Initial coin offerings (ICOs) were long-lauded as a crowdfunding model that could finally free small, yet ambitious companies from an expensive equity fundraising route or public offering. Instead of shelling out millions on lawyers, regulatory consultants, and brokers, an ICO allows a startup to raise money on the blockchain from millions of retail investors who hold liquid cryptocurrencies such as Bitcoin and Ethereum. As capital around the world was absorbed by this idea, central banks and regulators felt their hackles rise and started to pay more attention.
China started with a blanket ban on ICOs in 2017, and other countries followed. The US took a different approach and has recently verbalized some ways that it’ll be defining ICOs in the future. It turns out that it views many ICO tokens as securities, which were bought with the expectation of profit and minted by centralized (if miniscule) entities. Though these rules are not yet enforced, there has been a logical halt in the establishment of new ICOs, while projects try to figure out how to deal with this fresh and still ambiguous template.
The waning ICO trend is not due to harsh regulations, but rather a lack of them. Upcoming projects may want to take advantage of the blockchain crowdfunding model, but they also want to get out ahead of incoming regulations. With the recent indication by the SEC of how they’ll view tokens, it finally highlights the path that compliance-focused projects must take. The raw potential of the ICO can be applied to traditional markets and investing paradigms thanks to a phenomenon called security tokens, which are assets that reside on the blockchain, but that also achieve regulatory compliance due to some special characteristics.
ICOs vs STOs
Though ICOs allow companies proficient enough to publish a whitepaper and create a token to also raise money, this carefree model comes with high costs. Contributors aren’t investing in any kind of tangible product, service, or asset and can claim no rights to the token’s underlying value—though they could profit from its demand. This means that ICO-fundraising efforts enjoy virtually no accountability while token investors shoulder all the liability. However, many ICOs still fall into the predefined group known as ‘securities’ outlined by the SEC by virtue of how they were launched.
This is a double-edged sword because ICOs that sold what are now known to be security tokens would currently be in violation of the legal standard. Those with real “utility” tokens that don’t fit the definition of securities will probably not be regulated and therefore miss out on the enormous advantages that security tokens will gain in the future.
Security token offerings (STOs) provide the path for blockchain to find its niche in both financial worlds and finally connect them. They will open blockchain’s most beneficial utilities to centralized exchanges like Nasdaq while also building a direct channel to the cryptocurrency market. Investors will therefore be able to access a wider array of real assets instead of just cryptocurrencies.
The STO Economic Effect
The onboarding of traditional assets to the blockchain has benefits for both the traditional finance camp and the Wild West-like cryptocurrency market.
Institutional entities gain:
- A highly accessible and compliant blockchain crowdfunding model available via more traditional channels
- A way to onboard new assets with digitized value (art, automobiles, real estate)
- More fractionalization, smaller initial investment amounts for greater retail investor accessibility
- Lower fees, overheads due to blockchain’s low-cost model
- A way to acquire BTC, ETH from cryptocurrency-holding customers
Blockchain enthusiasts obtain:
- A way to trade tokens that they’re familiar with, except via their bank account and credit cards directly
- Hedging opportunities for crypto volatility with tokenized haven assets
- Wider array of investment opportunities
- Improved fungibility for their cryptocurrencies
The largest contribution of STOs to the market is less relevant to institutional finance and investors than it is for small businesses. The ability for a small business to quickly raise capital in a compliant, low-cost fashion is revolutionary, and presents immense potential for the international economy. This opens the spigot for small-cap investments from everywhere—hedge funds, pensions, retail investors, and new ETF-like instruments that will surely crop up when the trend hits.
Essentially, the ICO craze will be replaced by a different one: an STO-fueled influx of investment into real off-chain businesses which can suddenly provide equity in exchange for capital without the roadblocks of yesterday. This race towards value may even contribute to another bubble, making security tokens the next great opportunity for savvy investors. The best part is that it won’t be retail investors who make up the greatest demand for STOs—it will be institutional finance, lending even greater momentum.
Once regulators outline more concrete guidelines for ICOs and token regulations, large institutional finance entities like banks and exchanges can begin building their own proprietary (and compliant) channels for the blockchain sphere. Imagine being a novice investor with no blockchain knowledge and no cryptocurrency, yet being able to speedily and cheaply buy tokens for fractional equity in classic cars, for example. Seeing “ClassicCarToken” listed on a public exchange like Nasdaq is closer than we think as the STO phenomenon quickly advances.