Starting from the Beginning: Initial Coin Offerings (ICOs)
In 2016, ICOs started gaining traction within the blockchain and crypto community. The hype exploded exponentially, and by Q2 2017, the concept of ICOs and the desire for easy profits had spread to both VCs and average retail investors. More than $6 Billion was raised through ICOs in 2017. As 2017 came to an end, so did the unsustainable growth of the ICO market, and an inevitable market correction ensued. Hundreds of ICOs were caught performing exit scams and others were left with Ethereum (ETH) that they had raised, now worth less after the fall of crypto prices across the board. The year was a lesson for most crypto investors (many with no prior market experience); the ease of launching an unregulated ICO with no tested product or service, along with the lack of accountability for officers and involved parties allowed for unproven projects to be sold to unaware investors as the next paradigm. As investors cut their losses and looked to the future, a new model offered to solve many of the downsides of ICOs, allowing for increased regulation, full disclosure, accountability for the entity launching the tokens, and brand new value propositions.
A Promising Solution: Security Token Offerings (STOs)
Security Tokens, unlike Utility Tokens (and tokens sold under the guise of Utility Tokens), are classified as financial products, meaning that they are regulated according to similar rules as securities (many countries use systems similar to the Howie Test for classification). Backed by tangible assets, they represent a share in profit, dividends, interest, or some other expected financial gain. They are regulated by the regulatory bodies that govern financial securities, and require compliance with financial securities law, approval, and/or licenses to be sold.
Accountability and Disclosure
The lesson from the ICO boom is clear: though blockchain offers great transparency into spending and smart contract construction, more structure is needed in terms of disclosure. As STOs in most countries require abiding by the same laws that govern the issue of financial products to the public (or to accredited investors), steps to satisfy disclosure requirements must be taken before selling any tokens. At a minimum this usually requires publishing or sharing an offering memorandum, more detailed than the typical buzzword-heavy ICO whitepaper. As countries typically require companies issuing security tokens to announce their intentions to sell securities (through a filing, public notice, or application), the directors of the company are on file and can be held accountable if they do not act in the best interest of the investors. This makes it unlikely that a company “exit scam” or use funds for purposes different from those which were specified in the offering memorandum.