Cryptocurrencies have taken us on a wild ride over the past few years, and the ride is far from over. As the technology (and its social acceptance) continually changes and grows, we’ll start to see newer and more exciting uses for blockchains, distributed ledger technology (DLT), and decentralized fundraising efforts. The reason behind most of the currently traded altcoins was to supplement and perhaps even replace Bitcoin as the primary cryptocurrency. By the same token, ICOs may have run their course and will begin to be replaced in the very near future. Their successor? Security token offerings, aka, STOs.
2018 – The Year of Regulations
ICOs began in 2013, but it wasn’t until 2017 that they really began picking up steam. When comparing the total ICO funding raised from 2016 to 2017, according to Coinschedule’s data, we can see an increase of about 6,700%. When comparing this to the much smaller increase we saw between 2017 and 2018 (331%) you’re left with one specific question: what the heck happened?
In short – regulations.
With the great ICO boom of 2017 came an explosion of problems as well: tax evasion, investor scams, pump-and-dump schemes, money laundering, and more. Governments around the world quickly realized that they needed to step in and help regulate this “Wild West” investment culture. As a result, different governments approached the situation with varying degrees of severity:
- China banned all ICOs
- The US issued a large number of warnings and subpoenas to unregulated ICOs operating
- The European Union moved to increase regulations by declaring ICOs dangerous and extremely risky
- Japan followed suit by warning investors of impending regulations
- Many other world-leading governments followed the example made by the US and increased regulations around ICOs
All of this, in a nutshell, was the government declaring, “We don’t know how to treat this new type of investment so we want to classify it under existing laws.” Given that, ICO’s aren’t quite an IPO, but more like a regular crowdfunding campaign, so the governmental approach to regulations made sense at the time. In the long term, though, the companies behind them suffered much more than they benefit.
There are three key reasons as to why ICOs suffered a crackdown by regulatory bodies:
- Companies that had no legitimate reason to hold an ICO were using the hype in order to secure funding without ever intending to follow through on their blockchain/decentralized promises. Companies hosting an ICO needed to have a reason to tokenize their business, often just making up a reason instead of actually needing decentralization.
- Retail and industrial investors who invest their money in ICOs have little to no rights, and instead are relying on the good nature of the companies to follow through on their promises. ICOs provide no security against hacks or stolen account information, and because many ICOs didn’t have a real reason to tokenize in the first place, they became targets for pump-and-dump schemes.
- The majority of ICOs out there are, unfortunately, scams. During the height of ICO hype, all a company needed was a hastily written white paper and a website to raise funds, often relying on bounty programs and big promises (instead of quality products and sound ideas) to attract investors.
Not all countries cracked down on ICOs, though, as some countries like Malta, Gibraltar, and others realized that this type of crowdfunding is here to stay. They wanted to get involved, so they opened their borders to such companies. Even the US was technically ICO friendly, but they just had stricter regulations that made it inherently more friendly for STOs than ICOs. No matter what type of regulations (or lack thereof) were being implemented around the world, one thing was becoming clear – ICOs needed to change. The days of ICOs offering utility and payment tokens is quickly coming to an end, a process that is being expedited by the SEC launching a wide ICO crackdown and forcing companies to refund investors in specific cases: something that wouldn’t have happened if the companies had went the STO route instead of launching an ICO to begin with.
Security Token Offerings to the Rescue?
When you read into the detailed legal descriptions of why governments want to control ICOs, most often it can be boiled down to one thing: ICOs that aren’t securities are dangerous and untrustworthy. This global sentiment is laying the groundwork for a shift in crowdfunding from ICOs to STOs, and although there is a bit more legal work and regulations to follow, STOs make a much stronger case for decentralized crowdfunding than ICOs ever could. Security tokens are one of ICO Launch Malta’s specialties, and their CEO, Jan Sammut, recently explained in an interview that “as institutional clients pile on more and more pressure on asset managers to offer exposure to this emerging asset class, we will see an obvious increase in securitized offerings.”
