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What Is a Security Token Offering: Are STOs the New ICOs?

  • Alex Morris
    📚 WikiCoin

    Security tokens, a new strain of cryptographic tokens, have been an emerging trend in the industry. Will security token offerings (STOs) eventually outduel ICOs?


What Is a Security Token Offering: Are STOs the New ICOs?
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2017 was the year of ICOs — investors would blindly throw money at each new project without even doing basic research. As soon as the great ICO bubble popped (with 70 percent of all coin offerings not even exceeding their initial valuation) the so-called security token offerings (STOs) have become the next big thing in the crypto space. In this article, U.Today will determine whether STOs have a serious shot at replacing ICOs.

Understanding security tokens

Before grasping the idea behind security tokens, beginner-level investors should clearly understand what a ‘security’ is. It is a basic financial term that denotes a certain financial instrument that holds some monetary value (stocks, bonds, etc.).

What is a security token then? A security token is a share that happens to reside on a distributed ledger. All the information pertaining to one’s individual investment is stored on a distributed ledger instead of a single PDF paper.


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Companies can consider raising funds with the help of STOs if their annual revenue exceeds $10 mln, or they have a highly scalable business model. They can also opt for an STO if they are supposed to have transferable shares of an asset.  

The main difference between security tokens and utility tokens is that the latter typically function as an investment (the value of security tokens is determined by external assets). Meanwhile, utility tokens are not supposed to be an investment – they simply give access to a certain product. Case in point: Basic Attention Token (BAT), the 29th biggest currency by market capitalization, underpins the Brave browser ecosystem – users are able to earn the BAT token by watching content or performing other contributions to the network.

Security  token

ICOs vs. STOs: The uncomfortable truth

In such a short span of time, more than 4,000 ICOs have managed to raise a whopping $12 bln. Everyone with ETH was able to participate in the funding of new startups. Prior to that, this market was only opened to venture capital firms since they are able to afford the risk.  

However, the uncomfortable truth is that the majority of these ICOs didn’t have anything to offer their FOMO-driven investors (apart from their white papers). Now, we are in the post-euphoria stage when ICOs are slowing down, and ‘private’ coin offerings became a popular trend (when tokens are sold to accredited investors).

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While the cryptocurrency industry is still going through its ‘growing pains’ stage in terms of regulations, STOs arise as a more legitimate option since they are not more venturesome than the ICO space that is plagued with pump-and-dump schemes and other kinds of speculations. It is mandatory for STOs to be approved by the Securities Exchange Commission (SEC), which basically makes them fraud-proof.

(thetokenist.io)

The regulatory framework of security token offerings

China, with its infamous crackdown on cryptocurrency trading, remains vigilant of STOs with Huo Xuewen, Beijing’s Municipal Bureau of Finance chief, recently defining STOs as illegal. Last year, the country also banned ICOs.  

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However, in the US, the regulatory framework for security tokens is rather straightforward. The first thing that any issuer is supposed to do is to pass the Howey Test in order to determine whether you are dealing with a security or utility token (the Howey Test examines investments, profit expectations, work efforts of other individuals, etc.).

After that, there are two options: register with the SEC or apply for an exemption (listed below). Going for full registration with the SEC is not an easy feat since one will have to overcome a slew of financial and legal hindrances. Not surprisingly, the overwhelming majority of companies prefer the second variant.      

SEC Exemption Type

Explanation

Reg D

The exemption rule that allows a certain company to cut the costs that are attributed to hosting your own private offering. Those that meet certain rules that are specified in the Red D section are not supposed to be registered with the SEC in order to offer securities.    

Reg A+

Under these regulations, securities that were approved by the SEC can be sold to retail non-accredited investors. Long story short, it allows an average Joe to invest in private companies.

Reg S

This particular exemption type pertains to the transactions that are conducted outside of the US. Subsequently, security tokens (as well as bonds and stocks) can be sold to non-US investors that meet the Regulation S requirements.       

Reg CF

This is by far the simplest option for a token issuer but the amount of capital is strictly limited to $1.07 mln. For comparison, Reg D and Reg A+ allow raising a significantly bigger amount of capital.

Picture 3Picture 4

NB! Failing to comply with the federal securities laws will result in a potential derailment of the project. Eligibility for exemption still means that any given STO is subjected to federal regulations.  

Outside the realm of traditional IPOs

  1. Programming securities. With security tokens, you are able to include additional features in already existing securities since programming code gives much more flexibility.

  2. Fractional ownership. Some markets remain available only for high net worth individuals. For instance, U.Today recently covered Miami Art Week 2018, where tokenization became one of the focal points of the discussion. Not everyone is able to shell out $100 mln for a Picasso but dividing one picture into numerous different pieces (‘tokens’) would make it easier for different kinds of investors to dive into this multi-billion dollar market.

  3. No need for an IPO. Launching your own initial public offering (IPO) will cost you top-dollar. However, the gargantuan cost of hosting your own IPO can be practically reduced to null by hosting your own IPO.

