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The difference between stocks and security tokens

In the previous article, we went into what an STO actually is, how to spot an STO, and what some of the regulations around STOs are. To summarize, an STO is a Security Token Offering, in an STO, digital tokens are offered as securities.

This article will go into more depth on the differences and similarities of traditional equity investment vehicles and STOs. When discussing tokens, note that we’re only referring to security tokens, which represent company equity and are fully regulated. The information in this article is purely theoretical and for information purposes only. Please be aware information and practical implications related to STOs can change relatively quickly due to regulatory changes and the novelty of security tokens.

Shares and tokens

In traditional equity investments, a person can own a part of a company through the purchase of shares. The share or stock of a company is proof that you own X percent of said company. Owning stock of a company gives a person certain rights, mainly the entitlement to a proportion of the corporate assets.¹ Additional rights that could be gained are the right to a dividend and voting rights. Specific rights depend on the kind of stock (voting or non-voting), and whether or not the company is actively paying out dividends.

So, why would a company want to give up equity?

Companies normally sell stocks in order to raise funds. Depending on the stage of the business, the equity offering can be through brokers, on a stock exchange, or through an IPO.

Owning equity means that you own a percentage of the outstanding shares. It doesn’t directly mean that you own physical items in the company. This is called separation of ownership and control.²

Furthermore, there are two different types of stock:

Common stock: With common stock, investors normally have voting and dividend rights. However, common stockholders are paid out after preferred shareholders, creditors, and bondholders.
Preferred stock: With preferred stock, investors usually don’t have voting rights but get priority with earnings, dividends, and in the case of bankruptcy.³

Security tokens, on the other hand, are a relatively new ‘invention’ that blockchain technology has enabled. The basic functions of stocks are similar to security tokens. Both represent a company’s equity and give a percentage of ownership of a company. Similarly, depending on the type of token, investors may have voting rights and be awarded dividends.

So, what are the differences between stocks and security tokens?

Tokens are built on top of blockchain technology, whereas stocks are not.
Proof of ownership for stocks is usually done either at your broker or directly at the company in the registry. With tokens, however, investors can store ownership themselves since the tokens are linked to a personal blockchain wallet and the registry is pulled from the blockchain.
In order to sell stocks, the trade needs to be sent to a broker and/or sold on a stock exchange. Tokens can be quickly sold on a regulated Security Token Exchange.
The blockchain is an immutable ledger.
Currently, there is still some legal and regulatory uncertainty around security tokens. That’s not the case with stock.

IPO and STO

When a new security token is being created and sold, this is called a Security Token Offering (STO). The process of creating an STO is subject to the rules and regulations of the country of incorporation and where the STO is being held. If you adhere to all the regulations and can participate in the STO, you will be able to purchase equity in the company. In return, you’ll get a set amount of tokens.

An STO is similar to an Initial Public Offering (IPO). In an IPO, shares of a private company are offered to the public.⁴

The private companies already have shareholders, mainly founders, early investors, and venture capitalists, but is still a private company at this stage (not publicly traded). For regular retail investors, it may be difficult to access and successfully trade the equity of private companies.⁵

The main difference between an IPO and STO is that IPOs typically involve relatively big private companies that are going public (e.g. private valuations of 1 billion dollars).⁶

An STO, on the other hand, can be done on a smaller scale much more easily.

For more information on participating in STOs, check our previous article.

Advantages of an STO

An STO gives companies the opportunity to get tradable tokens/equity on an exchange quicker. For a company, getting from the startup phase to the point where they can launch a successful IPO might take a much longer period of time.
An STO offers a quicker path to tradable equity. A startup that does an STO has tokens that can be freely traded already. Conversely, a regular start-up without an STO or IPO has shares that might not be as easy to buy and sell.
Trading in private equity can require a lot of money to participate. An STO can have a much lower threshold.⁷

Conclusion

Stocks and security tokens are very similar in their core-role since they basically fulfill the same role. Yet there are key differences.

While traditional stocks are more well-known and are already fully regulated, there is still some uncertainty around blockchain. Companies and investors in STOs should stay updated on the latest STO guidelines and regulations.

Perhaps most noteworthy, tokens are built on top of blockchain technology. This gives tokens greater security and transparency, as they’re recorded on an immutable (online) ledger. Additionally, instead of being a name in a shares registry, a person can actually own, see, and use their tokens, as they’re stored in a personal wallet. Practically, this should make tokens much easier to transact between parties.

To conclude, doing an STO can help companies get easily tradable shares at a much earlier stage. This can benefit a company’s growth and provide potential investors with more flexibility and accessibility to trade their equity.

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Written and researched by Nathan van de Ven from the EMI R&D department.