ICOs (initial coin offerings) have declined substantially in recent years. Consequently, STOs (security token offerings) have paved pathways for regulated, efficient and secure crowdfunding on blockchain. 

Security tokens are regulated and, in most cases, backed by underlying tangible and intangible assets. They are known for generating regular returns for their issuers while providing stability and liquidity for investors. 

What is Security?

Fundamentally, security is a fungible, negotiable financial instrument that possesses some monetary value. It can be divided into three broad categories; equities, funds, and debts.

Equity is an investment in stocks of a company. The stock can either be private or public. They represent ownership of an entity that could be a corporation or a trust. Equity securities entitle the holder with some control of the entity on a pro-rata basis. 

Businesses and governments issue debt securities to finance themselves. Creditors purchase these debt securities to avail interest payments until the principal is repaid. 

An investment fund is a method used when investing money alongside other investors to get inherent advantages of working as part of a group. Each investor retains ownership and control of their shares. The same principle can be tokenized and the tokens can represent shares in the fund.

What is Tokenization?

Security tokenization is the process of materializing the ownership in security using token issuance mechanisms with distributed ledger technology (DLT). It enables tokenization of securities like equities, bonds, or investment funds for trading and other business opportunities. 

 The DLT infrastructure used for token issuance can be a primary register for the security-related transactions, depending on the legislation and users’ requirement. At the same time, it can be a representation of tokens primarily issued on a different infrastructure outside of the blockchain. 

We can find these securities everywhere, but they are difficult to physically transfer or subdivide. As a result, buyers and sellers use paper trading or share unsecured digital files that represent assets. These systems and processes are complex , difficult to transfer, and can be hard to track. The underlying assets also lack transferability.  

For instance, if the underlying asset is a piece of property, transferring ownership of an asset will require cross selling that particular asset. However, with security tokenization, the rights of these assets can be shared almost instantaneously with peer-to-peer trading mechanisms. 

Benefits of Security Tokens

Automation

Security tokens can automated several service functions generally carried out by middlemen through the blockchain. Currently, these various levels of intermediation often complicate communication between the security issuer and the investor. However, an STO simplifies and automates the processes with smart contracts. With the sharing of the same information, issuers offer shares directly to investors with accuracy, transparency and immutability.

Shared information and Transparency

Security Tokens eliminate the asymmetry of information that is present during the actual transfer of ownership of a specific security. Blockchain as a central source of truth makes governance and ownership more transparent and reliable than a traditional private security offering.

Cost-effective

In the traditional securities markets, middlemen charge significant fees for their services. By using blockchain technology and smart contracts, issuers can cut out many of the typical, low-value-added, expensive, intermediaries required for offerings.  

Immutability

Financial institutions currently rely on a private database. This is where blockchains can add substantial value. Once an investor buys tokens on a blockchain, nobody can erase the history of his ownership. Once data stored on to a blockchain, nobody, not even a system administrator, can change it. This is highly beneficial when it comes to auditing, as you can prove your data hasn’t been altered 

Inclusivity

Global reach and lower fees of the blockchain infrastructure allows for a new breed of investor and the potential for a worldwide investor base. The ability to divide the underlying assets into smaller units, making it more affordable for some investors and easier to transfer, allows for fractional ownership. 

Liquidity

Privately issued securities are often difficult to trade and therefore have been highly illiquid. The use of blockchain allows value to circulate more easily by bringing online trust, as it prevents the “double spending” problem. Traditionally, private securities could only be traded on secondary markets after using an extensive amount of middlemen and following strict, difficult to navigate regulations. By streamlining and automating these processes and by using a common distributed infrastructure, companies can remove the burdensome hurdles that previously restricted the liquidity of their securities. 

Use cases of Security Token Offerings

Real Estate: commercial real estate involves the changing of ownership of an illiquid asset that is expected to rise. These assets generate revenue for themselves. Security tokens enable individual and non-institutional owners of real estate to sell shares of their land and further convert it into cash. Token holders earn profits on capital and a certain percentage of the property’s future cash flows.

Raising Debt and Equity: As financial markets have become quite complex, security token offerings give companies an alternative to traditional institutional investment. Their compliance with SEC (Securities Exchange Commission) regulations cuts the trust barrier that traditional ICOs struggle with.

Art Ownership: Having possession of fine art and other assets such as: vintage cars highly consider as a status symbol of wealth and luxury, reflecting the owner’s ability to spend a big sum of money. In the year 2016, $56.6 billion was auctioned in art markets. Here, the token issuers and holders benefit from liquidating art assets without institutional auction houses in place.

Fundraising for Charity: Honestly, charities always struggle in gaining the public’s trust to distribute their capital. It is quite shocking that only 57% of people give charities their vote of confidence. The transparency of blockchain technology and accurate tracking of funds will facilitate charities to function freely. Charities conduct security token offerings via platforms such as: Lottery.com that assures distribution of their member’s donations effectively. Token holders can be quickly updated with how their funds are being utilized at the project level.

Fundraising for Artists and Musicians: A selected group of record labels dominate the music industry that creates 80% of the market. Security token offerings enable individual musicians to fund their tours and projects.

Conclusion

With the commencement of successful security token offerings, the traditional concept of ownership has been changed magnificently. Moving forward, 2019 opens a new gateway of successful security token offerings, having said that it won’t be wrong if we say that the tokenization in form of security tokens will play a vital role in the money management for many years to come.

Check out how Oodles, a security token offering development company, helps you navigate through the complex world of security tokens with its STO development services.