ICOs vs. STOs: How to Know Which One Is Right for Your Business
Security token offerings help you to avoid the potential fraud of an ICO, and let you utilize a crowdfunding platform to raise cryptocurrency.
There’s nothing worse than running out of capital when you’re trying to get your business off the ground. If you're an entrepreneur who's tapped all your relatives for money, and your bank account is bone dry, what options are left for you?
One alternative financing route is an initial coin offering (ICO), where digital currency is raised as an alternative to the U.S. dollar. Many entrepreneurs who wish to forego the traditional venture-capital financing route are launching ICOs.
But ICOs have a catch: This nascent crypto-market leaves participants open to questions about marketing speculation and their currencies' very legality. The result is that because of the lack of regulation iand the view in some quarters that utility tokens are actually securities, (unregulated) ICOs are sometimes viewed with suspicion.
At the same time, cryptocurrency financing is a trend that’s not going away anytime soon. Seeing a company pull in millions overnight can certainly leave an observer feeling at least a twinge of envy at this market's seeming ease to capital access.
Yet, this capital is beset with problems: In 2018, and now, as we approach 2019, it’s getting harder to attract investors to ICOs, due to the burnout investors are facing from 2017. Specifically, in July 2018, Satis Group Crypto Research reported that about 81 percent of ICOs in 2017 had been discovered to be scams.
A new crytocurrency mechanism to consider
At a time when thousands of ICOs are competing for the investor’s wallet, when investors are skeptical of that option and, worse, when some ICO projects have even disappeared, taking those investors' money with them, a new type of crypto-funding mechanism has appeared: the security token offering, or STO, which lowers the barrier to entry for the average small business.
An STO is a hybrid offering which operates like a security but comes in the form of a digital token. As Anthony Pompliano, a cryptocurrency evangelist and partner, wrote on Medium,"Security tokens are digital assets subject to federal security regulations."
An STO reduces investor risk because, unlike an ICO, STOs are the token-sale event for a security token, which is tied to the asset (like profits or shares) that investors are buying. Tokenized securities are digitized financial securities just as equity securities are, except that they're on the blockchain. Both ICOs and STOs produce a cryptocurrency, but STOs produce security asset-backed tokens while utility tokens, in my opinion, are the equivalent of Monopoly money.
Utility tokens, moreover, are tokens which are not investment vehicles and therefore may claim that they are exempt from federal securities laws. Whatever they are, utility tokens also happen to predominate among ICOs. But utility token holders can’t use those tokens outside of their respective specific platforms without first exchanging them.
Laimonas Noreika, founder and CEO of Paris-based Desico, a recently launched platform for STOs, told me that, “ICOs are offering utility token[s] just so [the companies] have an excuse to collect investment.
"Evading SEC regulations is illegal," Noreika pointed out. With no one holding [these companies] accountable, a few [ICOs] have acted irresponsibly with the investors' money.”
Simply put, an STO works better than an ICO for any company that wants to raise money but doesn't have its own utility token. These companies don't need a utility token because the value of their security is based on the company's own security and represented as a tradable financial digital asset, rather than being based on the usage of utility tokens within the company's social network.
If you’re a small business looking for investment, you may be asking: What are the advantages of holding an STO rather than an ICO? Here are several:
Lower barrier to entry
In my last article, I wrote about STOs as a financial pathway to lower entrepreneurs' barriers to access of capital. Traditionally, those entrepreneurs have needed connections and venture know-how to navigate the Silicon Valley venture capital path. After all, they're looking at a path to capital that's concentrated in a limited geographic location. They're going to need connections in that region, a solid track record and experience in pitching.
STOs avoid these issues by giving entrepreneurs access to retail investors in the United States and abroad. The way crowdfunding works with STOs is different from how crowdfunding works with fiat currency: Kickstarter and Indiegogo allow projects to sell their intended products ahead of the actual creation of those products, on a first-come, first-serve basis. The first customers to buy will be the first with access to these products.
However, crowdfunding with cryptocurrency STOs is different because investors are buying digital securities instead of that first access to the product. Just as anyone can buy the securities of publicly traded companies, digital securities offer the opportunity for retail and accredited investors to buy the securities of privately held companies, in advance of those companies' IPOs.
Just as the United States has passed legislation allowing for the creation of companies like AngelList, Kickstarter and Indiegogo in the United States, new laws are being passed (in Europe and the United States) to allow for token crowdfunding platforms to exist.
So, think back to Noreika's company, Desico. It may have "ICO" in its name, but the company is actually the antithesis of an ICO, because it's an STO-empowered platform that solves the problems ICOs face. Think: a Kickstarter-type platform for tokenized securities.
Entrepreneurs using the STO route can utilize crowdfunding platforms for cryptocurrency and not face the barriers they would with an ICO.
Greater investment potential
STOs, then, use the component of crowdfunding to bring additional capital into the traditional financing options open to most entrepreneurs. If you're one of those entrepreneurs and already raising money, you can use crowdfunding through an STO to raise even more.
You may also find it advantageous to use a platform that manages the regulation standards of "know your customer" (KYC) or anti-money laundering (AML). KYC is part of the AML governance framework that includes client risk assessments, transaction monitoring, screening and due diligence.
Governments impose these processes on startup investing in order to detect financial crimes and prevent terrorism. Entrepreneurs need to know their customer to establish and verify facts and behaviors, as well as prevent money laundering.
Entrepreneurs going this route must comply with current laws, of course: Any startup raising money must ensure that its U.S. investors are accredited. But the STO crowdfunding process allows U.S. companies to add additional investment from non-U.S. retail investors to their security offerings.
Easier to manage and scale
Utilizing platforms for STOs is one way to manage and scale the very cumbersome and complicated process. Think about how difficult and expensive (in terms of legal assistance) crowdfunding would have been before the debut of Kickstarter, Indiegogo and AngelList.
Now, think about the unregulated gray area that cryptocurrency inhabits. Do you trust yourself to manage that process and assume the liability? I didn’t think so.
In contrast, using a platform like Desico in Europe, or Republic -- an equivalent company in the United States -- is an easier solution than trying to manage crowdfunding on your own, especially when it comes to cryptocurrency. You want to be proactive, not reactive, in your funding-management plans.
More transparency and credibility
The ICO market is driven by rampant speculation and looks more like a way to bet on a Las Vegas casino table than an opportunity for intelligent startup investment. Despite the number of blockchain and cryptocurrency projects announcing ICOs, no projects have accomplished much -- and, as mentioned, many have operated as a scam or ended in failure.
Still, investors want to get in on this new emerging market because the confidence people have in Bitcoin and other leading currencies has yielded some of them great returns on investment.
That explains the huge demand for a legitimate pathway to bring transparency and credibility to the cryptocurrency sector. A transparent ecosystem is the only solution that might bring some resolve to the aftermath of last year's ICO fraud, when hype outbid reality and many people lost money.
Sure, an ICO may seem like a quick fix to financing. But the risk involved may not be worth the money when the SEC orders you to return all that cash to your investors.
Entrepreneur Leadership Network Contributor