The Revolutionary Shift in Raising Capital and how STOs are shaping the Capital Markets!
In this article, by Dr. Justine Scerri Herrera (LL.B, LL.M, LL.D), a Maltese Advocate specialising in Blockchain and Crypto (VFA Department), discusses the how security token offerings are changing capital markets.
Previously, entities wanting to tap the capital markets without raising debt could only do so through private equity or initial public offerings (IPOs). In particular, the latter entailed satisfying legal requirements in terms of initial capital and banking. This new era of Crypto and Blockchain has provided us with a new, innovative method of raising capital by launching an initial coin offering (ICO) or security token offering (STO). Billions of euros have been successfully raised to raise capital to launch ICO and STO projects, and the STO route has gained a lot of traction over the last few months.
Once soft caps are reached and token issuers can go forth with their ICO projects, issuers need to make good on their promises regarding the value and benefit of owning and using such tokens by following through with the path laid out in the Whitepaper within the stipulated time frames. This is why it is important for persons buying tokens to perform due diligence on the brains behind the teams offering these tokens, just as one would do background checks on a company offering equity through an IPO.
The most important, and some would say only, marketing tool for coin or token issuers is a Whitepaper (for ICOs) or Prospective paper (for STOs). If an issuer decides to launch their ICO/STO from a regulated jurisdiction such as Malta or Switzerland their Whitepaper of Prospective paper would need to meet regulatory requirements in order for the relevant regulator (for eg MFSA in Malta) to approve and register the Whitepaper or Prospective paper and concurrently licence the activity of placing the token or coin on the market. Notably the applicable legislation regulating ICOs and STOs differ in Malta due to Malta’s token classification system. For example the applicable legislation security tokens are subject to is the EU directive MIFID. Teams pursuing offerings in either form would need to include in their Whitepapers important components such as details of the token issuer and their advisory team, soft and hard caps, Wallet Security, AML & KYC considerations, token representation and value and other elements, so that potential investors will know exactly what they are buying. This process protects investor’s assets and also safeguards market integrity.
It is also important that token issuers issue their tokens from reputable jurisdiction with proper laws in place because most tokens may be traded and in order to be traded must be listed on exchanges. After a successful offering, issuers will want to list tokens on exchanges. Exchanges licenced in reputable jurisdictions will not list tokens which were not subject to legal vetting and approval.
Could STOs be the best thing that is happening to Capital Markets?
Security Token Offerings offer the same rights conferred with assets bought and sold in traditional financial markets. Tokenising securities affords a number of benefits which would not be possible in the traditional financial market channels. For example, tokenising securities enables assets to be placed on the market more easily and be made available to a borderless community. Furthermore, STOs traded on Blockchains allow investors to trade without the use of middle men such as banks since transactions made on a DLT can be made peer to peer (P2P), though centralised exchanges and OTC offices are still available. Fractional ownership is greatly facilitated as well. In the sense investors can buy fractional ownership of assets such as property or artwork. So if one would like to own a masterpiece but cannot afford it now they can just buy and own a portion of it.
What problems are STO facing currently?
A lack of sophisticated custody solutions are needed in order to complement and facilitate the tokenization era. Unfortunately custodians have not yet developed the infrastructure necessary to safely store and protect tokenised assets (private keys) and related activities such as transferring such keys in and out of custody. This currently creates a barrier to tokenised assets flourishing to their full potential. However I believe that due to the rapid rate that different players in the game are evolving and the continuous new innovative solutions are being put forward that it is only a matter of time till service providers crack this nut.
Another problem is Liquidity! STOs are at their infancy stage. Slowly but surely more and more assets are being converted into security tokens. One of the most common assets visualized is equity in the form of equity tokens. There needs to be an increase of platforms allowing crowdfunding sales of security tokens and also more security exchange platforms allowing these securities to be traded just like they would be on traditional securities exchanges. The ecosystem will only become fully functional and practical once there are a sufficient number of security tokenized assets to ensure market liquidity and integrity. Tokenized equity should go a long way toward solving this problem.
To conclude on a positive note;
We’ve heard many people say that it is risky to buy tokens since there are so many failing ICO projects, however I genuinely believe that the reason there were so many failed ICO projects is due to the fact that they were not launched from a regulated jurisdiction. When one buys company shares in an initial public offering isn’t there also the chance that this will turn out to be a bad investment? The common reply is that listing an IPO has certain legal protections. However if an ICO/STO is launched from a reputable jurisdiction subject to strict legal requirements and approval by the regulator that also can offer some investor protection. Of course there are other issues such as secondary market liquidity and token volatility (eg, if investors purchase tokens with crypto and the value of that crypto goes down) but issues such as market volatility could also be present for those purchasing shares in IPOs.. The underlying truth is that if an IPO, ICO or STO is properly chosen with the abovementioned points taken into consideration, then it could very well be a life changing choice was just like buying bitcoin for pittance a few years ago.