A security is a financial instrument that holds value and can be traded. Under this definition, many of the instruments we see today – stocks, bonds, options – could be considered securities.
In a legal context, the definition is considerably more narrow, and varies from jurisdiction to jurisdiction. Should an instrument amount to a security according to a given country’s criteria, it is subject to heavy regulatory scrutiny.
In this article, we’ll discuss how blockchain technology is poised to streamline the long-standing financial markets with security tokens and provide an understanding to STO meaning stock.
What Is A Security Token?
A security token is a token, issued on a blockchain, that represents a stake in some external enterprise or asset. These can be issued by entities like businesses or governments and serve the same purpose as their incumbent counterparts (i.e., stocks, bonds, etc.).
STO Meaning Stock
An STO, also known as a Security Token Offering, is a digital token supported by blockchain technology that represents a stake in an asset. STOs enable digital funding, while still complying with government regulations. Security tokens require extensive regulations, so they are not traded on regular token exchanges. However, they are similar to ICOs (initial coin offerings) in that they are fungible tokens, meaning that they hold monetary value.
How Do Security Tokens Work?
STOs function as digital representations of real-world assets, like bonds, stocks, or even gold. Security tokens are similar to the certificates issued for stocks. For stocks, ownership information is entered into a document as an official certificate of ownership. For security tokens, similar information is recorded, the major difference being that it is recorded on the blockchain and represented by a token. Because of this, security token offering services enable asset tokenization for many businesses.
Why Use Security Tokens?
To draw on an example, let’s say that a company wishes to distribute shares to investors in a tokenized form. These tokens can be designed to come with all of the same benefits one would expect from shares – notably, voting rights and dividends.
The advantages of this approach are numerous. As with cryptocurrencies and other forms of tokens, security tokens benefit from the properties of the blockchain they’re issued on. These properties include transparency, rapid settlement, no downtime, and divisibility.
Transparency
On a public ledger, the identities of participants are abstracted, but everything else can be audited. Anyone is free to view the smart contracts that manage the tokens or to track issuance and holdings.
Rapid settlement
Clearing and settlement have long been regarded as a bottleneck when it comes to the transfer of assets. While trades can be carried out near-instantly, reassigning ownership often takes time. On a blockchain, the process is automated and can be completed within minutes.
Uptime
The existing financial markets are somewhat limited in their uptime. They’re open for fixed periods during the days of the week, and closed on weekends. Digital asset markets, on the other hand, are active around the clock, every day of the year.
Divisibility
Art, real estate, and other high-value assets, once tokenized, could be opened up to investors that may not otherwise be able to invest. For instance, a painting worth $5M could be tokenized into 5,000 pieces, such that each is worth $1,000. This would dramatically increase accessibility, while also providing increased levels of granularity over investments.
It’s worth noting, though, that some security tokens may have a limit on divisibility. In some cases, if voting or dividend rights are conferred as equity shares, there could be a limit on token divisibility for execution purposes.
Security Token Offering vs Initial Coin Offering
STOs are similar to ICOs (initial coin offerings) in that they are coins issued to investors to represent their investments. However, they differ in their (reported) utility.
An ICO, also known as an initial coin offering, is used as a way for entrepreneurs to raise money through digital coins. They allow users to gain access to decentralized applications, and as such, they can step around laws by claiming they are made for utility not investments. Because ICOs do not need to remain compliant with laws and regulations, ICOs offer a lower barrier to entry and are more easily available to the wider public.
ICOs emphasize their utility, though if the project they represent is successful they can also be used as a form of currency to buy a product or services. ICOs are not well-regulated, which means they are riskier but also more flexible.
STOs differ from ICOs as they represent investment contracts for investment assets like stocks, bonds, or even real estate investment trusts (REITs). STOs come with additional legal obligations as they seek to comply with security laws ICOs are not subject to.
Security Token Offering vs Initial Public Offering
STOs (security token offerings) also have similarities with IPOs and are often regarded as a hybrid between an ICO (initial coin offering) and an IPO (initial public offering). The biggest difference between an STO and IPO is where the investment is issued, the blockchain or the traditional market.
An initial public offering is the process by which a private company first offers a share to the public. Both STOs and IPOs can represent an investment in a company, although STOs have more flexibility to represent assets beyond just company shares. With an IPO you receive a document communicating the ownership of your investment, while with an STO you receive a digital token recorded on the blockchain.
STOs are more flexible than IPOs and can be much more cost-effective due to lower fees. A company that offers an STO does not need to be completely tradable by the public, which makes it perfect for companies looking to secure investors for specific projects.
Types of Security Tokens
There are three different types of security tokens: equity tokens, debt tokens, and asset-backed tokens.
Equity Tokens
Almost everything about an IPO and an STO equity token is the same as they both represent shares in a company. Equity token holders are similarly entitled to a company’s profit, and even have the right to vote like a shareholder. The main difference between a traditional stock and an equity token is how the ownership information is recorded. Equity tokens will be recorded on the blockchain, while traditional stocks are printed on certificates and/or stored in a database.
Asset-Backed Tokens
Asset-Backed Tokens represent real-world assets, like real estate or art. These tokens use the blockchain to securely save a record of these assets. These tokens not only provide a secure transaction record but can also retain value which means that the token can itself act as a digital asset.
Debt Tokens
Debt tokens work like short-term loans that investors give to a company. The contract created for this loan will exist on the blockchain network and act as a security for the debt. The price of the debt token will be largely dependent on the dividend model and risk involved in the loan.
Closing Thoughts
Now that you’ve understood STO meaning stock, security tokens appear to be a logical progression for the financial industry. Despite their use of blockchain technology, they’re much closer to traditional securities than cryptocurrencies or even other tokens.
Should the promise of security tokens come to fruition, the operations of financial institutions could be significantly streamlined. In time, the use of blockchain-based tokens in place of traditional instruments may very well catalyze the merging of legacy and cryptocurrency markets.
