Investor 101: Complications faced in Security Token Offerings

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Complications in Security Token Offerings

What is a Security Token?

A token represents an asset or a tool that a company has and it usually gives it to its investors during a public sale called the ICO (Initial Coin Offering).

A security token is defined as “any block-based representation of value that is subject to regulation under the safety laws.” In other words, they represent ownership in a real asset, whether it is equity, debt, or even real estate. 

Security Token Offering

The offer of security tokens is a process of selling security tokens for cryptocurrencies such as BTC or ETH or fiat money, implemented in accordance with the securities Ordinance. 

In general, if a project sells its tool chips before the product is released or developed, these Utility tokens will likely be treated as securities.

Features of security tokens

Like utility-tokens, security tokens have a set of features that make them different from other types of tokens: 

  • A security token retrieves its value from an external, tradable asset that is actually a guarantee while Utility tokens provide access to all products or services, the security token gives its holders certain rights in the issuing company and focus primarily on financial benefits
  • Security tokens are usually backed by certain values: company assets, revenue, revenue, etc.

Purpose of Security tokens and why they matter

Security tokens serve for purposes outside the specific use as a swap within the platform or in addition to using them within the platform. 

These other purposes may include the token representing the owner’s actions of the project itself, a profit/loss sharing tool, which gives the holder the status of creditor/lender, giving the holder a bankruptcy application as a capital shareholders/creditors, or give the holder the right to return the purchase price and/or interest payments. 

Some of these include the SiaFund token for the SiaCoin project, the tZero token for the tZero Security Exchange platform and the KODAKCoin token for the KODAKOne platform.

Complications in Security Token offerings

  • The security token comes with many rules and restrictions on who can invest in them and how they can be exchanged. Therefore, they cannot be traded freely.

  • Since they cannot be traded freely and are subject to many secondary trade restrictions, liquidity may be significantly affected.

  • Many of the organizations that undergo an ICO have desperately tried to prevent their chips from being classified as security tokens. This is primarily because this nomination comes with  many regulations and restriction on who can invest in these tokens and how they can be exchanged.

  • Secondary trade and liquidity are greatly reduced for this type of token. This can limit or even negate the potential of the network and the use of these tokens to build a widely adopted platform or protocol.

  • The SEC has been quite clear that many of these ICOs are offers of unregistered securities. This can be a huge concern for investors in ICOs; and these reservations have contributed largely to the ICO apocalypse that has been witnessed in August 2018.

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Underlying Ambiguities

The security token is a natural bridge between the traditional financial sector and the crypto-currency industry. They have elements of values: stakes, the right to receive dividends and voting rights. Security Token Offer (STO) is a security token sale; a concept very close to ICO in essence. However, it has its own characteristics: 

  • Undergoing a traditional registration procedure for IPO is necessary. 
  • STO provides a security certificate holder with the same rights as a shareholder; 
  • The symbols in STO follow the legislative provisions and therefore guarantee the greatest protection for Investors. 
  • STO requires compliance with the KYC and AML (Anti-money Laundering) procedures; 
  • The eligibility buyers within STO may be limited in accordance with the law of a particular country, if the buyer is not entitled to purchase an investment asset by law, it will not be sold. 

All STO plans should, therefore, pay particular attention to the details below.

  • The development of a legal framework fully in accordance with the jurisdiction of the business residence and the place where the mere campaign is planned; 
  • Work with funds. Invest in traditional tools such as mutual funds, private investment and others- the participation of professional risk funds and private investors is largely a key to the STO’s success; 
  • Marketing and establishment of a community around the project (especially if it is a start-up, not an ongoing activity).

Risk Associated With Security Tokens

Although security tokens are typically the most attractive option for potential investors, an offering involves significant legal risks. 

Regardless of your country of incorporation, projects that sell security tokens to citizens or residents of the United States must comply with applicable securities laws. 

If the issuing company does not meet all these requirements, the ICO procedures may be legally confiscated and the founders can handle serious fines or even a prison sentence.

References:

  1. https://medium.com/setocean/security-tokens-what-they-are-why-they-matter-1e8d6b81d45
  2. https://techcrunch.com/2018/08/28/security-tokens-will-be-coming-soon-to-an-exchange-near-you/
  3. https://blockgeeks.com/guides/security-tokens/
  4. https://medium.com/waves-lab/sequrity-token-offering-next-step-in-crypto-7b35c3344e5
  5. https://hackernoon.com/how-to-value-a-security-token-part-i-factors-to-consider-5a5a79b3e5d9

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