  4. More liquidity in the market. Unlike traditional stock exchanges that have specific trading hours, you are able to trade security tokens 24/7. Apart from creating a more global market (there are no restrictions pertaining to the time zone), it also brings more liquidity to the market given that there are many buyers and sellers of different ranks. It doesn’t matter if you are an 18-year-old newbie who has just $100 worth of BTC – you don’t have to be an accredited investor in order to participate in this market.   

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The growing security token ecosystem

While security tokens are gradually entering the mainstream, a great ecosystem is being built by a few companies that are willing to capitalize on the buzz around ‘the new ICOs.’ Crowdfunding behemoth Indiegogo has also embraced security tokens by tokenizing the luxurious St. Regis Aspen Resort in Colorado. The company’s co-founder, Slava Rubin, predicts that we will see more security tokens in the future, gradually disrupting a crowd-financed world. Despite the fact that major exchanges are yet to list security tokens, major players like Coinbase are already pouring big money in the STO space.

Mainstream cryptocurrency exchanges are not suitable for trading STOs given that they can’t perform proper due diligence. There are fully regulated alternative trading systems (ATS) that create a market for security tokens. Apart from issuing a security token, ATS is useful for picking a KYC/ALM provider and tackling legal hurdles with the SEC.       

Polymath, which is also dubbed ‘the Ethereum of security tokens’, is a platform that is designed to make it easier for companies to issue security tokens (everything from stocks to real estate can be tokenized). The Polymath ecosystem unites issuers, developers, investors, and legal experts. The platform functions on the Ethereum Blockchain, giving its users an ability to issue ST-20 tokens.

Poly 

POLY, with its native ERC-20 token, is used as an economic unit for conducting all operations. It can be bought on all major exchanges, including Binance, Huobi, and KUCoin.      

How to register an STO with Polymath?
Here’s a quick guide on how to register a security offering with the help of the Polymath platform.   

Step 1.  Go to the main page and click the corresponding button to issue your ICO (considering that you’ve already connected your wallet to an email wallet).     

Step 1.

Step 2. Once you’ve done that, you have to choose your token name along with token symbol, entering them in the given fields.

   Step 2.

Step 3. After completing the reservation of your token, you are required to choose your payment provider (they won’t be notified since the token is running on testnet).  

   Step 2.

Step 4. You are required to get your offering details (the timing, the coin (POLY or ETH), and the rate).

Step 4.

Step 5. During the last stage of your registration process, you are required to fill out all a CSV file with all the necessary information pertaining to your whitelisted investors.

Step 5.

Polymath is considered to be the leader in the STO market, but there are also some alternatives:

  • Harbor;

  • Securitize;

  • Securrency;

  • tZero;

  • Bancor.  

The bottom line

Looking at the present-day situation, the market share of security tokens remains minuscule compared to traditional STOs. Moreover, the whole idea of a security token may sound confusing to an uninitiated investor who asks questions like, ‘How do security tokens work?’ and so on. Some aren’t even able to differentiate them from initial coin offerings.  

Generally speaking, STOs represent a hybrid of traditional stocks for institutional investors and cryptocurrencies, satisfying the needs of both camps. There is every reason to believe that STOs could eventually become huge, potentially disrupting the current equity market in a similar way to Bitcoin threatening fiat currencies.

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Still, there is a possibility that we won’t see any competition at all. Security tokens could be utilized as a fundraising tool while utilize tokens could be useful for interacting with the dApp. Hence, there a possibility that we will see a strong coalition in the form of one ‘security-utility’ token. A dual token could fix the pain points of the cryptocurrency industry.

Cover image via u.today
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SegWit Explained: What Is Bitcoin's Segregated Witness?


SegWit Explained: What Is Bitcoin's Segregated Witness?
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Segregated Witness (SegWit) is an implemented protocol update that solves the problem of the Bitcoin’s blockchain transaction malleability. The point is in one of the transaction components. The first part is the Basic information (the sender, the amount, the recipient). And the second part — Witness — carries a special cryptographic signature (code). This code is a confirmation of the virtual transaction in Bitcoin currency.

Witness’ signature creates difficulties for the blockchain because the form can be changed after the appearance in the block. Bitcoin will still reach the addressee, but the construction of new transactions will be complicated because they all go along the chain. Unconfirmed transactions slow down the speed of new ones, reducing the overall Bitcoin network performance due to pulling data from a past virtual transaction.


The current Bitcoin protocol makes it difficult to implement large-scale updates, as well as to conduct fast transfers. The problematic network feature is called the “transaction malleability”. Against this background began the movement for the introduction of SegWit.

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The goals of SegWit

Segregated Witness must restore the Bitcoin network and adapt the blockchain technology to new realities. The main task is to solve transaction malleability and scalability. SegWit optimizes the transaction process and creates conditions for the subsequent increase in virtual block size. SegWit has to solve such problems and questions:

  • If Witness signature is segregated from a block of Bitcoin increases size and bandwidth of the entire network.

  • The transaction size is reduced by 2 times.

  • Reducing the blockchain size, which saves disk virtual space for nodes.

  • Starting and synchronization of nodes speed up significantly.

  • The enhanced spam protection mechanism of Bitcoin currency.

