In our blog post about the Top 10 blockchain trends for 2023, we briefly discussed our prediction for the growth of the STO market. In case you’re unfamiliar with Security Tokens and STOs, this post will go into a little more detail about how they work and why they’re worth keeping an eye on.
How are STOs Regulated?
STOs are being increasingly embraced by many mainstream and institutional investors due to the fact that they are subject to regulations. ICOs often sidestep legal frameworks by arguing that their coins are for usage (not investment) because they give users access to a platform or dApp. This lowers the barrier to entry and makes ICOs more available to the public. However, it also carries more risk due to the lack of regulation.
It can be tough to launch an STO since it must comply with relevant regulations (varying across jurisdictions) and offer an investment contract under securities law. This makes them less flexible but adds a level of security that other cryptocurrency mechanisms can not offer.
The Securities and Exchange Commission (SEC) in the US is where many jurisdictions are looking regarding the issue of legally defining ICOs and Security Tokens, and how they should or shouldn’t be regulated. In 2017, the SEC released a report that concluded that ICOs can be classed as a security if they fall under the definition of an investment contract:
- “An investment contract is (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) to be derived from the entrepreneurial or managerial efforts of others.”
The fact that some ICOs may be subject to federal securities laws is what initially prompted the development of STOs. However, SEC decisions are not fixed, and since STOs are a relatively new concept, it is likely that bills and laws will be tweaked or introduced. Businesses looking to launch STOs should be prepared to respond to new laws and frameworks following the ever-changing regulatory environment.
It is important to note that not all countries will follow the decisions of the SEC. Some governments are completely against the idea of STOs and cryptocurrency in general, while others are still undecided about how to regulate these digital assets.
Advantages of STOs
- Lower risk than ICOs: required compliance with securities laws lead to more transparency and accountability, making STOs a safer choice for investors.
- Easy to assess token pricing: the fact STOs are backed by real-world assets means it is easier to assess if tokens are fairly priced. On the other hand, it can be difficult to evaluate the price of ICO tokens, especially if they’re offering utility functions.
- Removes the middleman: STOs can be cheaper than IPOs because they eliminate the need for banks and brokerages. Smart contracts also reduce the reliance on lawyers, and the nature of blockchain technology removes the need for paperwork. This can allow early-stage businesses to raise capital quickly without paying large fees.
Challenges of STOs
- Subject to government decisions: the rulings of governments will likely determine how the STO market evolves and grows, making global launches or expansion complicated. This can also be an inherent issue for those that advocate for decentralized blockchain technology.
- Limited to accredited investors: in the case of the US and numerous other jurisdictions, non-accredited investors can not own STOs. This makes STOs much less accessible than other tokens and ICOs.
- Heavy regulation: STOs can be more expensive than ICOs due to regulatory requirements, and they are often subject to secondary market trading restrictions.
Lambda256 and Luniverse are working to develop reliable and flexible STO services for enterprises. Make sure you follow our Twitter and join the Luniverse Discord to get insights about the STO industry and find out what we’re working on!