ICO vs. STO – Understanding the Differences

Beginner’s Guide / 24.08.2020

As a savvy blockchain investor, it’s smart to understand the differences between an ICO vs. STO. Recently, there has been a lot of hype surrounding STOs and their ability to service institutional clientele. Here is how these unique financial instruments came to be and why so many analysts see them as the evolution of Initial Coin Offerings (ICOs).

What is an ICO? – ICO vs. STO

The first step in this journey is to understand precisely what an ICO is and what purpose it serves. ICOs are blockchain-based crowdfunding campaigns. What makes them so unique is their ability to streamline the crowdfunding process.

Before ICOs, crowdfunding campaigns consisted of Initial public offerings (IPOs).  IPOs are the process by which a private company can go public through the sale of its stocks to the general population. The problem with IPOs is that they are expensive to host and require the company hosting the event to traverse an intensive regulatory framework. 

On average, hosting an ICO costs a company around $1 million. Additionally, there are specific requirements every company that wishes to host an IPO must follow. These regulations include publicly listing financial disclosure. Firms must also provide in-depth information regarding their executives and their network. Once you take all of these factors into account, it’s easy to see why SMEs decided to search for alternatives. 

 ICOs Eliminate these Costs

Through the use of blockchain technology, ICOs provide a more secure and efficient means to accomplish the same goals as an IPO. Blockchain leverages transparency and real-time monitoring capabilities to ensure the network remains secure. These systems also eliminate the need for third-party verification systems.

These systems are responsible for much of the costs and delays encountered in the IPO strategy. Eliminating these concerns lowers the entry bar for startups seeking to secure public funding. Consequently, it was only a matter of time before ICOs began to take flight.

The First ICOs

The first ICO took place in July 2013. The event, hosted by the Mastercoin demonstrated how ICOs could provide the same services as IPOs but at a fraction of the cost. In 2014, Ethereum launched an ICO that secured the network 3,700 BTC in its first 12 hours (approximately $2.3 million at the time).

2017 Break Out Year

In 2017, the entire crypto market experienced a breakout year. The value of most cryptocurrencies skyrocketed as more investors poured into the sector. At this time, it seemed as if all blockchain-centric companies were well on their way to success. However, this was not the case. 

Billions Made

Despite companies such as EOS securing billions during their ICOs, traditional investment firms and major corporations still avoided the practice. These companies felt as if the ICO sector was the wild west of investments, and the lack of an established regulatory framework left their investments open to unnecessary risks.

Sadly, many of their concerns proved to be true as scammers began to dominate the ICO sector. At one point, reports suggested that as many as 80% of the ICOs available to the public were scams. These scams resulted in billions of lost revenue. 

Regulators Step In

As the number of jolted investors increased, so did their voices demanding retribution. Eventually, regulators had no choice but to intervene. This intervention is known as the ICO crackdown. Officially, the ICO crackdown started in China after the government banned ICOs and cryptocurrency exchanges.

Over the following years, regulatory bodies such as the SEC began to go after major ICOs from 2017. These firms had to pay fines and penalties for “the illegal sales of securities.” In some instances, the firms had to refund investors fully.

Howie Test

Usually, regulators turned to the half-century-old “Howie Test” to determine if a particular digital asset fell under the strict securities guidelines currently in place globally. The Howie Test is simply a set of questions regarding a specific investment. If you answer yes to two of these questions, your investment falls under the scope of securities regulations. 

  1. It is an investment of money
  2. There is an expectation of profits from the investment
  3. The investment of money is in a common enterprise
  4. Any profit comes from the efforts of a promoter or third party

If You Can’t Beat’em, Join’em

As the regulatory climate began to become hostile towards ICOs, blockchain developers sought out other ways to continue to leverage blockchain technology within the crowdfunding sector. Soon it became evident that a new type of token was needed. 

What is an STO?

This token, known as a security token, would include all of the regulations required by the SEC directly in its protocols. These tokens featured advanced smart contracts that could approve and deny transactions based on their regulatory compliance. These new offerings received the name – Security Token Offerings.

What Makes STOs so Great

STOs provide traditional institutions the ability to conduct crowdfunding campaigns via the blockchain without the risk of future regulatory concerns emerging. These token can include a host of regulatory requirements. These regulations can include KYC/AML, geo-location-based restrictions, and minimum investment amounts.

Different than ICOs

Although STOs operate similarly to ICOs, they are very different in many ways. For example, in an ICO, anyone can participate from around the world. Additionally, there is little to no additional requirements to meet. In most instances, the only real concern is the ICO start and completion dates.

An STO requires a lot more work on the part of investors. Investors will need to meet all of the predefined stipulations before they can even invest in an STO. Additionally, STO investors are unable to trade their tokens to unauthorized parties. In this way, STOs retain regulatory compliance throughout the lifecycle of their tokens.

So Which is Better – ICO vs. STO?

In the end, there is no one size fits all when it comes to blockchain crowdfunding. If you live in a region with little regulatory oversight, an ICO will cost much less to host and provide you with the same opportunities as an STO. However, if you live in the US or EU, you will want to evaluate your project to see if it is wise to host an STO or an ICO based on its merits.

David Hamilton aka DavidtheWriter is a long time Bitcoinist and cryptocurrency journalist. Currently, he has over a thousand articles published on blockchain technology. His expertise and experience makes him one of the most reputable writers in the sector.