In the mid-2015, the Ethereum network went live with 72 million of ether premined. Conceptualized by Vitalik Buterin, it was the first programmable money and a platform for minting own cryptocurrency easily. As a result, Ethereum became a decentralized version of NASDAQ and paved the way for hundreds of tokens allowing their founders to raise millions of dollars in hours without complying with regulations. What’s now a part of history, was a crucial shift in the economic and social paradigms.
ICOs become global phenomena
The Initial Coin Offering (ICO) is an effective crowdfunding tool utilized by blockchain companies for raising the necessary funding. In exchange for invested money one receives a corresponding amount of new tokens that are promised to make a much greater return in the future once traded on the open market. Thus, for each $1 invested you get an x10 to x1000 return, based on the hype of the project. For instance, Stratis token buyers gained an astonishing 54,710% profit whereas Spectrecoin followed with 49,878% profitability.
The main benefits of ICOs for the companies and the investors include absence of regulatory oversight and the ability to spend cryptocurrency as an investment. According to Coindesk, around 55% of ICOs were failing between January 2017 and July 2018. Agencies like ICOrating concluded even more appalling results of which a fair part appeared to be scams. Therefore, regulators took charge. First, China outlawed ICOs in 2017. Then, SEC followed with charges against numerous projects in 2018 and 2019.
Total ICO funding by month. Overall: $20+ bln. Credits: CoinDesk
IEO or how exchanges saved the party
It is rather naive to claim that general public cares much about technology and decentralization. The majority became allured with a chance of earning a quick buck and just wanted to get rich quick. A shadow of fraud ruined reputation of ICOs, so exchanges figured out how to turn the problem into an opportunity. They became a trusted intermediary with the following steps to eliminate scams completely:
Setting up a legal agreement between the development team and the exchange team;
Checking the authenticity of the project as the exchange team performs a thorough audit;
Minting tokens and sending them to an exchange prior to the sale;
Selling the tokens to individual contributors according to predetermined rules.
As a result, an Initial Exchange Offering (IEO) was established. The key differences between the ICO and the IEO include immediate tradability of the tokens on the exchange, independent audit of each project, and a large audience available for each IEO. In reverse, ICOs had to rely on powerful marketing to attract individual investors.
STO or DSO: let’s talk real business
Everything we mentioned above sounds rather like a sales pitch. For the most part, ICOs and IEOs launch to afford their founders a new Lambo. Furthermore, both become victims of pump-and-dump schemes that are relatively easy to spot. Coinmarketcap alone lists over 2,100 projects, but only a fraction of them have showed a considerable. Security Token Offerings (STOs), also called the Digital Security Offerings (DSOs) resolve a specific market problem: making low liquidity or illiquid assets accessible on the market.
Current types of digital securities. Credits: Kepler Finance
While the term STO assumes “tokenization,” we will rather refer to DSO which doesn’t infer any cryptocurrency at all. Instead, digitization permits to identify, divide, and store physical objects on the blockchain. Why doing it at all? First, to remove ambiguity in settlements and reconciliations . Digital securities can substantially reduce the reliance on brokerage accounts and bring an equal level of liquidity that already exists in public securities, but at a lower cost and with greater accuracy. Secondly, to grant cheaper funding for the companies, while limiting risks for the investors . For example, digital securities make it possible to both invest and trade the stocks of startups while complying with the financial regulations. If we had DSOs popping up a few years earlier, perhaps, Uber wouldn’t not have needed to pursue its IPO.
Finally, to yield liquidity for commodities, including the real estate . Coupled with the blockchain technology, digitization of securities are expected to bring much anticipated liquidity to private assets that were previously too difficult to sell. The barriers were inefficiency of dealing with fractional ownership such as art pieces and absence of the necessary channels like equity of private companies. Now the solution is out there and the trend is clear.
We have briefly reviewed the evolution of crowdfunding based on a distributed ledger. From the ICO to the IEO and the DSO, blockchain has enabled us with a framework to leverage various financial instruments. To learn how digital securities can benefit enterprises by transforming certain verticals, read our next articles on digital securities.