It follows that SegWit addresses the most important aspects for Bitcoin: scalability, protection level, transactions speed, and interaction with new protocols.

The story of Segregated Witness

The first talk about the need to modernize Bitcoin’s protocol and about possible ways to solve the transaction malleability problem appeared in 2012. Bitcoin-Core developers Russell O’Connor, Luke Dashir, Gregory Maxwell and others became initiators. Active actions for the currency began in the summer of 2014, when Maxwell, Pieter Wuille and cryptographer Adam Back launched the blockchain research company called Blockstream. In this environment, they found a solution to Bitcoin’s problem. It was decided to separate special cryptographic signature from the main part of the transaction. They called this function Segregated Witness.

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In parallel with Segregated Witness, the idea of ​​optimizing Bitcoin’s blockchain by increasing the block size (the default is 1 megabyte) appeared. It could be realized only through a hard fork — a rigid network separation through the introduction of changes incompatible with the current protocol. SegWit, on the contrary, was a soft fork or partial update of Bitcoin’s protocol. To implement it, the Witness’s signature must be segregated in a new part of the virtual block. And its anchor (Merkle Root) recorded in the transaction of miners’ fees. As a result, more space remained in Bitcoin’s block, and its size increased without actually increasing. This result allowed us to solve the problem of the Bitcoin network scalability, which was also quite acute.

After the appearance of the second idea, a real war broke out, including among the developers of Bitcoin currency. Miners and pools couldn’t come to a consensus from 2015 to August 2017. As a result, SegWit was accepted and activated. A special code called BIP91, developed by Bitmain engineer James Hilliard, turned out to be the best compromise among all the proposals received over several years.

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Image by 123rf

 

The main advantages of Segregated Witness

The list of benefits which will be received by the Bitcoin network with the introduction of SegWit is very large, we focus the main ones:

  1. The third party will lose any options of signature’s changing, which will facilitate the development of new smart contracts.

  2. Dividing special cryptographic signature from Basic data will significantly increase transaction size and Bitcoin’s blockchain bandwidth, and the average virtual block size will be 1.7-2 MB.

  3. With Segregated protocol, transactions in Bitcoin currency will remain available to participants who have accepted SegWit, and those who refuse to do so. At the same time, users with an updated protocol will work with smaller commissions.

  4. The adoption of SegWit greatly simplifies the implementation of new soft forks, allowing to introduce new ideas to improve the security of Bitcoin currency.

  5. The block validation rate and transaction security will increase due to a change in the signature hash function from linear to exponential.

  6. A segregated signature will reduce the currency’s charging fees.

  7. SegWit will have a positive impact on the Bitcoin ecosystem here and now, as well as create a springboard for further development.

Arguments against SegWit

Even today, Segregated Witness is not fully accepted by the Bitcoin network. Sceptics believe that this will take years because the number of nodes has already exceeded 10,000. An increase in the number of participants and a virtual transaction will result in a Bitcoin’s block size of 2 MB is small for the needs of the ecosystem.

Partial centralization of Bitcoin’s system due to the implementation of the SegWit protocol will increase the number of unconfirmed transactions, which will strip the network and make currency vulnerable to hacker attacks.

Some Bitcoin developers and pools believe the adoption of SegWit is dictated by the economic gain of Blockstream, which owns the Lightning Network protocol. Its technical implementation in the Bitcoin network without Segregated Witness is almost impossible.

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Will the time come for SegWit2x?

Speaking about the implementation of Segregated Witness and Bitcoin currency, it is impossible not to mention the postponed indefinitely SegWit2x. The agreement was the result of heated discussions and a search for consensus. It was decided to make a hard fork, after which the block size should increase to 2 megabytes. The split was scheduled for mid-November 2017. In fact, Bitcoin would split into two networks with its own coin, rules, signatures and standards.

However, the idea was not destined to come true. Firstly, the negative attitude of the developer community and the launched NO2X campaign did not play into the hands of the “Segregated” protocol. Secondly, BIP91 was implemented earlier and it was successful.

As a result, on November 8, 2017, the complete closure of the project was announced. But there were people who positively evaluated the results for Bitcoin. For example, the head of Blockchain.info, Peter Smith, who initially supported the Segwit2x idea, spoke as follows:

“We’re relieved. The goal of the NYA was to bring the community together and keep the majority of the users on the same chain for at least a little while longer.”

SegWit usage metrics
Image by 123rf

Results for Bitcoin and blockchain

From the moment of implementation of Segregated Witness, a year and a half has passed, but the protocol is not accepted by 70%. Many large services have not yet implemented it into their processes. However, positive changes are already visible, especially for ordinary users. Now the average transaction cost with confirmation within 20 minutes, according to Bitcoin Core Fees, is estimated at 5 satoshi/byte, that is, about $ 0.08 for the entire virtual transaction.

Spam attacks on the Bitcoin network have also stopped, the mempool remains free, and the average block size has exceeded 1 MB. In addition, the activation of SegWit has opened the doors to the implementation of new solutions and prospects for Bitcoin and cryptocurrency in general.

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