Initial Coin Offering, or ICO, is a form of fundraising in which blockchain startups sell a certain number of tokens to investors before launching the platform. Over the past two years, $30 billion of investments have been raised in this way to develop various projects.
Most of ICO offered investors to buy so-called utility tokens – digital assets with which you can access the product or service of the blockchain platform. The peculiarity of such tokens is that their purchase is not an investment directly in the issuing company.
Utility tokens can bring investment benefits, but by their nature they are just “tokens” that open up access to the functionality of the blockchain, which, as a rule, at the launch of ICO, does not even exist. They are only useful:
– if the holder of tokens intends to use the blockchain of the project;
– if after entering cryptocurrency exchanges, this token can be resold with a profit.
In all other cases, the purchase of utility tokens is money to the wind. As the statistics show, investors throw out money in 85% of cases, since 15% of startups do not even reach the sale of tokens on exchanges, projects with a positive ROI are even less – 7%. The reason for the low success rates of ICO is that the release of utility tokens is not regulated at all and there are no assets behind them that would give them real value.
At least it was until 2017, that is, until the SEC decision on the DAO case and the first launch of Security Token Offerings (STO), which occurred in March 2018. STO offers investors to purchase security token – “digital” shares with real value:
– right to an asset: oil, gold, currency, etc.
– the right to dividend income;
– share of the issuing company;
– voting right;
In other words, security tokens are “digital” securities that have the same value as “stocks” or “bonds” in stock markets and are subject to the same legal rules. In the United States, they are The Securities Act of 1933 and the laws of the blue sky.
Thus, the main difference between ICO and STO is that in the first case, investors receive an asset that is not secured, and in the second, a valuable security, behind which there is real value. However, these are not all differences. Full list below.
Requirements for initiators
ICO. The legal status, requirements for issuers and the procedure for conducting the primary issue of coins are not currently defined in any country in the world, so anyone can de facto initiate an ICO as desired. However, as practice shows, the crowdsales will be successful, that:
1. Created a site that presents all the important information about the project.
2. Made a public offer, white paper and other documentation.
3. Have registered a legal entity.
4. Created an escrow account.
If this is not done, the project will not interest investors and, as a result, will not collect the necessary amount of money. But there are exceptions, for example, fraudsters can imitate all these points in order to lure money and escape. It is quite easy to do this – the SEC specially created a website with a fake ICO to show, by its example, the riskiness of investing in projects where there are not even formal requirements for issuers.
STO. According to a SEC report dated July 25, 2017, the security token must be issued in accordance with US laws and regulations that regulate the issuance and distribution of securities. In order to conduct an STO under these rules, a company must comply with at least three items from the following list:
– interest in this method of financing, which is combined with the company’s current client base;
– during the issue a token will be issued that can be transferred to third parties;
– annual income – from 10 million US dollars;
– global business management;
– high growth.
These are general requirements that the SEC may change in the course of market research and individual cases. In other countries, there are no clear rules for conducting STOs and requirements for companies that collect funds in this way. But this will change soon, like the EU countries, Japan and China are studying this issue and will soon give a legal assessment of the security token offering.
ICO. This crowdsale method is governed by general legislation unless it is a question of security tokens. In other words, there are no special standards, rules, requirements and legislative acts that would clearly define what can and cannot be done during the initial placement of coins.
This does not mean the absence of any rules. If during of the marketing ICO the general legislation is violated, for example, the organizers of the crowdsale illegally obtained personal data or stole investors’ money – the reaction of law enforcement agencies will be unequivocal.
The absence of specialized legislation means only that it will be difficult to prove the fact of theft or data theft. And only until the first decision of the court is made – case law “creates” laws in this way.
STO. At the federal level, the security token offering is regulated by the Securities Act of 1933, according to which blockchain business are required to provide financial and “other relevant information” about the company, crowdsale and tokens. The law also prohibits fraud and manipulation in the process of issuing and selling security tokens. At the state level, STO is governed by Blue sky laws.
When registering STO with the SEC, companies must write a corresponding application form S-1 and submit documents to the EDGAR database. At the same time, the company is obliged to undergo an independent audit so that investors can assess its financial condition. Documents submitted must provide any “material” information for investors, including a description:
– business and real estate companies;
– management structures and information about significant team members;
– token: security, risks, functions, technical issues, etc.
The issuing company is also obliged to publish the STO prospectus – this is an analog of white paper of ICO, only much more detailed. The information presented in it is not just a “note” – it is a kind of commitment to the targeted use of funds to investors.
Registration with the SEC makes the company public since all the information that falls into EDGAR and the results of the audit are made publicly available. Thanks to this, the investor can personally verify the issuer security tokens, which reduces the risks of fraud and the likelihood of unsuccessful investments.
All STOs must register with the SEC, however, as far as publicity is concerned, everything is not so simple. Section 4 (a) (2) of the Securities Act of 1933 contains a number of exceptions due to which the company is released. The exclusion rules are very blurred, so the SEC clarified to them:
– Regulation D, Rule 506(b). Up to 35 “difficult” and unlimited number of accredited investors can invest in tokens. The information disclosed by the issuer must be “generally the same” as with the usual full registration (in the prev article you can read the registration and jurisdiction of IСO). However, the company may not advertise or promote STO among a wide audience, which makes the crowdsale process “private” rather than “public” placement of coins.
