ICO or STO? A Pro & Con Analysis
STOs (Security Token Offerings) are a new and exciting way to raise capital in a manner that takes advantage of of the benefits of blockchain whilst remaining within the legal embrace of securities laws. This type of token sale can attract the more risk-averse investor who would not have participated in ICOs due to the tokens being in a legal grey area or the tokens exhibiting a lack of clear path to profit.
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This article will discuss the various pros and cons of STOs in comparison to ICO token sales. This is to help the reader make an informed decision when choosing whether to participate in an ICO or STO.
We will group together the different characteristics of each into 3 categories:
- Participation: is the process or means by which a person participates in an ICO or STO.
- Token/Share specifics: relate to token use case, token distribution, custody etc. Basically everything that has to do with a token or share.
- Legality: all things pertaining to compliance with law.
Check out our informative article about STOs here.
- Overall easier participation due to lack of need to comply with securities laws
- Usually lesser participation requirements
- Usually less personal or financial data given out
- Lack of strict KYC; means that some fake accounts may participate thus guaranteeing skewed distribution of tokens.
Notes: ICO participation requirements are all over the place due to lack of standardized requirements for participation. Some ICOs only have the requirement that you send ETH or any cryptocurrency to their smart contract and you automatically receive tokens whilst others have a very thorough KYC process that requires submission of multiple documents and video confirmation of identity before you can be cleared to send cryptocurrency. This lack of standardization is because of the grey area that ICOs operate in where legal requirements for participation are not that stringent, if they even exist at all.
Thankfully the ICO market is maturing and stricter measures are being put in place by top tier ICOs to ensure that proper KYC procedure, AML and token distribution is followed. It is very probable that ICOs will eventually adopt the KYC procedures of STOs.
- Typically more secure and more legally compliant participation system
- Tougher KYC means submitting more documents
- Need to submit more personal information other than standard identity verification documents. Additional information submitted may include financial documents.
- Possibly longer approval time due to need to process more information.
Notes: The requirements to join an STO are still not set in stone because of how new STOs are. But, it can be inferred that since STOs deal with securities, the participation process will be more robust than that of an ICO. Such verification processes might include video confirmation of identity, submission of IDs, and submission of documents that show proof of income or capability to participate in an STO.
Even though the list of requirements might be longer than an ICO due to the need for the STO to comply with securities law, it is still more accessible to people compared to an IPO. This is due to the STO being hosted on blockchain and the ability to receive not only fiat but also cryptocurrency.
Overall, it will be harder to participate in an STO due to the additional KYC requirements needed along with the fact that you have to surrender more of your personal information over the internet to satisfy KYC which might be an issue for some people. But you always need to bear in mind that this is done to satisfy legal requirements and provide a more robust token sale framework without which an STO cannot operate.
Learn everything you need to know about an ICO here!
ICO Token Specifics
- Easier to hold token generating event or token sale due to lack of need to register tokens as securities.
- Smart contracts can allow instant token transfer upon receipt of payment
- Token distribution amongst various accounts is often hardcoded into smart contract guaranteeing distribution that cannot be tampered with.
- Tokens can be traded on any platform or exchange that wishes to list tokens which increases liquidity and reach.
- Technology used for utility tokens is relatively mature and most if not all of the bugs have been worked out which means less risk.
- Use case may not clearly be defined especially if buyers treat token as a security and expect appreciation in price.
- Token custody and distribution may not be as robust as that of an STO due to the lack of need to comply with securities laws.
- Generally unregulated market means token price manipulation may come into play
Notes: Token use case for utility tokens were often not clearly defined in the whitepapers and supporting documentations with most buyers or investors expecting a return or appreciation in price. This meant, that most ICO participants joined ICOs because they treated the tokens as security tokens with an eye for appreciation in price or a return on investment.
This mismatch in goals means that token economics are slanted more towards the use of tokens to pay for a service, dApp, or blockchain rather than for appreciation.
Thankfully the ICO market is maturing and newer ICOs nowadays explicitly state their token use cases to clarify to participants what a token will be used for.
STO Token Specifics
- Well-defined token use case addresses buyer expectations of benefits token gives to investors.
- Token allocation or distribution is compliant with plans laid out during filing for STO. This keeps administration honest or else company will be legally liable.
- Tokens being securities need to be traded on a platform that can handle security tokens thus limiting reach and in some cases liquidity.
- Tokens may not be instantly transferred upon payment due to the need to audit a token sale.
- Tokenization of securities and assets are still being researched and could provide a risk
Notes: The biggest takeaway is that STO token use cases are clearly laid out to be an investment with investors expecting that the company or team work towards appreciation of token value. As such token economics are designed to encourage price appreciation, lower token velocity or give out a dividend.
- Faster time to market since ICO does not need to comply with securities laws.
- Maturation of ICO industry and laws pertaining to ICOs can differentiate an STO from an ICO
- Legal grey area for utility tokens and rapidly changing legal landscape means some tokens may be judged by government to be securities which may pose a roadblock until tokens are registered as securities.
- Extra care has to be taken to promote a token sale as utility tokens only.
Notes: ICOs still are in a legal grey area and this is one of the biggest risks which has meant several token sales prohibited US, China, or Korea based participants from taking part. This was being done to not run foul of a ban in ICOs in China and Korea.
- Tokens being registered securities will not be subject to enforcement since tokens comply with the law.
- Security registration is a mature and understood process.
- Possibly longer time to token sale due to need to build a business that is compliant with security laws.
- Some legal grey area still exists on how tokens are to be regulated as securities.
Notes: Security token sales are going through the more traditional route of registering their tokens as traditional securities. This is taking after an IPO where an entity that wants to go public has to have a running business with auditable books and a track record before it is allowed to do an IPO.
We believe that STOs will go through the same regulatory process as a company wishing to do an IPO. This means that it is a mature and well-understood process only with the addition of the necessity to incorporate the registration of security tokens. This significantly reduces risk since the token sale is conducted with the approval of the SEC.
There is also the possibility that some unscrupulous organizations will take advantage of a boom in STOs and start to register their tokens as securities when their tokens are only fit to be used as utility tokens. We advocate for due diligence and proper research to ensure that you only participate in token sales that you truly understand the pros and cons of.
STO & ICO Pro and Con Recap
Are STOs better than ICOs?
Based on the pros and cons, one might be led to believe that STOs are the better alternative to ICOs. We believe this is not the case because ICOs do have a use case for selling utility tokens and other tokens such as non fungible tokens.
We believe that a market consisting of both STOs and ICOs will constitute a lively and robust cryptocurrency ecosystem that can cater to the needs of people looking to get into or use blockchain and crypto.
As security token sales mature and increase in numbers, you can count on ico-check.com to provide coverage for all the latest STOs and ICOs.
For more, read this good opinion piece on STOs on Medium.com.