SECURITY TOKEN OFFERING

What is a security token?

A security token usually represents a stake in an asset or external enterprise.
Technically, a token is categorized as a security token when subjected to rules
and regulations under federal law and deriving its value from external tradable
assets or enterprises.

Governments or businesses can issue security tokens. As such, these tokens

serve similar purposes as stocks or bonds. Security tokens are different from
utility tokens, for example, because they represent the right of ownership to an
asset.

Simply put, they are liquid contracts in digital format that represent shares in
valuable assets like corporate stock, real estate, or a vehicle. By using security
tokens, ownership stakes are preserved on a public ledger (blockchain).

By tokenizing securities, startups launching initial coin offerings (ICOs) and initial
exchange offerings (IEOs) can improve their asset liquidity and attract more
investors. There are other benefits, too, like lower issuance fees, high market
efficiency, fractional ownership and improved access to real-world assets that
are digitized.

Uses of security tokens

Startups and companies wishing to distribute shares to their investors can now
do so in the form of security tokens.
Because security tokens are issued on blockchains, they are also transparent,
divisible, quick to settle and have no downtime whatsoever.

Transparent

Public ledgers allow for transparency of transactions despite participant

anonymity. As such, everything can be accessed on the public ledger and
audited at any time. Smart contracts that manage tokens, as well as holdings
and issuances, can be viewed by anyone.

Divisible

Extremely valuable assets like art and real estate can be offered to investors
who find the tokenized scheme more appealing and affordable. For example, a
sculpture worth $8 million can be tokenized into 8,000 pieces and then sold at
$1,000 a piece. Tokenizing assets increases accessibility by making them
divisible.
Quick to settle

Settlement and clearing usually take a long time when transferring assets. On a
blockchain, however, processes are automated. This means that reassigning
ownership can be done almost instantly.

No downtime

Financial markets typically have a fixed period for doing business. They’re
usually open on weekdays and closed on weekends. Digital asset markets,
however, have no downtime and can offer access 24/7.

Types of security tokens

Below, we briefly explain the various types of security tokens available on the
market:

Equity tokens

An equity token represents ownership of an underlying asset such as company

stock. An equity token holder may be entitled to dividends, voting rights, or both.
Similar to shares, a contract dictates the applicable terms and conditions of
such.

Debt tokens

Debt tokens are tokens that accrue interest. They are equivalent to the interest
rate or short-term loan on the amount loaned to a person or company. They
represent the debt owed by the token holder. There are two types of debt
tokens: stable debt tokens that represent a debt with a stable interest rate and
variable debt tokens represent a debt with a variable interest rate.

Asset-backed tokens

Tokens built on the blockchain and considered real-world assets are called
asset-backed tokens. These assets can be anything from real estate to company
shares, commodities, or even diamonds. They give users ownership rights over
valuable tangible or intangible objects, and in digital form.

Utility tokens

A utility token helps companies, startups and project development groups raise
funds and capital to develop blockchain projects. These tokens can be used later
on to purchase goods or services from the cryptocurrency’s issuer.

What is a security token offering or STO?

In a security token offering, or STO, security tokens are sold in security token
exchanges. STOs are a type of public offering that facilitates the trading of
financial assets via tokenized digital securities. Token transactions are stored
and validated through a public ledger or blockchain.

STOs are considered to be a more secure alternative to initial coin offerings that
are susceptible to fraud. Since tokens are classified as securities, STOs are also
subject to rules and regulations, offering token holders safe and legitimate
investment opportunities.

For context, ICOs were all the rage in 2017, as they became a popular method
for fundraising crypto projects. ICOs allowed startups to raise capital while
providing investors with coins or tokens in return. However, ICOs were not
subject to regulations and were thus vulnerable to scams, fraudulent crowd
sales and airdrops.

How does an STO work?

Similar to ICOs, security tokens allow startups to raise capital for crypto projects
and new business ventures. The difficulties and limitations associated with
securing funding through traditional venture capitalists made other ways of
sourcing capital like STOs quickly popular. STOs are legal and regulated, making
them a safe way for companies to acquire much-needed funding.

Another function of security tokens is crypto-fractionalization, where existing

assets in the real world are secured via tokenization or securitization. Global real
estate assets are worth approximately $326.5 trillion in total while the world’s
total market capitalization is estimated at $91 trillion, and technically, these
assets can be tokenized.

Tokenization facilitates easier trading of securities, not to mention the lower cost
of administration. Paperwork will likewise be significantly reduced or eliminated
once securitization is adopted in equity markets.

Security tokens typically represent the following security assets:

• Real estate: Similar to real estate investment trusts (REITs), real estate
equity can also be converted into security tokens.
• Capital markets: Organizations can tokenize their shares, offering token
holders the benefit of voting rights, earning dividends, or both.
• Commodities: Commodities can likewise be split into tokens that can
later be offered during an STO.
• Equity Funds: Equity funds can also tokenize their shares, with token
holders entitled to a portion of the equity fund’s earned profits.

It’s important to note that security token offerings technically offer the same
securities available on traditional investment platforms. Tokenization does not in
any way change these underlying securities. Rather, STOs just provide a new way
of approaching investments.

Factors to consider before launching an STO

Here are some things to consider before launching an STO:

What is being tokenized?

