Technology = Advancement
The development of blockchain technology has created new ways for companies to fundraise for their businesses. Blockchain startups can go the traditional route of raising money from friends/family, VCs, and other institutional investors, or they can have a “public” offering through an Security Token Offering (STO) or Initial Coin Offering (ICO). Public in this case, though, is a relative term. It can mean everyone (in the case of ICOs) or accredited investors only (in the case of most STOs) can participate.
The main benefit of a public offering is that it can be a much swifter way to raise cash compared to the traditional fundraising route, where institutional investors can take months of arduous due diligence, that is assuming you can even get a meeting with them in the first place. If they do decide to invest, you can end up losing a good chunk of equity in your business.This article will go over the differences between STOs and ICOs for U.S based investors since other jurisdictions have different policies, as well as cover the future of both in the current market environment.The common theme behind both is that your investment is now tokenized (digitized) on a distributed ledger.
ICOs = Initial Coin Offerings
ICOs are a sale of digital assets managed on a blockchain or Distributed Ledger Technology (DLT). ICOs are similar to traditional IPOs (Initial Public Offerings) in the sense that they are both mechanisms, through which companies can raise capital from both retail and accredited investors. However, instead or receiving equity (shares) in the company, investors receive a new cryptocurrency token specific to that ICO.
The token you receive does not represent financial interest in the company, but is rather an exchange for future products or services. In addition, the investor is betting that the token will appreciate in value. Also unlike traditional IPOs, the companies can be very early stage–sometimes having no product at all. Companies have raised ICOs based on a Whitepaper alone. According to Coinbase, ICOs have cumulatively raised $22.5 billion, $17 billion of which was raised in 2018.
With last year’s ruling that only Bitcoin and Ether were the two digital assets outside the jurisdiction of the securities law, ICOs are no longer the way to raise capital. Instead, companies are now pivoting to security tokens.
STO= Security Token Offerings
STOs are regulated digital assets that are managed on a blockchain or DLT. Unlike ICOs, STOs represent traditional securities like debt, equity, convertibles, etc, which means investors have ownership or governance rights that entitle them to a financial interest. Investors usually must be accredited in order to participate (This is true in most cases- although there are exemptions which allow non-accredited investors to participate). So far STOs have raised far less than ICOs–less than $300 million according to STO Scope. With that said a few ICOs last year “regulated” their fundraise by having private sales to accredited investors only. These precautions were a segue to STOs as the SEC began cracking down on ICOs due to fraud and price manipulation concerns.
In fact, these two offerings perfectly describe the evolution of how blockchain/crypto companies raise money. ICOs became increasingly popular in 2017 and the first half of 2018 as they raised billions of dollars, but have since died down due to regulatory concerns. Last year, the SEC served subpoenas on several companies that raised money through ICOs, establishing that ICOs are securities and therefore must be regulated as such. Jay Clayton, chairman of the SEC, said last year, “I believe every ICO I’ve seen is a security.” They found that Decentralized Asset Organizations issuing tokens must file for a security exemption (In most cases, a Reg D). Some companies were required to return all the capital they raised in addition to paying a fine. In reality the two offerings are essentially the same thing, with one being regulatory compliant. Actually CoinDesk,who puts out a quarterly blockchain market report, does not separate ICOs from STOs.
Where Do We Go From Here?
With the massive correction in the crypto markets in the second half of 2018, many companies withdrew their ICOs and re-strategized how they would raise money to fund their projects. Some are filing STOs, but many (and especially smaller companies) are going back to traditional equity/debt fundraising. Some companies that had raised ICOs are now trying to figure out how to reorganize their cap tables and valuate their businesses for future fundraising the traditional way (e.g. what is the the company actually worth? Is it the total dollars raised? Or is it the market capitalization of their token). The community of investors, entrepreneurs, lawyers, accountants, etc. are currently working together to figure this out.
The adoption of STOs is a positive step forward. As infrastructure and regulation continue to develop the industry, we at Cadence believe STOs will drive adoption for institutions to finally digitize financial instruments and move towards automated transactions. It is the job of regulatory agencies to protect investors from fraud by creating guidelines that will allow for further (and institutional) adoption of digital securities. Cadence is digitizing alternative assets to bring these securities to mainstream accredited and institutional investors. The future is digital and we are excited to be a part of the infrastructure buildout.