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Considering A Security Token Offerings (STO) For Your NFT Project? – 7 Things to Consider

Even in the relatively new cryptocurrency space, STOs and NFTs are both brand new entities that have presented both opportunity and risk to creators and investors alike. If you’re currently in the position of undertaking an STO for your NFT project, you may find yourself strategically and emotionally confused. There’s a lot to be gained, but there’s also a host of concerns that you must understand and prepare for. But don’t worry; this article is here to help.

In this article, we’ll cover a comprehensive list of 7 things for you to consider as you navigate the waters of launching an STO for your NFT project. Some of these considerations are included with the purpose of strengthening your understanding of the various terms involved, some are aimed at deepening your practical knowledge, and some are here to help you avoid serious consequences.

1.   STOs are Fundamentally Different From ICOs

Both STOs and ICOs are early offerings of coins or tokens to investors that are willing to get in on the ground floor of new cryptocurrency-based projects. During these events, emerging projects raise funds from investors for the purpose of developing and growing. For this reason, STOs and ICOs are often compared to IPOs in which companies sell shares of their companies to raise capital.

The important distinction between STOs and ICOs, however, lies in regulation and categorization of coins/tokens offered. ICOs, known for lack of regulation and oversight, allow the sale of “utility tokens” to early investors. In some cases, projects have taken off and made money. In many other cases, however, projects have failed or even been deemed outright scams. As a result, many in the cryptocurrency space have called out for increased regulation.

Although the idea is simplified and incomplete, STOs can be viewed as regulated ICOs – or ICOs that have earned the approval of regulatory bodies. This idea will be fleshed out in the next considerations.

2.   Security Tokens are Different from Utility Tokens

In consideration #1, we mentioned that ICOs often offer “utility tokens” to early investors. One of the main differences between STOs and ICOs is that STOs do not feature the sale of utility tokens; instead, STOs offer “security tokens” to investors. Let’s start with a simple definition of both of these types of tokens.

Utility Token: Cryptocurrency tokens intended to accomplish some use case on its specific ecosystem.
Example: ETH, the tokens of Ethereum, can be used to launch decentralized apps (dApps).

Security Token: Cryptocurrency tokens that represent ownership of either equity in a project or real world assets.
Example: NEXO, the tokens of Nexo, are “asset-backed” and classified as “restricted securities.”

While there is no reason that security tokens are inherently more valuable than utility tokens (or vice versa), the sale of security tokens may give investors greater peace of mind in some cases. The reason for this is that they literally represent some form of ownership. Utility tokens, meanwhile, may be more purely speculative in nature.

3.   The Existence of a “Security” is Determined by The Howey Test

While the simple definitions supplied above give a quick and easy distinction between utility tokens and security tokens, the real-world determination of whether or not a given coin or token that utilizes blockchain technology is classified as a security is performed with the Howey Test. The Howey Test, introduced by the US Supreme Court in 1946, is still used today by the SEC (the Securities and Exchange Commision) to identify securities and non-securities.

The Howey Test determines that an investment is a security when the following four conditions are met:

  • The investment is purchased with money.
  • The investment is involved in a “common enterprise.” (A common enterprise is any entity – like a company or cryptocurrency project – which functions to the benefit or detriment of multiple parties simultaneously.)
  • The investment is made with the hope of future profits.
  • Any profits will be made through the efforts of individuals who are not the investor.

Before you go forward with planning your STO, be sure to fully consider the Howey Test – and whether or not your NFT project’s coins or tokens meet its conditions.

4.   NFTs are Non-Fungible Tokens

While NFTs have become part of the mainstream conversation, many people still don’t understand what they are on a technical level. The truth is that NFTs and cryptocurrency are not synonymous. All NFTs are cryptocurrencies, but not all cryptocurrencies are NFTs.

Non-fungible tokens are, by definition, distinct from one another. As such, BTC (of Bitcoin), ETH (of Ethereum), and XRP (of Ripple) are not classified as NFTs; BTC, ETH, and XRP are all fungible. 1 BTC is the same as any other BTC and the same goes for ETH and XRP.

NFTs are non-fungible because of the assets they represent. One of the most common use cases of NFTs is art. If you create an NFT for a specific piece of art – let’s say a painting of a beautiful sunrise – that NFT is not identical to another NFT you create for a different piece of art – a painting of a starry sky, for example.

This consideration is extremely important if you’re considering an STO for your NFT project. It means that your STO may be more complicated than an STO would be for a non-NFT project. While any non-NFT project can easily sell its coins or tokens without any consideration for who gets which tokens (because they are identical anyway!), if your NFT project is selling NFTs of multiple assets, you may have to pay specific attention to how your STO sells its tokens.

Alternatively, the situation may be far simpler if your STO sells fractionalized ownership in one NFT asset. For example, real estate NFTs have been growing in popularity. If your NFTs represent ownership in a new resort, you could safely sell fractionalized ownership of that resort in your NFTs during an STO.

5.   Unless your STO Qualifies for an Exemption, it Must Be Registered

Recall that the major difference between STOs and ICOs is regulation. This means that it is absolutely imperative that your STO is approved by the SEC – unless your project qualifies for an exemption. The most common exemptions that STOs qualify for include:

  • Regulation D
  • Regulation CF
  • Regulation A+
  • Regulation S

Perhaps unsurprisingly, the regulatory landscape for STOs and cryptocurrency, in general, is getting quite complicated. Unless you are already very knowledgeable about all relevant regulations, you would likely be very wise to consult an STO lawyer to make sure that your STO is legal and compliant with all necessary guidelines.

6.   What Type of Ownership do your NFTs Represent?

As we began discussing in consideration #4, NFTs – almost by definition – represent ownership of some sort of asset. So while 1 BTC represents nothing more than 1 BTC, for example, the ownership of an NFT represents the ownership of something else – like artwork, real estate, or even tweets.

Before you’re ready to launch your STO, you’ll want to get crystal clear about exactly what your NFTs represent. And as mentioned in consideration #4, part of reaching this clarity is determining whether your STO will sell fractionalized ownership of one NFT – or a variety of separate NFTs. The latter case will be far more complicated.

7.   Which Platform will Launch your STO?

As an entity launching an STO, you will have your choice of which platform to utilize. There are a variety of different platforms that are capable of handling your launch – and the list of them is always growing. Some of the more commonly used platforms for launching STOs today include Polymath, Harbor, and Securitize. As you plan your own STO launch, you’ll need to consider your options carefully and select the platform that best meets your needs. Some specific factors that will influence your decision include:

  • Fees. When resources are limited, be sure to check the associated fees for launching STOs on all viable platforms.
  • Potential audience. Understand that each platform has its own audience. While you will be able to do your own marketing, choosing a platform with a larger pool of users may be advantageous, too.
  • Ease of launch. This consideration includes user-interface and all other factors related to how easy or difficult it is for you to navigate the platform.
  • Reputation. Especially since we’re talking about complying with regulations and ensuring that everything is “above board,” you’ll want to double and triple check that the platform you ultimately select is legitimate.

Seek Help When You Need It!

While this list of 7 things to consider before launching an STO for your NFT project will help you understand some of the complexities of your venture, it is far from exhaustive. As you can see, undertaking the launch of an STO project necessitates complying with regulations and legalities. And especially since large sums of money might be involved, it makes sense to invest in the help of knowledgeable and skilled professionals to be sure that you’re doing everything to the best of your ability and giving yourself the best chance of success.

For these reasons, investing in NFT and STO lawyers is extremely wise. Remember, any costs associated with the fees for hiring such lawyers is likely to be far overshadowed when compared with the profits of a safe and successful STO launch.

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