– Regulation D, Rule 506(c). The same conditions as in rule 506 (b), but you can advertise your STO among a wide range of audiences. Only accredited investors are allowed to participate.
– Regulation D, Rule 504. A company may not register with the SEC (but you need to submit an application on Form D) if you plan to raise up to $5 million and the tokens will be “frozen” within 12 months.
– Regulation A. Under the JOBS Act of 2012, the SEC divided this provision into two investment levels: level 1 — you can attract up to $20 million in investments, level 2 – up to $50 million.
– Startups must comply with the investment memorandum and follow the rules on disclosure. Both accredited investors and regular users can participate in the crowdsale. The number of the latter can be reduced by the decision of the SEC.
– Position crowdfunding (CF). Applicable if tokens give ownership of a company’s share. The maximum investment amount is limited to 1,070,000 dollars. Purchase of tokens should be carried out through an intermediary registered on the SEC website, broker-dealer or funding portal.
ICO. The main platforms for the initial issue of coins are Ethereum, Waves, Stellar, NEO, custom platforms and Bitcoin forks. Hyperledger technology is popular among large enterprises and industries.
The popularity of ethereum is explained by the fact that it is the first truly convenient platform for launching ICO, which is constantly evolving and acquiring new technologies.
STO. There are no leaders among the launch sites for the security token offerings since the first ones appeared in early 2018 (some have not yet passed the crowdsale stage). Blockchain startups just did not have time to test them and decide which one is best for STO.
Among the platforms for STO can be identified:
– Harbor. An open source platform that uses Ethereum ERC-20 standard tokens to launch STO. Harbor provides token emission compatible with Reg D and all KYC / AML rules.
– Polymath. The project is at the stage of crowdsale, which is tipped leadership in the market, because it attracted more than 50 thousand investors and received bids for STO from 20 thousand companies.
– CSE. Canadian Stock Exchange to launch STO, which will close the transaction almost instantly, instead of the usual two of it.
– tZERO. Overstock e-commerce store subsidiary that raised $ 100 million in its own STO. Hardcap was at the level of 250 million dollars. The site uses ERC-20 standard tokens and plans to pay dividends to all tZERO token holders.
The designated platforms were registered, having received the go-ahead from all the necessary authorities, so we can assume that the SEC approved their activities – plans to launch STO on an industrial scale.
The target audience
ICO. The target audience of ICO-projects, as a rule, depends on the crowdsale stage:
1. Private Sale — accredited investors and business angels. There are significant barriers in the form of a minimum investment size – from 20 to 1000 thousand dollars.
2. Pre-ICO, or Pre-Sale are usually the calculation goes to large investors. To become a member, you need to sign up for a whitelist before starting a crowdsale. There are restrictions on the size of the minimum investment, but less than during Private Sale.
3. Main Sale is designed for all comers. If the organizers are confident in the success of the project, the list of participants is limited to those who have signed up for whitelist.
STO. Target audience security token offerings – accredited investors – private individuals who meet one of the following criteria:
– personal income – from 200 thousand dollars a year, family – from 300 thousand in the last two years;
– the size of net assets – from 1 million dollars;
– hold the position of general, executive or just a director in the issuing company.
Legal entities can be accredited investor if all their shareholders meet the requirements of an accredited investor or their assets exceed $5 million.
ICO. According to research by Satis Group LL, 80% of all ICO projects are scam. Therefore, this type of investment can be considered high-risk: the initiators of the ICO do not owe anything to their investors, they can simply raise money and disappear and given the high anonymity of such projects, it is unlikely that they will be able to find intruders.
In addition, even even-numbered startups often undergo hacker attacks, such as hacking DAO, which led to the hartforky ethereum and the first significant intervention by the SEC in this market.
STO. All startups that have passed the SEC registration procedure are guaranteed to meet the minimum requirements that provide the prerequisites for the success of the project and for the benefit of investors. What you can personally verify by checking the public information about the company and STO in the public EDGAR database.
In addition, security token gives you real rights to:
– equity participation in a commercial enterprise or fund;
– ownership of real assets: oil, real estate, cocoa, gold;
– ownership of debt obligations;
– making a profit from owning a physical asset, an enterprise, or owning a debt obligation.
Future of ICOs and STO
Contrary to common misconception, there is no direct confrontation between ICO and STO in the market. New blockchain startups are already considering options for crowds with a double token structure: “security-utility token”. With such a structure:
– utility token will be used for you blockade and DApps modems;
– security token will be used to attract investment and trading.
Thanks to this, the initiators of ICO/STO, investors and speculators will be able to use the security token as an investment tool, waiting for the growth or volatility of the course. On the other hand, platform users will get a utility token with a stable price, which can be used daily without the risk of abandoning the blockchain’s functionality due to the rise in the cost of the token.