05 Jan STO explained [Part 1] Is it a next-gen ICO hype or real innovation?
Cryptocurrency market has skyrocketed since Initial Coin Offering (ICO) was successfully introduced in 2013. The amount of total cryptocurrency market cap exceeded US$129 billion at the time of writing contributed by Bitcoin (Ticker: BTC) at 51%.
Definition of ICO and STO
As the cryptocurrency industry shifts rapidly, the terminology has been newly created and disappeared (as people do not use any longer) almost like at the light speed. There are various terminologies related to the cryptocurrency funding models introduced lately such as Initial Exchange Offering (IEO), Equity Token Offering (ETO), Payment Token Offering (PTO). It is essential to understand the fundamental terminology though. Therefore I will focus on ICO and STO in this article.
ICOs are mostly referred to the type of funding using ‘Utility Tokens’ as a cryptocurrency method. When you say ICO in Asia, it usually refers to the utility token offering. In Europe, people mention ICO mostly for the public crowd sale phase and occasionally consider the private and pre-sale phases of the utility token sale as an ICO. It’s slightly different in Switzerland. Financial Market Supervisory Authority (FINMA) released a guide describing the three types of ICOs; Payment ICOs, Utility ICOs and Asset ICOs. In the FINMA’s guide, ICO was seen as an umbrella term including all types of token sales. In this article, ICOs will be referred to as a utility token offering like in Asia.
Utility Tokens have a utility feature, and it should pass Howey Test according to the US securities law.
ICOs are mostly referred to the type of funding using ‘Utility Tokens’ as a cryptocurrency method.
STOs are mostly referred to the type of funding using ‘Security Tokens’ as a cryptocurrency method. In Asia, people generally consider ICO and STO separately; ICO as a utility token offering and STO as a security token offering. The Asset ICO in the FINMA’s guide would be one of the STO types in this case. The new rising term ETO is also part of the STOs here. In this article, STOs will be referred to as a security token offering.
STOs are mostly referred to the type of funding using ‘Security Tokens’ as a cryptocurrency method.
The Current State of ICOs
ICOs significantly contributed to growing the cryptocurrency investment and trading volume, as well as the number of new cryptocurrencies appeared in the market. The Ethereum’s smart contract feature enabled hundreds of startups to apply the new alternative funding methodology currently known as ICO. Some of them converted their existing business model to the tokenised business model, while others started a brand new blockchain startup.
As a result, we’ve seen a total of 28 billion dollars raised via ICOs as of Aug 2018 according to Elementus. Take a moment to watch the history of token sale in this video.
The number of ICOs has doubled from 2017 to 2018 despite the significant market crash in the latter year. The total amount raised by ICOs was higher in 2018 compared to the previous year. However, the increase rate was only 1.6 times in 2018. So the question is, will this ICO trend continue in 2019?
Let’s explore a little more about the history of ICO.
What contributed to shaping the current ICO model?
Initial Coin Offering (ICO) began with an idea that Bitcoin could be utilised as a fundraising tool. The design was based on the crowdfunding exercises that was new and kind of famous in the startup environment at that time. MasterCoin (now called Omni Foundation), founded by J.R.Willett, initiated a hybrid offering of crowdfunding and Initial Public Offering (IPO) as a new fundraising methodology. We could say it’s an inaugural ICO, which J.R.Willett named it as Initial Distribution in 2013.
While several companies picked up the idea to raise funds for their businesses in 2014, Ethereum received a spotlight by successfully completing the ICO with 3,700 BTC raised within 12 hours after its offering announcement. Ethereum’s business model uniquely offered a secure, immutable and automated contract settlement process mechanism, currently named Smart Contract, invented by Vitalik Buterin. It has become the most popular cryptocurrency issuance platform for startups running an ICO to date.
Ethereum’s business model uniquely offered a secure, immutable and automated contract settlement process mechanism, currently named Smart Contract, invented by Vitalik Buterin.
The positive hype around democratisation also contributed to the ICO’s wide acceptance in the market. Many people know that the traditional startup investment has been monopolised by the Venture Capitalists (VCs) and angel investors in the past decade, hence the startup ideas belonged to not only the key trend but also VC’s preferences received a significant amount of funding. As ICO was introduced, it has become easier for the general public to participate in the startup investment that had no or little access to the opportunity previously. What’s more, the decentralisation movement successfully appealed to the early adopters of cryptocurrencies known as Crypto Whales, who believe that the blockchain and cryptocurrency will change the world.
“ICO is dead.” Is it true?
ICO rolled out successfully in 2017 with the anticipation that the blockchain and cryptocurrency will become a new frontier in economy and technology revolution. On the flip side, however, the crazy growth of ICO size was primarily driven by speculation. The over-hyped ICO market suffered from scammers, and its bubble burst in 2018 finally. Many people realised and got disappointed by a little or no use of utility tokens. And the cryptocurrency market experienced a dramatic correction throughout the year.
People argue that ICO sits in a grey area hence no regulation could be applied. This is not entirely true as many blockchain startups issuing a cryptocurrency had to allocate a reasonably significant amount of budget for the legal counsel. No matter what, it is inevitable not to avoid regulation. With the increased concerns revolving around regulation in cryptocurrency, people lost confidence in ICOs even further in 2018.
With the increased concerns revolving around regulation in cryptocurrency, people lost confidence in ICOs even further in 2018.
So, many people say that ICO is dead and STO is an up and coming trend. All of a sudden, people started to talk a lot about security tokens in late 2018. Why?
IPO, ICO and STO: Pros and Cons
Understanding the IPO process is an excellent start to learn about ICO and STO. I compared the operation processes of IPO and ICO as the STO operation process does not show a significant difference from them. Note that this table illustrates the generic information and the details may vary depending on the organisations and their funding objectives.
ICO was known as a new method of IPO. Therefore, there are many operational similarities in regards to phases, activities and types of participants.
ICO was known as a new method of IPO.
Key differences between the IPO and ICO are:
- ICO utilises a utility token that is a cryptographically secure and immutable digital ledger.
- Utility token’s smart contract feature enables the creative ways to digitise various work processes including settlement.
- Utility token can be circulated within the company’s platform or burnt to maintain a balance.
- Utility token does not contain any ownership of the company nor the company’s revenue; hence there is no liability.
The STO operation process is similar to the ICO’s. The significant advantages of the STO compared to the ICO are:
- STO utilises the security token that is fully complied to the securities law.
- Security tokens have a broad range of usage in its token economy model.
- Security tokens are backed by existing value at the time of issuance, i.e. asset, equity.
Security tokens are backed by existing value at the time of issuance
The negative aspect of the STO is that compliance takes time. However, when you consider the amount of time that the utility tokens can become fully functional at a blockchain startup, it may require counting more months or years for a utility token issuer than the compliance processing time for the security token issuer. Some companies run an ICO with the fully operational platform, yet there are other bottlenecks before enabling the utility token to be fully functional such as user acquisition or blockchain integration to their existing platform.
We’ve seen the market evolves quickly in the past few years. I believe that we are still in the middle of the groundwork phase in the new economy and technology transformation. The fundamental knowledge based on the learnings and experiences will be crucial sooner or later. ICO and STO concepts will evolve as well as this new transformation.
we are still in the middle of the groundwork phase in the new economy and technology transformation.
Thanks for reading the STO explained series part 1. Hope it was helpful! I will write an article about the STO ecosystem deep dive in part 2.
Do you think the STO is a new hype or real innovation?