Facing increasing regulatory scrutiny and tumbling prices, cryptocurrency enthusiasts are looking for reasons to be cheerful in 2019.
One potential positive? The ‘STO’.
STO, which stands for ‘security token offering’, has become a recent buzzword in the crypto sector. At the MJAC & CryptoCompare ‘London Blockchain Summit’ in November one keynote was titled: ‘Will STOs replace IPOs?’
Advocates hope STOs offer a legally compliant new growth area for crypto that will allow companies to put everything from stocks to artworks onto tradable crypto tokens.
What is an STO?
To understand the STO, you first have to understand an ICO. An ICO — short for initial coin offering — is where a startup issues digital tokens in exchange for money to fund its business. It is essentially crowdfunding, but investors are given tokens instead of equity. Usually, they are linked to the project in some way. It’s a little like raising funds to build a cinema by selling tickets in advance.
These digital tokens are usually structured similarly to ethereum, the second biggest cryptocurrency, in that they are digitally storable, tradable, and cryptographically based.
The first ICO was ethereum in 2014 but the fundraising method exploded in popularity in 2017, fuelled by a general crypto boom. By the end of that year, over 800 projects had raised more than $6bn through ICOs. This momentum continued into the first half of 2018.
However, the pace of ICOs slowed over the last six months as crypto prices sunk and ICO projects that had already raised money failed to live up to the hype.
“We’ve got the massive bear market which is slightly intertwined with the capital cycle slowing up and it’s created this negative reputational debt with this acronym ICO,” Edd Carlton, the head of institutional trading at BlockEx, told Yahoo Finance UK. “If you say ICO now, you get the air through the teeth.”
‘The stick approach’
Regulators have also cracked down on the fundraising method. In the US, the Securities and Exchange Commission said that most ICO tokens in fact qualify as securities. As a result, companies that issued them are breaking the law by offering unregistered securities.
Basis, an ICO project aiming to create a stable cryptocurrency, shut down last month and blamed “generally onerous” securities laws. The project had raised $133m from investors including Silicon Valley VC firm Andreessen Horowitz and Bain Capital Ventures. (Remaining funds were returned to investors.)
“You can’t ignore the fact that regulators in the US are driving people with the stick approach, scaring people away with orange jumpsuits and subpoenas,” said Carlton.
However, while historic ICO projects look to be in trouble, the SEC did not explicitly ban ICOs. As a result, lawyers and crypto advocates now see a new market for SEC-compliant ICOs. These have been dubbed ‘security token offerings,’ to reflect the fact that they are now classified as securities.
As well as offering the potential for legally compliant ICOs, advocates argue that STOs allow companies to put existing securities such as stocks and bonds on to a cryptographic blockchain. This would allow people to trade these securities without the need for a middleman.
In theory, any form of value could be ‘tokenized’ — stock certificates, diamonds, even art collections. Jeremy Allaire, the CEO of Goldman Sachs-backed crypto company Circle, likes to talk about the “tokenization of everything.”
‘A strong narrative for why this makes sense’
BlockEx is currently working in the UK Financial Conduct Authority’s regulatory “sandbox” to develop a sterling-denominated bond token, an example of an STO. It will target small businesses that usually cannot afford the fees associated with underwriting a bond.
“The benefits are clear: time to market and cheaper. You could also throw in the fact that they have complete oversight of who’s bought the bond,” Carlton told Yahoo Finance UK.
“In terms of the participants, settlement is now instantaneous between cash and security,” he said. “We’ve got a really strong narrative for why this makes sense.”
So far, STOs have been few and far between. But several projects are currently advertising plans to launch STOs in 2019 and the Swiss Stock Exchange is building its own platform to issue and trade security tokens in anticipation of a boom. 2019 could be the year of the STO.
“LinkedIn is always a fantastic gauge,” Carlton said. “The number of people whose profile has now changed from ICO advisor to STO advisor makes me laugh.”
However, he fears that STOs could be the subject of the same sort of overkill and excessive hype that ended up damaging ICOs.
“I think we really risk falling into the same trap now — everyone’s like, ‘I’m going to stick STO on this and then all of a sudden the clouds will part and people will drop gold into my lap and everything will be fine’. That’s absolute rot.
“When people say, well why don’t I just do an equity raise via an STO — what’s the benefit?” he said. “For security tokens, there has to be a need for it.
Oscar Williams-Grut covers banking, fintech, and finance for Yahoo Finance UK. Follow him on Twitter at @OscarWGrut.