Security token offering (STO) tokens have built-in mechanisms that add investor protections lacking in ICOs. An STO makes possible seamless capital formation just like an ICO, but it also satisfies regulatory restrictions and provides token holders a vested interest in a company’s stock, liabilities, profits, or investment fund.
An ICO is a useful tool for attracting startup funding, but the utility tokens issued in an ICO are merely a digital asset, unsecured by a promissory note or bond. An ICO promises no fulfillment of future fiscal obligations, and there is no guarantee that the tokens will ever be liquid and tradeable. When they are negotiable, utility tokens trade outside the purview of regulators with little or no restrictions.
Security tokens, on the other hand, are linked to a company’s capital as a sort of “digital share.” A security token offering imposes certain obligations on the issuer. Owners of tokens issued in an STO can receive income from the issuing company’s activities, and they may have the right, bestowed via a smart contract, to participate in the management of the company.
With the advent of the security token offering, a civilized investment market is emerging from the “Wild West” coin offering landscape. A security token issuer must disclose all information about the state of the project being funded, and it cannot allow unknown persons or entities to hold tokens. The concealment or falsification of information on the part of the issuer is prosecutable.
PolyMath’s ST-20 security token platform facilitates the creation and distribution of security tokens. Polymath ST-20 was developed to make regulatory-compliant token issuance easy by taking the Ethereum ERC-20 standard, used for utility tokens, and adding the ability to enforce trading restrictions such as investor accreditation and jurisdiction.
Unlike ICO-issued utility tokens, STO-issued security tokens can only be acquired by parties that have passed KYC, AML, and investor accreditation checks. ST-20, written in Solidity, extends the ERC-20 interface in a way that ensures that both sender and receiver have been cleared to transact. Transfers over certain amounts can be prohibited, partial token transfers can be restricted, specific Ethereum addresses can be blacklisted, and issuance can be made subject to restrictions that prevent the reselling of tokens within the first year of issuance.
Traditional securities administration and governance requires the interactions of an assemblage of separate parties who do not trust each other. Securities are tracked on interdependent ledgers that are technologically isolated from one another. The result is a complex system of private ledgers that is difficult to manage, audit, and regulate. Security tokens can help fix the system.
A security token smart contract, as expressed in the form of published computer code, can align the incentives of issuers, holders, and regulators, and even customers and employees, enabling a significant degree of trustless transacting with less need for a third party involvement. The transfer of a security token from the originator to a stakeholder, its “issuance,” is an activity now regulated in Malta by special legislation.
Security tokens have the potential to reform an inefficient financial system in desperate need of sweeping change. Whereas ICOs have sought to be compliant with securities laws by way of exemptions, the STO enables functionality across a wide range of tokenomic and legal challenges. Security-token-driven decentralization offers a surprising and marvelous way forward that asset holders, investors, and regulators should embrace. The capacity of asset holders to issue regulated security tokens portends a seismic shift in the way capital markets function, as more and more businesses contemplate equitizing their assets with a security token offering.