After the scandals that accompanied the bursting of the ICO (Initial token offering) bubble in 2018, many market experts argued that STO — Security token offering — would be a better alternative. Unlike ICO, which is practically not regulated in any way, STO is digital assets done by the book. The STO regulation makes it possible to attribute this method of investing to the purchase of securities, while ICO is actually a kind of crowdfunding. In some jurisdictions, only qualified investors are allowed to participate in STOs. For example, such a requirement is established by the US Securities and Exchange Commission (SEC).
Fundamental features of STO
Security token in fact acts as a blockchain-based wrapper, shell, or envelope of an underlying asset. All properties of this token can be described using a smart contract, including:
- number of tokens issued;
- the amount of the underlying asset each token represents;
- type of investor (accredited, qualified, institutional);
- token distribution;
- token lock-up period — and others.
The most important differences of STO are KYC/AML and Investor Accreditation. Most often, STO platforms use for KYC/AML third-party services that perform identity verification, background checks, and bank account linking. In some cases, accreditation verification, which is important for STO, can be added to the KYC/AML procedure. But it can also be done by the token issuer manually. As a result of the Investor Accreditation procedure, certain investors are whitelisted while others are shut out from STO.
Although a large amount of private investment is excluded in this way, in general, the ability of accredited experts allows the STO market to grow. According to the SEC, in 2020 only 10% of Americans were qualifying as accredited investors, but they have represented nearly 75% of the US wealth, about $75 trillion.
Current Market Situation and Forecasts
During the COVID-19 pandemic, the STO market experienced less of a slowdown than other segments of the cryptocurrency industry. This can be explained by greater investor protection and also some structural changes such as storing securities in the digital form along with the rise of the service provider ecosystem and accumulation of expertise by them.
The infrastructure is growing, including licensed platforms, broker-dealers, and transfer agents. Since the adoption of cryptocurrencies is also constantly increasing, some experts assume that more private companies will bypass traditional initial public offerings (IPO) and instead use blockchain technology to digitize the capital-raising process with STO. Some experts expect this industry to surpass the market volume for cryptocurrencies in the next five years.
In 2021 exponential growth of the market was already noticed. According to the data and forecasts of the 21.finance marketplace, the global security token market could reach $3 billion by 2025, growing at 56.9%, compounded annually.
According to BlockState headquartered in Switzerland, equities are the majority of security tokens.
Distribution of asset classes tokenized
Ethereum is the most popular platform used by companies for STO.
Distribution of protocols used for STO
Finance is the most successful industry. For this area, investment security traditionally occupies the most important place. Therefore, it is for finance and banking that STO is considered the best way to raise funds, according to the founders of new projects.
Distribution of funds raised by each industry
The most successful STOs are launched in the Middle East, Eastern Europe, and Western Europe.
Target funding raised by the region
In Western Europe, the situation is changing fast for the better for STOs. In mid-2019 Tozex supported German company Bitbond, which has launched its BB1 token via the first STO approved by the German financial regulator BaFin. Bitbond Finance funds SME loans and aims to be a leading provider of tokenization technology in Europe.
The BB1 tokens were issued on the Stellar blockchain with a hard cap of €100M. The duration of the bond is 10 years with an annual interest of 4%, and a variable interest amount equivalent to 60% of the profits realized by Bitbond GmbH in its business activities. According to Bitbond, its STO is a clear signal that Germany is now leading the STO race in Europe.
Several other notable projects that are launched on the Tozex platform can strengthen the position of the European crypto business in the field of STO. First of all, should be noted:
- Spantale, which uses sponsorship crowdfunding via a blockchain-based platform to connect athletes and sponsors and give fans and companies direct access to sponsorship and donations;
- 3WM, which develops innovative solutions while allowing climate players to monetize their actions in favor of the climate through a cryptocurrency.
From the global side, it can be argued that an upward trend is that tokens should be structured as securities, which regulates investors’ rights and let them participate in the business via an interest claim. STOs highly likely will gain traction as an alternative asset class over time.