ICO vs STO: What’s the difference?

ICO vs STO: What’s the Difference?

The quest for funding can be a long journey. It can feel like a never-ending cycle of pitch calls, pitch decks, PR rounds and the like. This money-generating circus of sorts can be especially taxing when looking to raise capital through traditional processes like IPOs. In order to raise money in this way, through public investors, a private company that has gone public needs to go through a strict vetting process and even stricter regulatory measures once the offering has been initiated.

But that’s not the only way a startup or established private company can raise funds. Today, other offering types are opening new doors for those looking to gain financial backing for their business.

ICOs and STOs are providing another means for business owners and operators to generate funding. But what are these new capital raisers all about and how do they differ? Let’s take a look:

What is an ICO?

Let’s start by defining an ICO. ICO or an initial coin offering has become a popular way to generate capital within the blockchain and crypto space. Investopedia explains that interested investors can buy into an initial coin offering to receive a new cryptocurrency token issued by the company. This token may have some utility related to the product or service that the company is offering, or it may just represent a stake in the company or project.

Basically, any company can create a crypto token and decide to put it “on the market.” They first decide on the structure of the token’s value (static supply and static price, dynamic supply and static price, or static supply and dynamic price). These are all complicated ways of saying either the price of the currency can change, or the supply of the token can change, increasing or decreasing its overall value. However, much of this comes with very little oversight.

According to David Colin, CFP®,AIF® and Senior Vice President of Investments at Diamond Wealth Partners of Raymond James when it comes to ICOs, “It’s really challenging to know what to believe, who to believe, and what you are tangibly receiving.”

In comparison to an IPO, ICOs require far less regulatory compliance across various regions–including the US. That being said, some countries like Australia, New Zealand, Hong Kong, and the United Arab Emirates already have published guidelines governing ICOs.

What is an STO?

A security token offering or STO also involves an investor exchanging money for coins or tokens that represent their investment–however there are more regulations in place. STOs will undergo extensive investigations into token listings, data sharing, and investor onboarding procedures. In this way, an STO is more similar to an IPO.

“There’s a little more framework [with STOs]. There are more requirements from the SEC—it’s still based on blockchain technology and it’s backed by assets; companies’ securities; bonds, etc.” says Colin.

Basically, an STO is an ICO that’s backed by real-world value, not as determined by supply of the token or the price determined by its creators. Get it?

Security token offerings distribute securities or tokens that are fungible, negotiable financial instruments with attached monetary value. Security tokens are not traded on regular token exchanges and do trade on specialized exchanges.

“With STOs, many of them have a lock up. That could be a good or a bad thing– it doesn’t provide the purchaser an opportunity to sell for a period of time. The purpose of this is meant to prevent unscrupulous activity.”

ICO vs STO

When compared to an ICO, “An STO adds regulatory complexity. It can also add some legitimacy to the process, because ICOs have gotten a bad rep,” states Colin. “Using a regulated process helps individuals and businesses involved understand that there is some sort of framework.”

ICOs start with an intention to raise capital. From there a company will have to decide who they want to target as investors. Once tokens are created, the company will have to promote the offering to their target market to gain interest.

While referred to by some as the wild west of investments, ICOs may be attractive because they create direct connections between the company and investor and remove the invisible middle man from the process.

Still, Colin points out that, “ICOs are quicker [in part because] there is no regulatory oversight–but I don’t see any of that as a benefit.”

STOs learned from some of ICOs’ faulted ways. Security tokens can be programmable and enforced by smart contracts. That being said, Colin cautions,

“The biggest thing to consider is that the end users can lose money, there’s a healthy amount of risk that is involved in any of this.”

How IPOs, STOs & ICOs Compare

Unlike an IPO, which goes through a ton of regulation and a ton of cost, an STO is meant to sit somewhere in between an IPO and ICO. “An STO is in the middle,” notes Colin.

IPOing–while above board–is an extremely costly process, making it more aspirational than feasible for many companies that are just starting out. Companies must hire investment banks to market, gauge demand, set the IPO price and date, not to mention have at least one, if not a team, of dedicated lawyers putting together and reviewing all of the necessary documentation.

In comparison to traditional securities like IPOs that take a long time and a lot of money to process, security tokens facilitate services at a lower cost. Plus security offerings are open to anyone on the internet and not limited to local individuals. But, “While blockchain technology has the potential of improving the efficiency of traditional processes like the IPO,” says Colin, “there’s still a lot of work to be done to know if it’s the way of the future.”

Getting in at ground level and doing something in a new way often comes with an inherent risk. And Colin agrees,

“Anybody going into this, whether they are a business owner trying to raise capital or a person purchasing securities, it’s complex–the stakes are high.”

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