Security tokens may be poised for exponential growth as security tokenization industry players reveal optimistic forecasts based on surging demand. With that, the market size by 2025 could reach the $3 trillion mark, according to the area2invest report, a security token marketplace. The study by the Liechtenstein-based security token marketplace also suggests a market compound annual growth rate (CAGR) of 56.9%.
As Bernhard Thalhammer, head of issuer relations at area2invest, told Cointelegraph: “Every day, we receive several requests, not only from blockchain or crypto companies but also from more traditional businesses which have very concrete STO projects in mind.” He added: “We are actually quite surprised how well informed they are and how far they are in their decision-making process.”
Major institutions have already uncovered their security tokenization experiments, with recent examples include European Investment Bank, Thailand’s Central Bank, and the Union Bank of Philippines in collaboration with Standard Chartered Ventures.
This May, crypto exchange INX held the first security token offering (STO) registered with the United States Securities and Exchange Commission (SEC), with over $125 million in proceeds from the fundraising.
Despite STOs being more popular among companies across the blockchain industry, growth opportunities for the security token market may rely on businesses from traditional sectors, which have less experience with tokenization technology.
Eventually, security tokenization could upend the traditional stock and bond issuance model, but the knowledge gap puts the brakes on the STOs market growth in addition to the regulatory hurdles. However, the security token issuance process is more straightforward than one would expect. It can be broken down into four steps, according to the area2invest report. The preparation for the token sale could take up to 18 to 24 weeks, followed by an investment period of 15 to 52 weeks.
The report suggests that the very first phase of an STO boils down to designing the ideal model of a security token offering and drafting the plan on how to bring the token to the market. At this stage, a potential issuer has to answer some questions about the investment idea, including the specifics of the oncoming investment product, the type of investor the product is aimed at and the target funding volume.
Recent STOs show that the digitization of the capital-raising process gives companies flexibility in terms of the type of securities they would like to issue and the kind of investors being targeted. In April 2021, for example, the Exodus wallet completed an SEC-approved STO, offering its shares to both professional and retail investors through its wallet. The issuer can also opt for another combination. This May, the Singapore-based DBS Bank issued an $11.3 million digital bond, available for professional investors only.
Companies starting the security token offering journey also have to consider their marketing and distribution strategies, the entity that would be carrying out an STO, market sentiment analysis and the regulatory framework.
Drilling down into the aspects of the oncoming STO, the issuer has to eventually define the project budget — how much would it actually cost to hold an STO? Is the issuance justified by the numbers? “As with any issuance, there are initial fixed costs, which is also the case with STO, e.g. the prospectus. In addition, there are costs associated with the funding volume,” added Thalhammer.
Structuring an STO
With the plan of the security token offering in place, the issuer should have a more nuanced conversation about the financial aspects of the upcoming STO. The token price should reflect the real valuation of the company, so the issuer should consider a corporate financial advisery to confirm that the soft and hard caps match with the fundamentals.
Another question floating to the surface in the second phase is the rights and obligations the potential investors obtain, and how security tokens as a product should be structured to protect all of the STO participants.
One crucial task is to identify the most attractive jurisdiction for the issuance and ensure that the token offering is compliant with the country’s regulation in every requirement, including taxes. To scope out the most efficient routes to solve any legal issues, hiring a legal adviser is strongly recommended, according to the report.
Based on the information above, the issuer should prepare product documentation, which can be presented in the form of a securities prospectus or an investment memorandum, and be distributed across the potential investor base.
The digitization of securities requires issuers to take notice of the technical side of an STO. Smart contract programming is a key element in this, but it is also important to ensure the safekeeping of the tokens. This requires partnering with market participants that are specialized in asset tokenization and custodians so that the STO execution would go according to plan.
The main criteria to consider is the track record of the tokenization company, as well as the fact that the interfaces and the information exchange are well integrated into the STO ecosystem. A tokenization partner should suggest the right blockchain.
Listing and distribution
In the third phase, the issuer has to bring the tokens to market, and the report identifies five steps. Before the tokens are created, final preparations need to be made. The token model has to be reviewed by an external source, usually a broker, and the marketing campaign of the token to be carried out.
Then, the security token of the company is minted, and the investors that qualify through the Know-Your Customers (KYC) and Anti-Money-Laundering (AML) requirements get access to the token sale. After the purchase is completed, the tokenized securities are delivered to investors' wallets. Despite the simplicity of this process, the token sale could take up to 52 weeks depending on the level of demand from the investors.
Post-issuance support, which includes plenty of administrative actions, is an integral part of an STO, although it often remains in the shadows of token sales. As full-fledged security, tokens need to be serviced properly. This implies building the reporting standards for the tokenized assets and organizing investor relations.
A sustainable token-based model should also comprise user-friendly systems for paying coupons or dividends, depending on the type of security, and a vehicle for investors to vote on corporate actions.