The year 2017 is considered a success ride for ICOs by far. Apart from a few flakes, a large number of ICOs have proved to be successful for their commencers as well as the investors. Despite being popular and a successful fundraiser, ICOs still remain a puzzle for many, people are yet to understand how it functions and how can they get benefit out of it.
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Dawn of ICOs
ICO (Initial Coin Offering) is a means to raise fund for startups by offering digital tokens or coins instead of equity shares. It enables the startups to raise capital by selling the tokens instead of going through the conventional seed money procedures. Last year, a huge surge of ICOs was noticed in markets across the globe.
Besides getting recognition by the investors worldwide, it also caused the regulatory bodies to frown upon its functioning and allocation of tokens. The root cause of this mistrust lies in the nature of tokens being copiously dispersed right now. The ERC 20 tokens which are distributed in an ICO are regarded as a Utility token, which is not meant to be a security.
However, in July 2017, a report released by Securities and Exchange (SEC) mentions that a number of tokens issues in ICOs are actually securities and their exchange as a regular or utility token is the breach of security laws in the US.
Also Read : How to develop ERC20 Token Web Wallet?
Different between Utility Token and Security Token
The tokens distributed in ICOs are classified into two categories, Utility Tokens and Security Tokens.
The utility tokens are more or less like gift vouchers, they give you access to the company’s products and services. They do not hold any type of ownership or stake value with them.
The security tokens are the ones that carry or represent the shares of company stock. These tokens are fungible and backed by the external sources, they are also subjected to federal securities regulations.
The basic difference between them is, utility tokens do not grant you any ownership to the company, whereas security tokens bestow you with the possession of the company.
ICO is broadly viewed with the similarities drawn from IPOs (Initial Public Offering), hence the tokens released during an ICO are believed to carry ownership rights to company. But, it is not always the case.
A Howey Test can help us determine if a digital token is a security token or a utility token. This test came into existence following a litigation filed in 1946 in Supreme Court of United States. It was named after the defendant “W.J. Howey” and has served as a precedent for testing instruments’ viability for being an “investment contract”.
A token must meet the following requirements to become an investment contract:
- An investor must invest his money or assets for buying tokens.
- The investor expects profits as return of investment.
- Investment has to be in an “Enterprise”. ( This has been vaguely explained by many courts and subjected to different interpretations)
- Involvement of a third party or promoters and gaining profits by them.
If a token meets all these requirements, it will be classified as a security token. However, the SEC is yet to finalize its norms for security tokens.
Current issues with ICOs
Although most of the startups issue their tokens as a utility, the SEC filters them through “substance over form” rule, which means that they monitor the tokens as per their actual usage, contrary to the way they are meant to be used.
Investors expect a rise in the value of tokens over time, as a result they are viewed as an investment, however many projects are viewed as securities owing to their attributes.
This worldview is being objected by the regulatory bodies as they tend to infringe the security laws. To avoid this issue, many ICO projects are being held to be released in the US.
Benefits of Security Tokens
Security tokens which follow the guidelines of SEC are cheaper as well as more functional than the utility tokens. As the SEC is starting to crack down on the security tokens operating under the disguise of utility tokens, issuing valid security tokens can save you from legal risks, it can also provide protection to both the company and contributors.
Firms that default on these parameters may face harsh punitive measures. Many ICO projects are already on alert and doing everything they can to not fall under category of securities. This is being done in a bid to exclude them from many regulations and restrictions laid down by SEC which can severely curtail their adaptability to different platforms.
Read More : ERC Standards Cryptocurrency Token Development Services
Accredited Investors Can Only Invest in Security Tokens
Not everyone will be able to invest in the private securities offerings, as an investor, you’ll have to meet some requirements to become eligible.
- Only with an annual income of over $200,000 individually, or $300,000 with a spouse, continued for the period of two year and with the same expected income of the current year.
- Your net assets need to be atleast $1 million or above, which exempts the primary residence.
- An organization with over $5 million of assets.
- An organization which exclusively comprises of accredited investors.
Forthcoming Security Token Projects
Overstock
Overstock has revealed that one of its portfolio companies, tZERO, is all set to launch an ICO which will issue licensed security tokens recognized by SEC. The tZERO token holders will be getting quarterly dividends from the profits generated by tZERO as per private securities regulations.
Kodakone
Kodakone is another company which is going to roll out security tokens in its ICO. Kodakone provides a platform for photographers to sell their photos, it will launch Kodakcoin as private security offering to its potential investors and users.
Polymath
Polymath will be first ecosystem under which the security tokens will be developed. Just the ERC 20 tokens are generated in Ethereum, polymath will be developing its own security tokens which will be known as “Poly”.
This ecosystem can be used by the companies to create their own security tokens. The method and circulation of tokens will be the same, it’s just the compliance which will make these tokens different from utility ones.
The year 2017 saw the rise of ICOs, though unregulated, it introduced people with the most common form of cryptocurrency In 2018, with the beginning of security tokens, we hope to see a more reliable and regulated conduct of ICOs.
