Crypto offers new ways for startups to raise funds, with two of the most common ways being an initial coin offering (ICO) and a security token offering (STO). However, these two funding methods differ in several ways, including regulation. In this guide, we’ll compare ICO vs. STO funding for startups and investors to better understand the advantages of each.
Both STOs and ICOs offer investors a chance to get in on the ground floor, potentially earning significant returns by providing seed money for projects or business ventures. However, as with most investments, there’s no guarantee that either type of investment will bear fruit. The same is true for the team leading the project. Planning, execution, and good fortune all play a role. Let’s discuss the differences between ICOs and STO to learn how each of these works for both startups and investors.
An initial coin offering is a fundraising method used by crypto projects to gather funds for startups. These startups offer project tokens for sale, typically in exchange for another cryptocurrency, such as Ethereum or Bitcoin. In fact, Ethereum itself began as an ICO, with early investors buying Ethereum tokens (ETH) with Bitcoin.
The tokens sold as part of an ICO do not confer ownership of the project. Instead, they typically provide utility for the proposed project. However, in many cases, token holders can also vote on proposed changes to the project.
An ICO typically has four stages, starting with a whitepaper that details the project goals and the role the tokens will play in the ecosystem. For example, Vitalik Buterin, one of Ethereum’s cofounders, published the Ethereum Whitepaper prior to the project’s presale and launch.
Token holders can use their tokens in the new ecosystem after the crowdsale and distribution are complete or trade them as markets open for the new tokens. Initial coin offerings are generally unregulated, although some tokens have come under scrutiny by the US Securities and Exchange Commission, which alleged most cryptocurrencies were securities due to a presale.
A security token is a cryptocurrency token that represents ownership of real assets, such as real estate, stocks, or commodities. Imagine a luxury building project issuing a billion tokens, each representing a small stake in the property. Security tokens open investment opportunities to a wider audience and allow projects or startups to raise capital for building, improvements, and operational costs.
One of the primary benefits, however, centers on increased liquidity for otherwise illiquid assets, such as real estate. Although STO tokens don’t trade on popular crypto exchanges like Coinbase, buyers and sellers can transact on specialized platforms, such as tZERO, INX, Polymath Exchange, or Securitize.io.
Security tokens, sometimes called tokenized IPOs (initial public offerings), represent fractional ownership of real-world assets, such as equity in a company or real estate. The asset’s value is then divided into tokens, each representing a proportional ownership share, using blockchain technology. In effect, these digital tokens serve the same role as stocks in this role. However, STOs can also represent ownership of bond funds, such as Blackrock’s BUIDL, valued at more than a $500 million market capitalization.
Unlike ICOs, STOs face a heavier regulatory burden. In the US, for example, these tokens typically must be registered with the SEC. However, the process follows a similar path to that of ICOs, although also sharing some of the regulatory requirements of IPOs.
STO exchanges typically require KYC (Know Your Customer) identity verification. Some platforms or specific CTOs may also restrict trading to accredited investors. For example, securitize.io currently does not allow trading for non-accredited investors outside the US. An accredited investor, as defined by the SEC, is an individual with a $1 million net worth or an entity owning more than $5 million in assets.
When comparing ICO vs. STO, several key differences set these two fundraising efforts and investment opportunities apart. Chief among these differences is the type of token and what each (STO vs. ICO) represents for holders. Let’s examine the difference between ICO and STO in more detail.
In most cases, both ICOs and STOs launch as ERC-20 tokens on the Ethereum blockchain. ERC-20 tokens are fungible, meaning each token from the same token contract is identical. They are also divisible, allowing partial token ownership.
Although other chains, such as Polygon and Algorand, can support similar tokens, liquidity and the proven security of the Ethereum blockchain play a large role in the decision to deploy on the chain. More than $115 billion in staked ETH tokens safeguard Ethereum against bad actors.
However, while the tokens are often similar between ICO vs. STO, what these tokens represent differs significantly. ICO tokens provide utility on a chain or protocol, sometimes also allowing voting rights for decentralized protocols. By contrast, STO tokens are a proportional claim against an underlying asset. This asset could include equity in a company, ownership of an investment pool, or real estate.
Regulatory requirements also differ when comparing ICO vs. STO. The value of a token launched via ICO may or may not be driven by the efforts of others. This is one of the key components of the Howey Test, which is used to determine if an asset represents an investment contract. In decentralized protocols, the community as a whole determines the success or failure of the project.
By contrast, STO tokens do represent an investment contract, similar to owning shares of a stock or a real estate investment trust (REIT). A third party manages the underlying asset, with token holders benefiting from the third party’s efforts. Notably, the US SEC has focused much of its regulatory actions on ICO tokens that raised money through a presale but did not register with the agency.
Securities regulations surrounding STOs can add significant costs to this fundraising method. Although often less costly than launching an IPO, STOs can be more expensive than ICOs, the cost of which centers on marketing costs. Most of the expenses for STOs center on legal fees, although KYC compliance and exchange listing fees with specialized exchanges add to the price tag, effectively reducing the amount of money raised through token sales.
Another area in which ICO vs. STO differs is in investor rights. While both types of tokens can provide voting rights, an ICO isn’t a claim on an underlying asset. Instead, it’s a bet on the success of the protocol and the value of the token within that protocol. Ethereum launched its ICO at $0.31 and trades at more than $3,000 today, with its value mostly derived from the ETH token’s utility.
While it’s important to perform due diligence before making any investment decision, the research path for each type of token (ICO vs. STO) differs. Both types of tokens typically begin with a whitepaper. However, the level of detail and the required information can vary depending on whether the token is an ICO or STO.
