lawyers in the process (in the long-run) due to the use of smart contracts;
- Automate dividend payouts;
- Make the voting process easier. Investors are able to take part in shareholders voting from any part of the world, everything they need is a computer.
The Potential for 24/7 Markets
Most traditional markets are tied to strict working hours. For example, most US stock markets open trading at 9.30am and close at 4.00pm each weekday, with the exclusion of holidays. After Friday’s closing bell you cannot trade stock again on the major exchange for roughly 65 hours, and even up to 89 hours on a holiday weekend.
While markets are closed, any number of influential events may occur. Security Tokens are available 24/7. By enabling around-the-clock trading of assets, investors get an opportunity to act on new information in a timely manner. This also allows to expand investment geography by opening up access for investors across a range of time zones.
Blockchain allows a uniform method of verifying and tracking data and prevents any tampering with it due to its built-in immutability. With these characteristics in place, it becomes the perfect infrastructure to store ownership of securities in a fully transparent and secure way. This will make reporting and auditing much easier which will help to prevent fraud, mispricing, arbitrage, third-parties manipulation.
Liquidity and Fair Access
With Security Tokens enabling fractional ownership and thereby lowering minimum investments, more liquidity will come into the market. As more people will be able to purchase smaller stakes, many assets that are considered to be illiquid, or not easy to sell can increase their liquidity.
By using security tokens, the issuer can market its deal to almost anyone on the internet. This increases asset valuation and in turn, also leads to a huge number of investors. Because when the issuer company can reach anyone on the internet its investor base will increase exponentially and will no longer be limited to a particular place. Moreover, prior to security tokens, there were only two ways that investors could get involved in the early stages of investing, either by becoming an accredited investor or by taking part in crowdinvesting where they were fees two types of fees charged: up to 6% from the whole campaign and 2% from the payout to an investors.