An initial coin offering, known as ICO, is a common method for cryptocurrency and blockchain projects to raise initial funds while generating interest in their project. The ICO is similar to an initial public sale for a company on the stock market. The project offers coins or tokens of some sort in exchange for funding. In most cases, there are incentives in the form of bonuses for participation in an ICO, letting contributors receive more tokens than they would for the same price following the sale.
There are several variations of initial coin offerings. Security and equity token offerings both build on the idea but offer a unique type of token.
Why the Type of Token Offering Matters
It is crucial to distinguish between security and equity token offerings because the two are treated differently. The IRS, SEC, and other relevant organizations will push different regulations depending on if you are dealing with a security, equity, or another type of token.
Understanding Equity Tokens
Before getting into the difference between a security token offering and an equity token offering, you must understand what each of these tokens is.
Some experts feel that the best explanation for an equity token is comparing it to the 21st century version of a stock. An equity token is a representation of a share within the company underlying the token. With an equity token, you literally own a fraction of the total enterprise represented by the token. Holding an equity token gives you rights to vote on the future of the company and to a portion of its profits.
The main difference between traditional stocks and equity tokens is how ownership is recorded. While traditional stocks get recorded in a database, equity token records are on the blockchain.
There are various classes of equity tokens in their form of shares of ownership. By default, they are common stock, which equally divides voting power and earning. Variations are like Class A or Class B shares, which adjust the voting rights, giving the holder of the equity token additional rights. There can also be stock classes based on a preferential dividend, or what percentage of dividends the equity token represents.
Understanding Security Tokens
Most tokens that are not equity tokens are security tokens. Essentially, these are investments in blockchain products or companies that get their value from the company but without transferring any ownership. When you buy a security token, you do not own any part of the project or receive dividends from profits. Instead, you anticipate that the value of the token will increase in the future, letting you sell it for a profit. In many cases, security tokens will rely on assets, such as gold, real estate, or something with value, using that item as collateral.
Security tokens receive their value depending on a metric that relates to corporate performance. Because of how the SEC classifies securities, security tokens qualify as such.
Of course, not all cryptocurrencies are security or equity tokens. Ethereum and Bitcoin both qualify as neither, just as assets.
Examples of Each Type of Offering
You will be hard-pressed to find examples of a legitimate equity token offering since these are incredibly rare. This largely comes down to the fact that while an equity token offering would grant ownership rights, a security token offering does not. Another factor is the lack of clear regulations or restrictions on equity tokens. So far, Documo and Nefund have both announced equity token offerings. There are many more examples of security token offerings, including Polymath, Harbor, and tZERO.
Security and Equity Token Offerings Are More Secure Than Other ICOs
Whether you look at a security token offering or an equity token offering, it will typically be more secure than a regular initial coin offering. That is because security and equity tokens fall under the regulation of various regulatory bodies, such as the SEC. As such, they must be monitored and audited to prevent fraud. This is not necessarily a requirement for ICOs in most jurisdictions. Both security token offerings and equity token offerings, by contrast, tend to be fully legal due to the registration and other requirements associated with the company conducting the offering.
Security token offerings also deliver improvements over traditional security offerings. A security token offering typically has compliance built right into it via the smart contracts. These smart contracts outline the ways that tokens can be bought, sold, or traded while remaining compliant.
Security tokens are also incredibly liquid since you can trade them on global security token exchanges, unlike with a conventional security. Because of the nature of blockchain, all transactions are immutable and public, creating a trustless procedure.
Other Types of Tokens
Security and equity tokens are not the only types of tokens that come up when dealing with blockchain technology and initial coin offerings. As mentioned, some tokens are simply cryptocurrencies. Those have their own inherent value and can be used for financial transactions. Bitcoin and Ethereum are examples.
Utility tokens give those who hold them access to services and goods from the project. They may also provide premium access or some sort of discount to the project’s goods and services. Utility tokens tend to have a limited overall supply, which leads to an appreciation in value as the demand for the service increases. As with equity token offerings, you will not find many utility token offerings, since cryptocurrency and security token offerings tend to be more popular.
A security token offering and an equity token offering are both methods by which a blockchain project can raise funds by offering tokens. The difference between the two comes down to whether the holder of tokens owns a share in the company. In either case, the token holder expects to experience a return on their investment. Compared to other ICOs, both security and equity token offerings face stricter regulations and are monitored by the SEC and other regulatory bodies.