The rise of blockchain has transformed how companies raise funds and how investors access opportunities. Beyond traditional stock offerings and crowdfunding, a new model has emerged that combines blockchain’s efficiency with the regulatory safeguards of conventional finance. This model is known as the Security Token Offering, or STO.
STOs provide digital tokens that represent ownership of real or financial assets, giving investors rights similar to those of shares or bonds. Unlike ICOs, which often lacked oversight, STOs comply with securities regulations and aim to offer better protection for participants. In this guide, we will explore what STOs are, how they work, their benefits, risks, and why they are gaining global attention.
What Is a Security Token Offering (STO)?
A Security Token Offering, or STO, is a blockchain-based fundraising method where companies issue digital tokens that represent ownership of assets. These assets can include real estate, company equity, revenue streams, or other tangible and intangible holdings. By using blockchain, STOs enable faster transactions, transparency, and programmable compliance.
Unlike Initial Coin Offerings (ICOs), which provide tokens without clear legal rights, STOs are treated as regulated securities. This means they must comply with financial regulations and offer investors similar protections to traditional instruments like stocks and bonds. By combining blockchain innovation with established legal structures, STOs create a bridge between traditional finance and digital assets.
How Do Security Tokens Work?
Security tokens function as digital versions of traditional securities, offering legal rights to investors. They are designed to represent equity, debt, or other assets secured through blockchain technology.
Equity Security Tokens
Equity security tokens represent ownership in a company, similar to traditional shares. Holders may receive dividends, voting rights, and profit-sharing opportunities. These tokens provide transparency and efficiency by recording ownership on the blockchain, reducing reliance on intermediaries. For businesses, they create new ways to raise capital while ensuring compliance with securities laws.
Debt Security Tokens
Debt security tokens operate like digital bonds, offering investors fixed interest payments over time. They represent a company’s debt obligation and are typically backed by collateral or revenue. Investors benefit from predictable returns, while issuers can access capital quickly and efficiently. By using blockchain, the issuance and repayment process becomes more secure and transparent.
The Security Token Offering Process
Launching an STO involves several structured steps that ensure compliance and investor protection. Each stage is critical for establishing trust and enabling smooth participation in the offering.
Token Creation and Backing
Security tokens are built on blockchain platforms and are backed by assets such as equity, revenue streams, or real estate. The backing ensures that each token holds intrinsic value. This link to tangible or financial assets provides greater confidence for investors compared to unregulated tokens, making STOs a more secure fundraising approach.
Compliance with Regulations
STOs must comply with strict securities laws in the jurisdiction where they are launched. This includes disclosures, audits, and ensuring investor protection through transparency. Compliance reduces risks for both issuers and investors, making STOs a safer alternative to ICOs. Meeting these legal standards builds trust and credibility in the fundraising process.
Issuance and Distribution
Once compliance is ensured, companies issue security tokens and distribute them to investors. The process is recorded on the blockchain, which guarantees transparency and efficiency. Investors receive tokens directly into their wallets, representing their ownership rights. This streamlined distribution model removes unnecessary intermediaries and reduces administrative costs.
STO Regulations and Legal Framework
Security Token Offerings must operate within established legal systems to protect investors and ensure legitimacy. Regulations vary globally but share the common goal of governing fundraising activities responsibly.
The Howey Test
The Howey Test is a standard used in the United States to determine if a token qualifies as a security. It assesses whether an investment involves money, a common enterprise, expected profits, and reliance on third-party efforts. Passing this test ensures compliance with securities laws and confirms investor protections.
Regulation D
Regulation D allows companies in the United States to raise capital without fully registering with the SEC. It simplifies the fundraising process while still requiring companies to file Form D, which discloses essential information about directors and the offering. This provides transparency while reducing regulatory burdens for smaller firms.
Regulation S
Regulation S applies to offerings made outside the United States, giving international companies a framework to raise capital without breaching American securities laws. Issuers must still follow the rules of the country where the offering occurs. This regulation supports global participation in STOs while maintaining legal clarity for issuers.
Regulation A+
Regulation A+ permits companies to raise up to $50 million from accredited and non-accredited investors. It opens STOs to a wider investor base, combining public participation with private funding. Although it requires SEC approval, Regulation A+ balances accessibility with investor protection, making it a popular choice for larger projects.
Also Read: On-Chain vs Off-Chain Transactions
Benefits of Security Token Offerings
STOs combine blockchain technology with regulatory safeguards, giving both businesses and investors a range of advantages. These benefits make STOs a promising alternative to traditional fundraising methods.
Improved Access to Assets
STOs allow investors to access asset classes that were traditionally difficult to trade, such as fine art, real estate, and private equity. Tokenisation opens these markets to a wider audience, providing more opportunities for diversification. This accessibility helps investors expand their portfolios without the barriers usually associated with high-value assets.
Cost Efficiency
Launching an STO is generally more cost-effective than conducting an IPO. By using blockchain, companies can embed compliance features into smart contracts, reducing legal and administrative costs. This efficiency ensures greater transparency while lowering the overall expenses for issuers. As a result, STOs make capital raising more affordable and streamlined.