As we’ve mentioned before, security tokens represent a variety of assets and

interests like physical assets, equity interest, or debt, among others. As such, the
type of asset being tokenized will not only require various legal attachments but
will also hold varying levels of appeal among investors. Hence, it’s important to
consider the type of interest before launching an STO.
The jurisdiction of the token

A token’s area of incorporation has a significant impact on its STO structure. As

such, the right jurisdiction has to be taken into consideration, depending on the
following:

• The physical asset’s location

• Security regulations and other laws specific to the area
• The classification of the interest being tokenized
• The founders’ countries of origin, for tax purposes
• Marketing strategy and efforts that will work in said location

A proper corporate structure and governance

This is a very important consideration before launching an STO. For example, if

the tokens resemble traditional equity securities, their issuance should also be
authorized in the issuer’s corporate documents.

Other limitations and rules might apply, as mandated by the law. The number of
token holders, for instance, might be subject to limitations. In the United States,
most tokenized securities are limited to 99 investors residing in the U.S.

AML, KYC

A majority of the countries today have Anti-Money Laundering (AML) Know Your
Customer (KYC) requirements. These apply to financial businesses including
issuers of security tokens. AML and KYC stand to ensure that the investment
money was acquired legally.

Tokenization platform

Various online tokenization platforms are available, like Securitize, Tokensoft

and Token IQ, among others. It’s important to consider which platform to use, as
each one has a different approach. You’ll also want to look into the partnering
price and support post-launch, as well as the percentage of commission on the
funds raised.

Some things to check before committing to a platform are its track record of
launching tokens successfully, whether or not it provides resources for KYC and
AML checks and how it handles secondary trading.

How to launch an STO

Phase 1: Preparation

Before launching an STO, you need to have a solid foolproof idea to engage
potential investors. During this step, it’s best to take legal advice to sort out
regulations and consult experts on how the token can gain value.

Generally, a token’s value is decided based on its role, purpose and feature. The
role that you define for your token will generate a corresponding purpose. In
turn, its features can be decided and tailored to fit business goals.

It’s important to sort these things out and fine-tune the details before you dive
into launching your STO.

Phase 2: Pre-STO

Remember that even before launching your STO, you should already have
introduced it to the market. This is where your marketing strategy will come into
play. You also have to maximize crypto community forums and websites that list
STOs and ICOs. Make sure to get the right information out there, such as:

• Your white paper

• Token structure
• Your team’s credentials
• Milestones

It would be best if you also choose a credible cryptocurrency exchange as your

partner. Choose one that practices high levels of due diligence, as this will
eliminate fraudsters from the mix and save you a lot of time and grief down the
line. Ensure that the exchange likewise allows investors to comply with KYC and
AML regulations in their country.
The collateral assets for security tokens must also have custodians. Typically,
third parties that have Special Purpose Vehicles or Trust Companies can do this.
Popular custodian organizations include Coinbase and Prime Trust, among
others.

After ironing out these details, you can now proceed to token creation and
marketing your STO. The token creation process will largely be dictated by the
platform you choose, so make sure you have already researched a platform
thoroughly.

Phase 3: Launching STO

The next phase in the security token offering process involves running a crowd
sale, the most crucial part of an STO project. This is where your company will
finally sell your tokens to the general public so that you can raise funds.

Now is the time to publish the selling portion of your website. Ensure that the
section and buttons for token sales are highlighted on your site and easily
accessible. From here, investors can register and go through KYC and AML
checks and purchase tokens. You can also enlist the help of STO launch services
in this step.

Ensure that your community support services are in place to offer timely
assistance to investors as well. Your support team should be available to help
investors and answer queries on crypto forums and social media platforms.
Promptly responding to inquiries is crucial, as it can spell the difference between
a fulfilled token sale and a missed one.

Have a hotline or ticket submission portal on your website so that clients can
submit their queries or reach out to you whenever they need help with an issue.

Phase 4: Post-STO

Once the crowd sale is completed, it’s time to build your product. Now is the
time to build an application on the blockchain. Ensure that your app is user-
friendly, robust and, most importantly, secure.

It’s crucial to ensure that the product you build will support your newly-launched
security token. During this stage, it’s important to hire developers with expertise
in blockchain app development and STO development.

While you are building your product, you should also keep your investors
updated. They will want to know that the business plan is being executed as
intended and meets their expectations and needs.
After you have built your product and launched it to the public, the last thing to
put in place is technical support to ensure that all issues raised by customers are
addressed promptly and properly. Tech support should be available 24/7 via
chat, social media, your website and other platforms that your customers use.

Advantages of STO
STOs are deemed more secure and carry lower risk compared to an ICO. This is
because laws are heavily enforced on STOs. Since security tokens are also
technically pegged to a real-world asset, it’s easier for a potential investor to
assess whether it is priced fairly or not, compared to current market value.

STOs are also more cost-effective than, say, initial public offerings, or IPOs.
Through the use of smart contracts, there’s no need for expensive legal counsel.
Meanwhile, the blockchain also eliminates traditional paperwork and
dependencies, reducing processing time drastically.

Furthermore, STOs open up the market to beginner investors who may not have
access to investment opportunities if not for crypto-fractionalization. Trading
can also be done 24/7, providing investors with both convenience and liquidity.

Disadvantages of STO
One of the advantages of STOs can also be considered one of its biggest
challenges: regulation. STO platforms are subjected to increased regulation that
makes processes more complicated on the administrative side. STO platforms
have to constantly keep up with changing regulations concerning AML, KYC,
exchange approvals, tracking ownership and the like to ensure compliance with
existing laws.

Regulations in certain areas might also limit who can invest in STOs (e.g., as
residents only or citizens only), thereby reducing the pool of investors and
lowering investment opportunities for investors.