The hype created by ICOs for the past couple of years have caught the attention of almost every entrepreneur. Especially when in 2017 it outperformed venture capital funding and became the number one method of funding blockchain organizations. The speedy growth in this sector has increased the level of fraudsters to come up with fake campaigns to loot the money out of ICO investor's pockets. To put an end to fraud ICOs, SEC(Securities and Exchange Commission) of the USA have defined a set of rules and regulations to protect the investor interests.
Token offerings are mainly classified into two, based on the type of token which is issued. The two kinds of tokens are utility tokens and security tokens. Utility token lets individuals utilize a product or service provided by the token issuing company. For instance, a utility token can be used in a chat platform to purchase new emojis or stickers in the chat. The utility tokens are not for investment but many people contribute to utility token ICOs hoping that one day the value of the token may increase with the demand for the company's product and service. Security tokens are all about profit. Security tokens act as an investment contract. They are similar to traditional IPOs. A security token is backed by external, tradable assets. One of the main applications of security tokens is that they grant companies the ability to issue tokens that represent shares of a company's stock.
The success of an ICO is determined by how effectively it can attract the ICO investors and they are easily attracted if the token can offer a decent profit in a short duration. This has made most of the ICOs offer profitable tokens to the investors without complying with the regulations set by SEC. At present, token issuances are gradually moving towards the STOs from ICOs. Let's look at what an STO is and how to identify one.
What is a Security Token Offering?
STOs or security offerings were introduced in the crypto community to provide legal protections for investors. It is similar to ICOs but the difference is that STO provide security tokens in the place of utility tokens as seen in ICO. We can expect an increase in the number of STOs in the latter half of 2018. A legit STO will go through a set of processes as explained by SEC to register and establish itself as a trustable security offering. One can differentiate the security token from other tokens using the Howey test. This test makes sure whether or not a transaction qualifies as an 'investment contract'. If the requirements in the Howey test are met, the token is considered to be a security and it will be subjected to additional disclosure and regulation requirements. The token must follow the conditions given below to be classified as a security token.
- The user is investing money
- The user anticipates profit from the investment
- The investment is in a 'common enterprise'
- The profit which comes from the efforts of a third-party or promoter
In an STO only accredited investors are allowed to take part, investors should meet any one of the following requirements to be an accredited investor.
- An annual income of over $200,000 individually or $300,000 with a spouse, maintained over the previous two years and with the same expectation for the current year.
- Net assets worth upwards of $1 million, excluding the primary residence (unless more is owed on the mortgage than the residence is worth).
- An institution with over $5 million in assets - e.g. a venture fund or trust.
- An entity made up entirely of accredited investors.
Security tokens can minimize legal risk and can provide protection for both the founders and the investors. Founders who are not able to comply with these regulations will be categorized as unregistered security offerings. In an STO, only accredited investors are allowed to invest in private securities offerings. Most of the founders launching ICOs try their best to avoid having their tokens classed as securities. This is because the token categorized as security places regulations and restrictions on who can invest in and exchange the tokens. This limits the founder's ability to reach a wider investor community. The perspective of 'profit' labeled to the token can attract bigger fishes to the campaign.
