Security Token Offering 101 — The Benefits. What Is In It For The Issuer And The Buyer?
In our first article in this series of Security Token Offering 101, we elaborated on the basics of the STO principle. In this second article, we will tell you more about the benefits of STO for the token issuer and the token buyer, which again we will illustrate with an example.
Suppose that a real estate project developer is planning the construction of an apartment building for a total budget of 10 million Euro. As explained in our previous article, this project can be financed via STO by issuing for instance 10 million security tokens, each worth 1 Euro and representing an equal ownership part. Figuratively speaking, one can say that each security token represents a brick — or several bricks — in the building. The token issuer in this example could be the real estate project developer, while the token buyers could be any regular investor — we will call them John and Jenny Smith — purchasing a certain amount of “bricks”.
Benefit 1: Inclusivity
Often, 10 million Euro apartment buildings are financed by a handful of investors, each contributing several millions. Few individuals however have access to these kinds of amounts, which means that most of the people who actually want to invest in an apartment building, are not in a position to do so. Thanks to STOs this becomes possible, as the threshold to invest can be lowered significantly. For instance, the token issuer can set the value per token to be 1 Euro, allowing for John and Jenny Smith to also benefit from future returns like rental income and asset value increase of the apartment building. As such, STOs foster financial inclusivity, which is generally defined as “the practice or policy of including people who might otherwise be excluded”.
Also, for the token issuer, the project developer in this case, it can be beneficial to have more than just a few investors. Suppose one investor goes bankrupt during the construction period of the apartment building. With an STO financing structure, it will be much easier (and quicker) to find replacement investment because of the (1) access to more potential investor candidates and (2) lower threshold investment amount.
Benefit 2: Liquidity
Perhaps the biggest benefit of STOs for token buyers is its potential in terms of liquidity. Liquidity describes the degree to which ownership of an asset — such as an apartment — can easily and quickly be converted from and to cash, by buying and selling. Suppose that John and Jenny Smith want to buy an apartment in a traditional way. (Not to live in, but as an investment.) In this process, they will need to find a potential apartment for sale, gather the full investment amount, pay notary and registration fees, etc. All these steps take time, which translates into “low liquidity”, as the timeframe to buy (or sell) the apartment takes at least several weeks. However, an apartment (or apartment building) which is tokenized (i.e. its value is represented by security tokens) would have much higher liquidity, if the security tokens are traded on a public digital security exchange.
A public digital security exchange is an online market platform where digital securities — like security tokens — can be bought and sold. Once a specific security token is listed on an exchange, it means it can be traded around the clock (24/7/365). As such, liquidity of these security tokens is very high, as the process of buying and selling security tokens on an exchange only takes a few minutes. So if the security tokens from our example (fractionally representing the apartment building) become tradeable on an exchange, John and Jenny Smith can buy or sell these tokens instantly. Additionally, they will not be required to invest in a single apartment or in the apartment building as a whole, they will have the choice to invest in real estate security tokens for the exact investment amount they are willing to spend.
For the token issuer, issuing a highly liquid security token is an attractive way to find investors. After all, the chance of raising the full financing amount for the apartment building will be higher, and the search for investors will be less time-consuming.
Benefit 3: Programmability
In our first article, we explained that security tokens are digitally programmable. As a result of such programmability, the project developer (token issuer) does not need to worry about high administration costs for managing the relationship between all the token buyers, because the “smart contract” embedded in the tokens will take care of this. The smart contract is a programmed set of rules, which could automatically verify token buyers, draft and close investment contracts, distribute rental income, frame rules for token trading, and so on. Imagine a project developer doing all this manually for let’s say 1.000 different investors, an administrative nightmare!
And how will John and Jenny Smith (token buyers) benefit from this? Through STOs, many of the traditional intermediary parties, such as the real estate broker, the notary, and the loan agent, could become obsolete in the investment process which will save token buyers both time and money.
Benefit 4: Security
Due to their intrinsic legal qualification, security tokens are subject to securities’ laws and regulations that deal with traditional asset ownership, equity, and debt rights. This implies that John and Jenny Smith’s investment in security tokens (representing real estate ownership) will be fully regulated by law and subject to all common consumer and investor protection legislation.
In the event something goes wrong, for example if the real estate apartment building is not actually built for any reason, John and Jenny Smith will have the possibility to go to court — perhaps together with other investors — and take legal action against the project developer. Similarly, the project developer will be in a position to assert his rights the moment that a token buyer takes unauthorized actions such as identity fraud for instance.
Benefit 5: Immutability
Security tokens are digital tokens running on blockchain technology, which means that all transactions relating to these tokens — for example if John Smith buys tokens from the project developer or sells tokens to Jenny Smith — are recorded on a blockchain.
A blockchain is in fact a sophisticated database where data is stored in an immutable way, meaning that the records can never be altered or deleted by anyone or anything. As such, the blockchain provides us with a permanent overview of all parties ever involved in the financing and ownership relating to the apartment building, and at the same time reflecting exactly what actions took place between these parties! This “overview” might not seem so special at first glance, but if anything goes wrong with the real estate project, it will be relatively easy to track what exactly went wrong, at what point in time, and who is responsible.
The five benefits described in this article — inclusivity, liquidity, programmability, security, and immutability — are all equally important pillars and success factors for “tokenization” or security token technology implementation. Each of these benefits make it possible for John and Jenny Smith to invest freely and within their own limits in a real estate apartment building, something they never thought would be possible.
The same goes for the project developer. He is democratizing the real estate investment project, inviting a broader range of people than usual to participate, while benefiting himself via the smart contract. Therefore we believe it is safe to say that security tokens offer unique benefits for both the token issuer and the token buyer, and we are convinced that we have not yet seen their full potential.
Written by Maarten Van Doorslaer, Marcell de Vries and Alvaro Garrido, partners at 2140 Consulting. 2140 Consulting is specialized in capital financing with use of digital technologies.