24/7 Trading
Unlike traditional markets with fixed operating hours, STOs benefit from blockchain technology that supports trading at any time of the day. This flexibility allows investors to respond quickly to market conditions. Around-the-clock trading increases participation and makes investment more dynamic, especially for those managing diverse portfolios across different regions.
Fractional Ownership
Through tokenisation, investors can purchase smaller portions of high-value assets. This fractional ownership makes it possible for more people to invest in sectors that were once limited to wealthy participants. It increases inclusivity while helping businesses attract capital from a wider investor base without requiring large contributions.
Increased Liquidity
Tokenisation improves liquidity by enabling faster transactions and creating active secondary markets. Investors can buy and sell tokens more easily, improving cash flow and flexibility. Enhanced liquidity also benefits issuers, as it attracts more investors who value the ability to exit positions quickly, unlike in traditional illiquid markets.
Risks of Participating in STOs
While STOs offer many advantages, they are not without challenges. Investors must carefully evaluate potential risks before participating to protect their capital and manage expectations effectively.
Regulatory Uncertainty
STOs depend on compliance with securities laws, which vary across countries and can change over time. Sudden regulatory shifts may affect the legality of tokens or restrict trading opportunities. This uncertainty can create difficulties for both issuers and investors, making it essential to stay updated on legal requirements and international guidelines.
Limited Market Adoption
Although STOs are gaining attention, their market adoption remains relatively limited compared to traditional fundraising methods. Smaller participation reduces liquidity and can impact token value. Investors must account for the possibility of low demand in the secondary market, which could make it harder to sell or exit positions profitably.
Potential Loss of Assets
Like any investment, STOs carry the risk of financial loss if projects fail to deliver expected returns. Even with regulatory safeguards, factors such as poor management or underperforming assets can reduce token value. Investors should conduct thorough due diligence on issuers and assess underlying assets before committing funds.
Examples of Security Token Offerings
Several STOs have already demonstrated how this fundraising method works in practice. These cases highlight the diversity of industries adopting STOs and the potential they bring to global finance.
tZERO
tZERO launched one of the most notable STOs in 2018, raising approximately 134 million dollars. Its platform focuses on creating a more transparent and efficient stock trading system using blockchain technology. This example illustrates how STOs can modernise existing financial markets by combining regulated securities with decentralised innovation.
22x
22x is a tokenised venture capital fund that raised around 22 million dollars through its STO in 2018. It enabled investors to gain fractional ownership in a portfolio of start-ups. By offering direct exposure to multiple ventures, the project highlighted how STOs can provide broader investment opportunities with reduced barriers to entry.
LXDX
LXDX became one of the first companies to issue stock through a Security Token Offering. Tokens represented direct ownership in the exchange and were priced at one euro each, raising 57 million dollars. This demonstrated how STOs can streamline fundraising for companies while making ownership more accessible for investors worldwide.
Preflogic
Preflogic used smart contracts to issue security tokens under Regulation D, S, and CF. Its STO Wizard platform allowed companies to launch their own compliant offerings without high legal costs. This example shows how STOs can reduce barriers for issuers and simplify entry into regulated fundraising markets.
Conclusion
Security Token Offerings have emerged as a regulated way for companies to raise funds while giving investors rights similar to traditional securities. By combining blockchain technology with compliance, STOs bridge the gap between digital innovation and established financial systems. They provide efficiency, transparency, and access to asset classes that were once limited.
For investors, STOs offer opportunities but also come with regulatory and market risks that must be carefully assessed. KoinX helps you simplify this journey by tracking your security token investments, managing reports, and ensuring tax compliance. With KoinX, you can stay informed and in control. Get started with KoinX today and take a smarter step into regulated digital assets.
Frequently Asked Questions
How Are STOs Different From ICOs And IPOs?
STOs differ from ICOs because they are regulated and provide legal rights such as dividends or voting power. They also differ from IPOs as they use blockchain technology, allowing faster settlement and fractional ownership of assets.
Can Anyone Invest In A Security Token Offering?
Participation in STOs often depends on regulatory rules in each country. In many cases, only accredited investors can take part, while some frameworks, like Regulation A+, allow broader access to non-accredited investors.
Are STOs Recognised Globally Or Limited To Certain Countries?
STOs are subject to local securities laws, meaning recognition varies worldwide. Countries like the United States and Switzerland have established frameworks, while others are still developing regulations for security tokens.
How Do STOs Improve Transparency For Investors?
STOs improve transparency by recording ownership and transactions on the blockchain. This ensures accurate records, reduces reliance on intermediaries, and gives investors greater confidence in the security and traceability of their holdings.
What Is The Role Of Smart Contracts In STOs?
Smart contracts automate compliance by embedding legal and trading conditions directly into the token. They help enforce restrictions, ensure transparency, and reduce costs by replacing many manual administrative processes.
Do STOs Offer Dividends Or Only Token Value Appreciation?
Depending on the design, STOs may provide dividends, interest payments, or profit shares in addition to potential token value appreciation. The rights attached to each token are clearly defined in the offering terms.
How Long Does It Take To Launch An STO?
The timeline for launching an STO varies based on compliance requirements and jurisdiction. While blockchain enables faster token creation, regulatory approval and disclosures can extend the process from several weeks to months.
