Tech & Innovation

Security Token Offering (STO): What It Is and How It Works

Security Token Offering (STO) What It Is and How It Works
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In this article, we’ll explain what a security token is, how an STO works, and why it might be a good option for startups looking to raise money. Let’s get started!

The introduction of Bitcoin in 2009 has revolutionized how we look at technology, especially the technology revolving around financial institutions. Blockchain technology’s evolution, a combination of distributed ledger and cryptography-based security, is regarded as the next big thing in the financial industry.  

Major financial institutions like JP Morgan, Goldman Sachs, Citi Group, Credit Suisse, etc., have been heavily investing in blockchain technology to secure and improve the banking experience. Financial Consultancies like Deloitte, KPMG, etc., are working with blockchain-based software to enhance security, reduce human error and fraud, and improve data confidentiality. Barclays have been facilitating KYC and Fund Transfer using blockchain-based software.

Blockchain in the future will play a crucial role in the financial sector as it provides security, decentralization, and transparency and makes the processes involved much more efficient, trustworthy, and secure.

What Is Security Token Offering?

Security Token Offering or STO also referred to as tokenized IPO (Initial Public Offering), offers tokenized digital securities. These security tokens are used for trading financial assets, equities, fixed income, and assets in general. Security Token Offering uses blockchain technology to enhance security and serve regulatory objectives like disclosure, transparency, fairness, integrity, innovation, and automation using smart contracts. STO can be regarded as digital representations of asset ownership like gold, real estate, the share of profit, revenue, equity, bonds, intellectual properties, and other rights.

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How Does a Security Token Offering Work?

Security Token Offering involves the creation of a secured Blockchain network. The tokens can then be created, acquired, transferred, sold, and can be burned and are governed by the rules of their blockchain network and its smart contract code. It can be offered over existing blockchain networks like Ethereum or can be specially created with unique guidelines and rules.

STOs are quite similar to companies raising funds through IPO. STOs differ from IPO as in an IPO. The investor is offered stocks against his investment. In STOs, digital tokens legally represent assets that can be gold, equity, real estate, etc., and are offered to the investor against his investment in the company.

STOs were introduced after many ICOs or Initial Coin Offerings scammed the investors. ICOs were unregulated, while STOs bring the best of both worlds, i.e., the power and security of blockchain in a regulated environment. STOs are secure as they fall under security regulations and come under many jurisdictions. 

Why Should a Company Look Forward to STOs?

Any startup or company looking forward to raising funds with an IPO can look over the alternatives in STOs that offer the same benefits digitally like shares (or any legal asset represented by the STO), voting rights, dividends, etc., and offers additional benefits of blockchain technology.

STOs are transparent, making auditing easy and more viable. All the participants can view the digital ledger and track the holdings of the tokens. Instant Settlement is automated using Smart Contracts on a Blockchain network and is another key feature offered by STOs. Moreover, STOs are based on a Blockchain network and hence allow operation on a 24×7 basis, i.e., all kinds of transactions, settlements, etc., can be done irrespective of the time, day, holiday, etc. 

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How Many Types of Security Tokens Are There?

There are three different types/ categories of security tokens available in the industry:

  • Equity Tokens are more or less like equity offered against investment digitally instead of physical documents. Equity Token holders can participate in decision-making, have the right to vote, etc.
  • Debt Tokens are the digital representations of short-term loans (with or without interest) against assets like bonds, real estate, gold, etc. 
  • Asset-based Tokens are the digital representations of assets, real estate, art, commodities, gold, etc. Blockchain allows a secure, immutable, transparent, trusted transaction record and reduces the risk of fraud, and automates the settlement process.

What Is the Purpose of Security Token?

STO solves the following issues comfortably:

  • Corporate assets’ low liquidity (how easily an asset can be converted to cash without affecting market price) leads to lower valuation and less investment attraction.
  • Higher cost and delay in operations due to the involvement of third parties like banks, financial institutions, and government.
  • Limited fundraising opportunities due to the inability to attract investors.
  • Issues of Protection of Data.
  • Inefficient and Error-prone management of transactions.

Security Token Offering vs Initial Coin Offering

ICO (Initial Coin Offering) and STO (Security Token Offering), both rely on blockchain technology as token distribution requires smart contracts. 

ICO is mainly used to buy products or services while on the other hand when it comes to STO, it is a kind of investment. STO is a trade-enabled external asset that should comply with the rules and regulations of the state.

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How Do You Get a Security Token Offering?

STO Development solutions must have to be safe, secure, transparent, and comply with all the financial standards and regulations, i.e., SEC regulations, etc. The two most important factors a client should consider while choosing a good STO development provider are:

1. Development Methodology

The Development Methodology depends on the product. When a product is trying to solve a problem, it has to be worked upon very specifically. Hence when it comes to STO development the development methodology becomes an important part. In more than 70% of the cases, companies follow the Agile development methodology. Agile helps to achieve collaborative development by addressing cross-functional needs.

2. DevSecOps

DevSecOps, also known as the security through code development approach. Security is one of the most important requirements when it comes to STO development, so the STO development service providers who follow the DevSecOps approach tends to make 85% better STO products in terms of security than those who follow the DevOps approach.

Along with the approach and methodology, the ideal STO development provider must also address the following issues:

  • Tokenization of assets helps fractionalize ownership, enhances liquidity, and helps attract financial investors.
  • Blockchain, a decentralized technology that eliminates go-betweens, enhances the operation speed and lowers costs.
  • STO complies with the legal frameworks, allows 24/7 access, and attracts international investment against security tokens.
  • Blockchain automates the process using smart contracts.
  • The use of robust cybersecurity algorithms helps achieve higher security and minimizes financial fraud.

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Conclusion

Security Token Offerings (STOs) are the new way to raise money and they’re gaining in popularity. STOs offer a number of benefits over traditional methods such as IPOs and crowdfunding. If you’re looking for a more secure, compliant way to raise money, then an STO might be right for you.

We’ve outlined the basics of how STOs work in this blog post, but if you have any questions or suggestions, leave them in the comments below. We’d love to hear from you!

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