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ICO vs STO – What's best for your startup?

6 min read
Oct. 03, 2019
Kamil Śliwak
Kamil Śliwak
Kamil Śliwak
Kamil Śliwak
Co-founder, CTO
6 min read
Oct. 03, 2019

In 2017 and 2018, ICOs were one of the hottest topics in the startup and cryptocurrency worlds. The rapid popularization of blockchain technology provided thousands of startups with the opportunity to collect funds from investors all around the world in the form of ICOs — Initial Coin Offerings.

It took only the first seven months of 2018 for the ICOs to generate more than $12 billion. However, not all of that money was used to support startups genuinely interested in collecting funds for the development of their products.

Due to lack of proper regulation, the cryptocurrency bubble, and numerous con-artists jumping on the crypto bandwagon, many ICOs turned out to be scams. It is estimated that up to 80% of all ICOs conducted in 2017 were never supposed to generate any value for their investors.

Of course, that doesn’t mean ICOs are dead. But there’s a new instrument in town which is quickly becoming the preferred option for those looking to invest in new businesses — Security Token Offering.

What’s the better choice to fund your startup?

The core benefit of funding with ICOs and STOs

First, let’s take a quick look at the core benefit of ICOs and STOs for the average startup. While each of them comes with a set of individual benefits, probably the biggest advantage of these blockchain funding instruments is the ease of participation of potential investors.

Blockchain technology makes it possible for almost anyone with enough money, an online wallet and access to the Internet to invest in the offering of their choice. Thanks to that, both ICOs and STOs attract people from dozens of countries all around the world. A recent Bitbond Security Token Offering secured investments from investors from 87 different countries.

On top of that, both STOs and ICOs can be targeted at an individual investor. This means that startups don’t have to limit themselves to seeking wealthy individual investors or venture capital funding and instead can easily get funded by anyone interested in investing in their product or service (with certain exceptions — we'll discuss them later in this article).

Naturally, both tools have their advantages and disadvantages. Let’s jump right into them.

The advantages of ICOs

An Initial Coin Offering allows startups to collect money directly from those interested in their idea without offering them equity. Instead, most startups promise that the token will have utility in the future. While this often means that users are buying nothing more than a dream, it offers startups huge flexibility in how they want to attract potential investors.

On top of that, if you work with a software house experienced in blockchain technology, you can move your startup from the idea phase to getting funded in a very short time. And, since there are fewer regulatory requirements that you need to pay attention to as compared to an STO, ICOs are an inexpensive and fast way of reaching individual investors around the globe.

Disclaimer: Keep in mind that ICOs have fewer regulatory requirements only because they skirt around them by claiming to sell utility tokens which are not treated as securities. Because of that, not all investors trust them (more on that later).

One other advantage of an ICO is the ability to assess market demand. This is because, unlike the traditional ways of gathering funds, ICOs often target the startup’s potential customers directly, so companies can gather funds and market data at the same time.

The disadvantages of ICOs

Because so many people got burned by Initial Coin Offering pump and dump schemes, it’s becoming harder for startups with no history, big VC backing or a revolutionary idea to get funds from individual, small-time investors. And, if the startup already has big Venture Capital backing, they usually don’t need an ICO anyway. Simply speaking, investors don’t trust ICOs as much as they used to.

On top of that, the SEC may view certain ICOs as securities — even if the founders classify their tokens as utility. In fact, only 8% of all ICOs were designed to be used exclusively within the app itself. This means that, should they be classified as securities, founders would have to register them with the SEC, which is a long and very expensive process.

Because of that, many startups restrict Americans from investing in their tokens. While this saves them a potential legal headache, it eliminates a huge pool of potential investors from one of the richest and most developed markets in the world.

The lack of trust, low perceived credibility and potential legal problems mean that despite the low entry barrier, ICOs can potentially turn out to be more expensive than STOs. That’s why if you can justify the initial expense, it might be worth looking into raising funds with the help of Security Token Offering.

The advantages of STOs

At first glance, the advantages of STOs are more beneficial to potential investors than to entrepreneurs. Because Security Token Offerings are regulatory compliant, they are, by default, more transparent than ICOs. Even after the launch, companies must stay in compliance with several legal requirements and provide investors with access to company data, including its financials.

These two things alone are the reason why STOs are perceived as a much safer investments in more mature projects with higher potential. And, despite all the legal hassle, the increased investor protection means that attracting new people willing to invest might be easier. There’s just one catch…

Investors in STOs are not anonymous.

For some blockchain fans, this alone disqualifies STOs as a potential investment, as it goes against the idea of the anonymous, distributed nature of cryptocurrencies. However, it offers the startups issuing STOs extra protection.

This lack of anonymity means startups can restrict who can buy and sell the tokens (as all investors need to be identified), assuring the owners that their Security Tokens will be held and traded only by validated investors. This is important especially if you want to prevent your startup from getting funded by money coming from illegal activities.

The latter might prove valuable especially when considering that, unlike utility tokens, security tokens represent ownership of equity, the right to dividends, and all the other rights that business investors enjoy.

Additionally, even though the numbers are much lower for STOs as compared to those achieved by startups during the ICO craze, the market trend seems to favor security token offerings. In the past few months, we witnessed several spectacular STOs, such as the $20 million raised by Figure Technologies or the overfunding of TokenMarket in less than 48 hours. Since the trend is here to stay, at least for companies that work on offering genuine value to their customers, we might expect much more impressive numbers for some future STOs.

The disadvantages of STOs

Despite all the great benefits, security token offerings are not for everyone. Sadly, the administrative burden takes money and time. Unlike ICOs, STOs need to be officially registered with the relevant financial regulatory body — the Securities and Exchange Commission in the United States, BaFin in Germany, and the FCA (Financial Conduct Authority) in the UK.

Unfortunately, this also means that companies might get stuck doing paperwork for the government instead of working on their Unique Value Proposition and dedicating resources to impressing their customers.

Additionally, STOs are not cheap. Those interested in issuing Security Tokens need to consider that, on top of preparing financial statements confirmed by an independent accountant, they need to prepare detailed company and STO descriptions and apply for an exemption to look for an investment. This alone means you will most likely need legal help, and the fees and time it takes might mean that STOs are not the right solution for startups with no startup capital at all.

What to choose?

Some market analysts believe that security token offerings will soon replace the ICOs. However, considering the complicated nature of regulated investments, not every startup can afford an STO. This means that ICOs could remain the go-to blockchain-based crowdfunding choice for smaller companies at a very early phase of their development. However, they will need to work hard to prove that they are a genuine business if they want to attract any funding.

Speaking of ICOs and STOs, we also can’t forget about their target group. Most of the time, they are aimed at completely different kinds of people. This allows startups to reach out to different groups of investors, often with different goals and expectations. Due to their regulated nature and the fact that, unlike ICOs, STOs always represent equity — even if a single token is just a fraction of the whole company’s equity, STOs will most likely be preferred by more serious investors (those interested in investing long-term).

This difference also means that should your startup succeed with an ICO and your idea get traction, you might get enough money to prepare an STO. It may also work the other way around. Once you prove your credibility with a Security Token Offering, you'll have a chance to draw more people to your Initial Coin Offering. On top of that, considering the decentralized nature of ICOs, you might be able to create enthusiasm that will attract thousands of people from all around the world willing to invest in your idea.

Still not sure which fundraising option is right for you? Or maybe you have an idea for another blockchain-based project? Reach out and tell us about it – we'd love to help you out!