Could the rise of security tokens render ICO’s redundant?
The global phenomenon of initial coin offerings (ICOs) has taken the world by storm. To illustrate this strong appetite for a piece of the crypto start-up cake, between 2014 and 2016, the cryptocurrency equivalent of just $295 million was raised across the entire ICO space. In 2017, this figure jumped to more than $5 billion, and in just the first three months of 2018 alone, to more than $6.3 billion.
However, with Q2-Q3 figures appearing to dry up, on top of increased rumors of impending regulatory oversight, many argue that a new breed of crypto-fundraising could be on the horizon. This potential sea-change, known as a security token offering, bears a resemblance to a more traditional initial public offering (IPO). Companies that are looking to raise funds need to first receive approval from their respective national regulator — a process that in itself is highly stringent — and token holders would receive a range of investor rights in a similar fashion to that of a traditional shareholder.
As a result, the underlying specificities of a security token could have a positive effect on the industry, insofar that it would deter unsavoury projects from attempting to dupe investors into investing in a project that has little chance of success. Whether it’s the $660 million Pincoin/Ifan scandal, celebrity endorsed $32 million Centra project or any of the other ICO failures that have resulted in widespread fraudulent activity, it is highly probable that in the case of a security token offering, they wouldn’t have got past the initial due diligence stage.
We are a utility token, therefore you are afforded no rights
One of the key facilitators that has allowed ICO projects to circumvent regulation is the manner that they market their respective token. Upon scrolling through the project’s whitepaper, you will notice that there is a dedicated section on what the token represents. To give you an example, take a look at this segment from the EOS platform:
“The EOS Tokens do not have any rights, uses, purpose, attributes, functionalities or features, express or implied, including, without limitation, any uses, purpose, attributes, functionalities or features on the EOS Platform.”
Many within the cryptocurrency community argue that standardized whitepaper protections such as the above example are merely a way to avoid regulatory scrutiny. The reason for this is that should an ICO token resemble a security, then it would need to receive the full approval of national regulators like the Securities and Exchange Commission (SEC).
One such example of this was the SEC shutdown of the AriseBank ICO in early 2018, whereby the regulator explained that the so-called crypt bank was a security in all but name, adding that that the project was not registered with any securities or banking regulators. However, according to the AriseBank whitepaper, the token resembled a utility. Nevertheless, this is one of the key reasons why crypto projects are so keen to avoid the dreaded “Tokenized Security” label, as seen in the recent court ruling involving Ripple.
How are Security Tokens different?
To illustrate what a security token can offer, it is well worth taking a quick look at the impending security token offering planned by billionaire investor Kevin O’Leary, who is most known for his role in the TV show the Shark Tank. O’Leary is hoping to raise $400 million in capital to purchase a hotel in the city of New York.
By opting for a security token, those who decide to invest in the project will hold a legal share in the hotel, proportionate to the amount they invest. In return for their financial contribution, investors will receive a digital token that represent their holding, all of which will be facilitate via a blockchain protocol.
However, unlike a traditional ICO — whereby currently no regulatory approval is required — the hotel will need to go through a due diligence process. Although the project is still in its early days, O’Leary has stated that the tokenized offering will adhere to the very same rules as you would expect in a conventional IPO. As a result, not only will the project have a stringent regulatory oversight in the form of the SEC, but investors will themselves have a range of consumer safeguards which would otherwise be non-existent in an ICO.
Although we are yet to see the world’s first security token offering go live, if the phenomenon does take off, we could see investor appetite transition from the Wild West of ICOs over to that of their security token counterpart, which more closely resembles traditional equity offerings.