Guest post by Cal Evans from Gresham International
Cal is the Managing Consultant of Gresham International.
The security token offering, or STO as it is better known, has become more commonplace in today’s crypto fundraising market. As we all know, the initial coin offering (ICO) spawned a generation of technology enthusiasts that were looking to launch their currency in the open market, and in doing so, offer them at a cheaper rate.
There appears the evolution of the STO, to date its origins may seem harmless enough; however, if you fully understand the model of the ICO and the typical investment world, you will understand that the STO is nothing more than a play by those in the old-school finance world to take back some level of control in their funding world.
Note: For the purpose of this article we shall treat ICOs and Token Generation Events as the same.
This article explores the backside of what an STO really means and the factors that come into play when you are considering an STO.
You’re Bowing to VC pressure
Generally, in issuing an STO and security tokens, you are bowing to venture capitalists and institutional investors. The reason that they have little appetite to enter into an ICO is that their risk-reward model is much lower. That stands to common sense when you consider that they usually have to account to trustees, boards or some kind of member of their organization.
ICOs, in their standard form, are very very risk-oriented. Therefore, the risk-reward structure is aimed at those who take the most risk get the most reward. Hence why so many see hundreds of percentage returns if they get into an ICO early.
In pursuit of this “VC” money and in an attempt to gain back control of their lost position, VCs have convinced many companies to issue security tokens rather than a strict ICO utility token; thereby, ensuring that the VC firm gets its usual ability to obtain some kind of equity passed through from the security token. Meanwhile, those who are undertaking a true ICO control all of their company.
It is worth remembering that most VC and financial firms hate ICOs for the simple reason that it signifies the death of their operating model. For too long, VC firms have been demanding the lion share of companies in exchange for early capital in the hope that the company is successful. When it does succeed, the VC firm will install its own board and allocate its shares to whomever they see fit. Essentially, the dreams of the founder(s) are pushed aside in the need for capital.
So when the concept of an STO is proposed to VC firms, naturally they love it because it helps them maintain their current status quo. A status quo that sees them controlling access to the investment, startup and bootstrap environment.
There Is No Secondary Market for STOs
To date, there are no exchanges operating in the secondary market–although there are many in the planning phase. The possibility of these exchanges in markets such as the U.S. and China is nothing more than a long dream for many. Whereas utility tokens are already operating well within these markets (subject to controls imposed by the various governments and exchanges), they have a thriving industry and many exchanges are now actually outgrowing typical financial institutions.
An STO exchange would be, as we all know, a broker. These brokers would be subject to harsh control laws including how much commission they can take, annual filings, KYC checks and account maintenance. This impacts the user in a number of obvious ways. For example, if I am working with a stockbroker, these transactions can be subject to a large number of obstacles. As easy as most brokers attempt to make these transactions, the legislation simply gets in the way most of the time.
Additionally, it would almost be impossible for any, one exchange to be able to service clients on a global scale in the STO market. Keeping up with each countries’ individual exchange laws would be cumbersome, costly and take more effort than the reward would be–so a “universal” security token exchange could be impossible.
Register One, Register Them All
Where will you register your STO? To become an STO you need to actually have registered the offering somewhere, meaning you are subject to a country’s laws, KYC principals and government inspection. Naturally, governing bodies love this as an idea.
Let’s take the U.S. as an example. When you fill out Regulation D, A, C or any other security paperwork, you effectively pass over ALL your personal information to them. When the SEC (or any other controlling body) has all of that information, it is very easy to keep track of the company for the purposes of say, tax, complaints, investigations etc. When you do register in the U.S., all you are doing is allocating yourself under that law. European companies, meanwhile, can’t sell U.S. Securities without the requisite license, just as you can’t sell European Securities in the U.S. without the requisite license. So just because you have become an STO in one location does not mean you have complied with laws across the globe.
As for those companies that believe they can become a security in one location and not a security in another is madness. I wouldn’t register under an exemption in the U.S. and then pretend to the U.K. market I was NOT a security. I have already signed paperwork and filed it with a government body saying I am a security. Remember–if you file in the U.S. you are subject to U.S. laws. The SEC will ask how you are selling your U.S.-based security to foreign individuals and what laws you have complied with in that local country.
Finally, the number of people who believe that filing paperwork in the U.S. does not make them a security is again, mind-blowing. When you file a Regulation D, you are filing an exemption. This means you are a security but you are exempt from the usual filing requirements because of the method and people you will sell to. Securities laws still apply.
When you file paperwork with any authority, you are removing your decentralization. The authority has control over everything you do, as a company, as an individual and as a project. It has to be done in line with the laws and rules of that country.
This means that, as well as passing over all of your information, you are also allowing the governing body to get information on all of your participants, whom will then be subject to taxes, laws, rules and controls of that country. It kind of removes the spirit of true decentralization, doesn’t it?
You Should Just Do a Public Offering
If you don’t have the stomach to attract the crypto community and share in the risk-reward level with them, the argument is that you should ultimately just undertake a public offering in some kind of jurisdiction.
A public offering allows you to sell your company and raise funds to achieve your purpose. It also means you can advertise and sell to anyone that is within the jurisdiction’s reach. The whole purpose of an ICO is to allow companies to raise capital without giving away any of their equity or control. In exchange, there is a digital asset created that can be traded, which may or may not go up in value.
When you do an initial public offering or an STO, you are removing the community control and the naturalized economics of the token itself.
Example: What pushes the price of Apple Inc. up? Company news and activity. What pushes the price of Bitcoin up? Community news and activity. You push the economics of your token out of the hands of your supporters and into the hands of traders, creating a totally different situation, and one that means rather than being able to realize a reward of a few hundred percent, you’re only rewarding your believers with a few percentage in moves–most of which will be tied to general market activity more so than cryptocurrencies.
There Is a Difference Between Tokenized Assets and an STO
Finally, it is worth noting that there is a difference between an STO and tokenized assets. If you want to tokenize an asset using a digital signature (blockchain), that is actually a common-sense step to take, and many successful projects have been launched out of the concept of fractional ownership. These do very well when they control the exchange of these tokenized assets on their own platform or exchange zone. Organically, they grow very well and receive support from their user base, and are often only tradable with their own token, which is issued during a typical ICO. Just because something has been evolved into a fractionalized ownership model through tokenized assets, does not make it a security token by default.
The conclusion here is that the STO is a model that is loved by those in the VC, finance and even the typical legal world. Yes, even U.S. lawyers love the STO model because it doesn’t scare the life out of their insurance company nor does it mean they will be subject to a possible SEC investigation.
The truth of the matter is if you are considering an STO you should probably just follow the conventional equity route–loan notes followed by an IPO. There is little that can be done with the tokens and you are losing most of the control of your company if it is tied to equity or listed through the regulators in any event. My message is this: Stop falling for the STO line. If the market grows up and STOs become a real possibility, then consider it. Until then, you’re just surrendering to the old-school finance world.
Cover Photo by Crawford Ifland on Unsplash