STO vs ICO: Differences in raising capital
Raising capital by trading funds for part ownership is a practice that has existed for centuries. In the past decade though, there have been adaptations to the traditional Initial Public Offering (IPO) method. More simple ways have been developed to avoid red tape, and with promising future growth for cryptocurrency, the IPO is becoming almost obsolete.
Initial Coin Offerings (ICO) was brought into life by cryptocurrency as a form of crowdfunding, and a way to avoid the lengthy and difficult process of raising capital through financial intermediaries or investment angels. Early backers and buyers of token sales therefore become the basis of asset ventures at the fundamental development stage. This process resembles an IPO, because the digital tokens can be liquidated – but importantly, this does not give token owners any form of ownership in the company.
Over $4billion has been raised so far through ICOs. Its first occurrence was in 2013 by Mastercoin – but made popular a year later when Ethereum raised over $2 million in under a day.
A startup company may plan to launch a new app for their digital users, for example like the SmartO project. A way to raise the funds for this project could be through an ICO – an incentive for outside investors to own new some digital tokens specific to the ICO with great potential, through either trading their existing tokens or through fiat currency.
ICOs to an extent actually design the tokens to represent a portion of ownership in the company. It isn’t in a literal sense, but instead it is somewhat a purchasing a part of the technology projects ecosystem. The lack of regulation does leave investors open to scams, however.
As we can see, the growing perception that companies think of ICOs as “free money” with little accountability has caused a drop in the amounts funded over 2018.
Security Token Offerings are a big answer to the concerns of rife ICO scams – they are also contributing to the decline in ICOs (graph above). STOs are legally-binding investment contracts, registered with the Securities and Exchange Commission. The legality in conjunction with investors gaining some right to the firm upon token ownership means they’re very comparable to shares.
The regulation of STOs has been a great way to filter out fraudsters and gain governmental support. There is a predicted boom on the horizon as STOs are still in its infancy. Despite being heavily regulated, there is no need for a broker. The absence of such a middleman makes transactions more frictionless and cheaper.
There is no secondary market for STOs unlike utility coins, although the possibility of one in the future remains possible. At this time though, liquidity is somewhat a concern for many investors.
The differences between ICO and STO
|Characteristic of the tokens offered||A utility token||Security certificates|
|Regulations||Free of regulations||Governed by regulations|
|Another characteristic of the token||IPO is a shareholding||STO is an asset-backed token|
|Time and cost||ICOs were a faster alternative to IPOs, and cheaper than traditional methods||STOs are still cheap, but have the added administrative and legal costs comparable to IPOs|
|Risk||High risk||Low/medium risk|
Ultimately, the risk associated with both need to be addressed, but STOs seem to have already surpassed ICOs. Blockchain technology is having huge implications to finance, giving retail investors more opportunity to buy into a market that could have great returns. Equity Token Offerings (ETOs) may be the answer for some investors, with a chance to claim representation of a company’s assets: virtual shares. ETOs are somewhat a subset of STOs, both legally recognised – but specifically with tokenised shares in a company. ETOs look promising and have yet to make their mark, but have had some early recognition from Neufund and Binance.
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