2017 and 2018 are milestone years in the history of the cryptocurrency industry. Projects around the world raised more than $6.7 billion in 2017, and this figure grew to more than $21.4 billion in 2018, approximately three-and-a-half times higher. In addition to the growth in the number of funds raised through ICOs, the regulatory framework and guidelines surrounding these fund-raising events have grown parallel.
Unlike the mad ICO rush we witnessed in 2017, the cryptocurrency industry has moved out of its infancy with more sophisticated or rather regulated fund-raising mechanisms taking its place such as token sale events, regulated ICOs, and security token offerings (STOs). Among these upcoming terminologies, security token offerings (STOs) have amassed significant acceptance. As STOs become more mainstream, it is quite common to find cryptocurrency experts debating about the benefits of STOs over their predecessors, ICOs. Every cryptocurrency enthusiast must understand the critical differences between ICOs and STOs before rooting for any of these fund-raising prodigies.
ICO Versus STO: The Difference
How an STO differs from an ICO
ICO or an Initial Coin Offering is a fund-raising mechanism that allows startups to raise funds publically by issuing digital tokens, mostly in an unregulated manner, or at least that’s what we have witnessed. These digital tokens are described as utility tokens that the owner or investor would require to use the services of the startup upon launch. Prior to the release of the ICO, the project team launches a website, project whitepaper, and other supplemental material to provide an insight into the project. Investors analyse the ICO based on this information and participate accordingly in the token sale.
An STO or Security Token Offering, on the other hand, is a regulated fund-raising mechanism that, unlike an ICO, offers ownership of assets or revenue/profit sharing in the startup. While the fund-raise process of an STO appears quite similar to that of an ICO, being approved by a regulatory body increases its overall trust factor. STOs offer a relatively low-risk investment opportunity to the investors.
An In-Depth Analysis of the ICO Vs STO Debate
ICOs offer utility tokens to the investors. These digital tokens may or may not provide equity ownership, and they are instead used to pay for the services within the platform. Let us consider a startup that offers cloud-based services to its clients as the token issuing party within an ICO. The startup will sell utility tokens during the ICO which can later be used to pay for its cloud-based services. However, these utility tokens do not entitle any voting rights or equity ownership to the token holder within the platform. In case of failure, the token holders incur a complete loss, receiving nothing in return for their investment.
STOs are security offerings under which the company sells digital tokens backed by its assets or the promise of revenue/profit sharing in the future. It is safe to consider STOs as digital securities, and unlike an ICO, the participants will receive ownership in the company. It is essential to understand that these security tokens do not necessarily offer voting rights to the token holders, and they, instead, offer financial benefits such as revenue sharing or dividends to the token holders.
Regulatory bodies around the world are tightening their grip on the cryptocurrency industry and rightly so. Nearly 46% of the ICOs conducted through 2017 failed within the first quarter of 2018, so much for the promises or gains mentioned in their whitepapers. With nearly half of the ICOs failing, regulatory bodies have stepped in to protect novice investors from further financial losses or risk exposure.
In the case of ICOs, regulatory bodies are increasingly coming up with comprehensive guidelines, requiring ICOs to comply with strict regulatory rules. Some examples of the changing regulatory guidelines for ICOs include the release of a regulatory framework by Malta Government and the regulatory bodies in Lithuania.
STOs, on the other hand, must seek approval from their local regulatory bodies and present vital information such as their business plan as well as details about their founders/team. Depending on the jurisdiction, STOs might only be able to raise funds from accredited investors.
Transparency is a significant challenge in the cryptocurrency industry. A study published in early 2018 revealed that approximately 80% of the ICOs conducted in 2017 were scams. The presence of lax regulatory guidelines and limited understanding of cryptocurrencies among governments was a major reason behind this figure.
With growing awareness among regulatory bodies, the current legal environment is better-equipped to handle scam projects. Going back to the ICO versus STO debate, STOs offer better transparency to the investors, primarily because of the involvement of a designated regulatory body in their approval. For ICOs, regulatory authorities have introduced legal frameworks, requiring ICOs to disclose as much information as possible prior to their launch.
Ease of Raising Funds
ICOs were a massive hit because of the ease of raising funds and lack of regulatory guidelines. Startups that otherwise had little hope of raising funds in VC rounds were able to raise millions of dollars based on their whitepapers and website alone. Despite the tightening regulations, ICOs hold an upper hand in terms of the ease in raising funds for a project.
STOs require approval from regulatory bodies, which means most of the projects are likely to be rejected at the initial stage itself, lowering the ease of raising desired funds for the project.
Lower Investor Interest
When comparing ICOs and STOs, it is critical to consider the investor interest in these fund-raising methods. One of the primary reasons why ICOs generated massive interest was their speculatory nature. Investors put money in ICOs for quick gains instead of the internal value or utility of the token itself. There have been multiple instances where the investors received multi-fold returns on their ICO investments.
STOs, on the other hand, are security offerings and hence are likely to generate relatively lower interest among crypto investors. Additionally, a limited number of cryptocurrency trading platforms offering support for security tokens is another factor affecting investor interest.
Conclusion: ICO Vs STO
While ICOs had a decent run in both 2017 as well as 2018, the tightening regulatory environment is likely to drive investors towards STOs. STOs are poised to emerge as winners in the upcoming years and courtesy of their lower risk profile, investors might favour them over ICOs in the long run.