Because they are not an investment contract, ICOs for decentralized projects may be less detailed or even subject to significant changes. By comparison, STOs typically provide much more detail in regard to the legal entity managing the project and principal team members. STO whitepapers and promotional materials may also need to detail risks and financial projections. These rules vary by jurisdiction.
Lastly, not all investors may be eligible for both types of tokens. ICOs are generally unrestricted, although some geolocations may be blocked from access due to regulatory concerns in that specific locale. Largely speaking, anyone can participate in most ICOs due to the decentralized nature of many blockchain projects. Access to STOs, however, may be limited based on geography or accredited investor status.
From an investor’s perspective, risk creates a wide gap between ICO vs. STO opportunities. According to data from CoinGecko, a leading crypto data aggregator, more than half of all crypto projects launched since 2014 have failed. The majority of these originated during the 2020-2021 bull run when market euphoria reigned. Often, ill-fated ICOs caught a bid regardless of long-term viability.
By comparison, STO tokens can still bring risk, although being backed by real-world assets often makes them less risky than hopeful crypto projects – or outright exit scams masquerading as legitimate ICO projects.
In both cases, investors need to perform adequate due diligence and manage crypto portfolio allocations responsibly.
As a fundraising method, choosing between ICO vs. STO requires careful consideration. However, the real distinction lies in the type of token itself, meaning how the token will be used and whether it represents ownership of a real-world asset. Let’s review some of the questions to consider before choosing an STO vs. ICO for fundraising.
Does the token provide utility on a blockchain or protocol? If the answer is yes – and if the token does not confer ownership of real-world assets – then an ICO may be the best route. Consult a legal team with experience in the field before making your decision. However, if the token provides fractional ownership of an underlying asset managed by a third party, it’s likely a security token in the eyes of regulators.
While the regulatory environment has little bearing on the type of token and its role in the ecosystem, it’s wise to understand it and take steps to ensure compliance. In 2020, the SEC sued Ripple for allegedly selling unregistered securities with its ICO, and the case is still ongoing. In October 2024, the court ordered Ripple to pay $125 million, slashing the $2 billion penalty sought by the SEC.
The target investors for an ICO vs STO can also be a consideration, although this factor plays a larger role in whether to restrict investments to qualified or accredited investors. In the end, a token that is clearly a security token risks regulatory enforcement if issued as an ICO vs STO. Generally, STOs are best suited for traditional investors, including institutions, accredited investors, and those who invest more conservatively.
ICOs offer a faster way to raise capital, although projects still need to create a whitepaper and analyze the market to understand which voids the project fills and challenges it might face. With that in mind, a token that is definitively a security token risks costly regulatory battles if issued as an ICO to save time.
Compliance expenses, such as legal fees and KYC and AML (anti-money laundering) compliance costs, can add up quickly, reducing the amount of available capital. However, with an STO, these costs are largely unavoidable, although they may be lower than those associated with a traditional IPO.
Think beyond phase one and consider how the project might evolve. While the initial goal is to raise funds for the project, projects with long-term aspirations should also focus on avoiding costly legal battles with regulators that can threaten the project’s future.
In all cases, it’s prudent to consult an attorney or legal team well-versed in securities law, IPOs, and related fields in your jurisdiction. With regulators seeking millions or even billions in penalties from ICO issuers, the risk justifies the consultation cost and potential delays. In 2023, LBRY, Inc. shuttered operations after losing a court case in which the SEC alleged the company sold unregistered securities.
While Ethereum started the ICO boom when it raised funds in 2014, several ICOs that followed raised considerably more capital. Similarly, STOs have raised impressive amounts of money to fund startups, expansion, and operations. Let’s review some of the standout success stories for both ICOs and STOs.
Crypto project ICOs have raised some truly impressive amounts of money, in some cases drawing the attention of regulators.
Asset or equity-backed STOs arrived on the scene in 2018 when the Praetorian Group filed its security token offering for $75 million with the SEC. Since then, several successful STOs have launched.
The difference between ICO and STO tokens centers on whether the token provides utility or represents ownership in an asset, such as an investment pool, real estate, or equity in a company. ICOs are best suited to utility tokens, whereas STOs are for asset-backed tokens with the assets managed by a third party.
In both cases, these fundraising initiatives can generate a massive war chest to jump-start new projects. However, regulations in jurisdictions around the world require issuers to comply with local rules. An investment in compliance can help ensure the success of the project.
STOs, or security token offerings, represent fractional ownership of an asset, such as equity in a company, a bond fund, or real estate. ICOs issue utility tokens that provide functionality on a blockchain or protocol.
STOs and ICOs both raise money by issuing tokens. ICOs typically accept a cryptocurrency such as Bitcoin or Ethereum in exchange for a newly created token. STOs are often purchased with traditional currencies, although some also trade with cryptocurrencies.
STOs are generally considered to be the safer option for investors. Regulatory compliance and a primary audience of accredited investors help ensure safety in the marketplace. Additionally, STOs are backed by an asset, whereas ICOs are tokens for a project that may or may not ever materialize.
No. Rules for ICOs and STOs can vary throughout the world, and ICOs are banned in certain jurisdictions, such as China. Even in areas where ICOs and STOs are legal, it’s essential to follow regulatory requirements.
If you’re fundraising for a project, the type of token usually points the way. Utility tokens generally use ICOs, whereas tokens that confer ownership of a real-world asset generally use STOs to raise funds. However, regulatory guidelines vary throughout the world. As an investor, STOs offer a safer investment environment. ICOs are largely unregulated.
Source: cryptonews.com
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