Mr. Sammut went on to emphasize that “the main advantage is that this will in effect behave like a register of shareholders, with the entity having full KYC and AML visibility on every last holder … From a client perspective, we can now offer them a cryptographic equivalent to any of Wall Street’s instruments on a fully compliant platform which is terribly exciting.”
STO vs. VC/Angel Funding
According to a Medium post by Evercity, there are three things STOs can offer that make a stronger case than VC funding:
- Higher investor liquidity – Traditional VC funding locks up funds for five or more years, while STOs can have a turnaround time of as little as a few months if the investor chooses to sell.
- Lower barriers of entry – Many investors don’t have $50,000 to throw at a project or they would rather diversify their portfolio with 50 projects at $1,000 than lumping it all into one. STOs can set their minimum investment as low as they desire, so long as the investors are accredited and rely on a larger number of smaller investments instead of only a few large ones.
- Maintaining control of a startup/company – STOs offer legal protections for investors without the company having to give up board seats or control of their company. By diversifying their investors in a decentralized environment, STOs can decide what rights they tokenize and sell, instead of being forced into an undesirable situation by a primary VC donor.
During an interview with CNN, technology lawyer Diana Stetiu explained, “Anything that is considered today by applicable laws as a security (e.g. shares, bonds, debentures, notes, options, warrants) can be tokenized, therefore, the potential of security token offerings (STOs) is huge.
From now on, we will be definitely hearing a lot more about the STOs because they have the potential to become the market standard form of funding for both startups and well-established companies that want to tokenize their securities offering instead of listing them on a stock exchange.”
STOs in Action
Even Nasdaq is onboard with STOs, claiming that they are set to take center stage by 2019 in the fundraising world, although only a small percentage of ICOs are STOs at the moment – those are the companies that are ahead of the curve. Some of these companies are launching in the U.S. in order to comply with SEC regulations, but so long as the company follows local laws (i.e. SEC’s in the US) they can be based anywhere in the world.
Elio Motors, a low-cost commuter car company, is the perfect example of a successful STO. They are based in the US, only open to US investors, and they raised over $70 million through their STO. In addition to this, they raised another $21 million in reserve funding, and they already have over $300 million in pre-orders. Elio is 100% compliant with SEC regulations and was able to raise their capital without giving up control of the company to VCs since they had over 6,000 different investors.
Another high-profile STO currently running is the BR11 token, the first STO to be held in Brazil. BR11 is a company that will work with “11 pre-selected high growth startups that are among the best performers in Brazil’s under-valued entrepreneurial ecosystem.” BR11 has Alex Michaelis, the CEO of Coinschedule, as their primary investor and the company is expected to do very well in regard to funding.
Running an STO (Where and How?)
As mentioned earlier, places like Malta, and even the United States, are all solid choices when choosing a jurisdiction in which to launch your STO. These jurisdictions each have their own set of pros and cons, of course, so it is important to do your due diligence.
When it came to ICOs it was possible for a company to do everything themselves, from marketing to legal documents, community management, and more. But with the increased complexity that STOs present, it is highly recommended to use a turnkey solution to ensure that every box is ticked and every form is filed. For launching in the United States, contacting a law firm/turnkey solution like Dilendorf & Khurdayan, Templum, Securrency (or the equivalent) is a great place to start. Malta has a similar situation, but the market is a bit smaller there with one company pulling out ahead of all the others with good reason.
ICO Launch Malta won the 2018 Maltese Blockchain Startup Awards, an award given out during the Maltese Blockchain Summit by a panel of 30+ crypto-centric judges. The key reason ICO Launch Malta beats out the competition is because their turnkey service (taking clients from the conceptual stage to hitting their hard cap with marketing, tokenization, platform, and legal services) is completely integrated with Maltese laws and regulations. They stay up to date by maintaining relationships with local Maltese banks and lawyers who are knowledgeable on changing regulations.
There are many “full package” solutions that span many jurisdictions, and although they may be as adequate, it is almost always recommended to seek a solution that focuses entirely on one jurisdiction that can ensure the best service and outcome.
Thanks to the Howtotoken Agency experts for the information and comments provided for this topic.