Security Token Offering 101 — An Introduction. What Is This New Thing Called STO Anyways?
A Security Token Offering (or STO) is a new financing method based on blockchain technology. An STO is best described as a process, in which fractional ownership of assets, equity, or debt is offered in exchange for money. It is, to a certain extent, similar to crowdfunding.
Suppose you are dreaming of owning a $100.000 sports car, but your personal wealth does not let you. In that case, you could organize an STO in order to divide the ownership of the sports car into multiple equal parts, each representing, for instance, an amount of $5.000. As a result, you would have 20 equal ownership parts, each worth $5.000.
During the STO process, you would try to sell these ownership parts to interested investors, who may be willing to step in either because they too want to own and drive a $100.000 sports car, or because they simply consider it as a potential investment — which could certainly be the case if the sports car is a rare old-timer.
So if you manage to find 19 other investors during the STO process, each willing to contribute $5.000 just as you, next thing to do would be collecting the money and then you would be able to buy the sports car. So far so good!
However, you are owning the car together with 19 other co-owners, so you better start working on a shared ownership agreement, under which all of the co-owners would agree on the ownership principles. These principles could for instance explain who can use the car and when, what would need to be done in case of an accident, what kind of insurance cost would be due per co-owner, and so on.
Setting up these shared ownership rules is complex, yet feasible. A far more difficult step would be the setup of an independent control authority, to check which co-owner is complying to these rules, and which co-owner is not. After all, it is unlikely that all other co-owners will belong to your circle of close friends. It is more likely that you will not know them personally, which complicates things in terms of trust.
In a civilized world, we look at governments (for instance, justice departments) to act as independent control authorities. This system works, however it is often very slow and not very proactive. But what if we could program a set of rules in computer code, and let the computer act as control authority, so that all of the 20 co-owners have to comply with these rules automatically, before they can even start using the car?
In an STO, this becomes a viable option thanks to the introduction of security tokens. A security token is a third generation digital blockchain token, following the first generation “crypto currency token” (e.g. Bitcoin) and the second generation “utility token” (e.g. Ether). Unlike the first and second generations, security tokens are subject to securities’ regulations, allowing for ownership rights of assets, equity, and debt, due to (1) their intrinsic legal qualification, and (2) their eventual purpose. But even more important is the fact that security tokens are fully programmable!
Hence, in our sports car STO example, we would represent each ownership part of $5.000 by a security token, resulting in 20 equal security tokens in total. At the end of the STO, each co-owner would receive a digital security token, in exchange for his/her $5.000. This security token would be programmed — in what is called a “smart contract” — with the set of rules agreed upon by all co-owners in the shared ownership agreement.
For example, there could be 20 sets of car keys, each having a digital link to the “smart contract”. This would mean that a set of keys could only be digitally activated, for example, when the relevant co-owner has paid his/her part of the insurance cost, as this would be a rule programmed in the “smart contract”. No insurance paid means no driving, because the keys won’t let you, it’s as simple as that.
Of course, not all rules will be programmable, but a vast number of them will be. As a next step, you could easily replace the sports car in this example with any other asset, for instance a house, an artwork, or a musical instrument (and we are not even talking about equity and debt instruments yet). As such, STOs bring a lot of new cooperative investment possibilities to the world, and although the principle is similar to crowdfunding, the programmable outcome makes it far more advanced and appealing to investors.
Written by Maarten Van Doorslaer, Marcell de Vries, and Alvaro Garrido, partners at 2140 Consulting.
