Guide

Digital Security Offering (DSOs) Explained

What are Digital Security Offerings?

Digital Security Offering is the sale and offering of tokenized assets considered as securities that existed and are issued on a blockchain, hence the reason for their name, digital securities. Compared to traditional securities, digital securities are transferred, settled, issued, and restricted differently. However, every security issued in a digital security offering is still considered a security, having met the circumstantial test (the Howey Test) established in the United States for defining the securities.

Digital Security Offerings are often used interchangeably with Security Token Offerings (STOs). It is also referred to as “Token Generating Events”, where investors are issued security tokens. Oftentimes, digital security offerings are confused with Initial Coin Offerings (ICOs), but there is a huge difference between them. One of the differences is the fact that ICOs involved “Utility tokens” whose design, development, and issuance are different from security tokens which are the basis of digital security offerings. Not to worry, in subsequent sections of this guide, there will be a comprehensive compilation of the difference between digital security offerings and initial coin offerings.

To further understand what digital security offerings and security token offerings are all about, you must know first off, that STOs and DSOs are mostly theoretical and it is currently being worked on. As of now, the two terms may be adopted eventually, and they may or may not be used to explain the same concept.

Before expanding the offering part of the phrase, it is much needful to look into the meaning of the term “Digital Security.” Basically, they are a new class of digital assets or products that are also considered securities or that deal with securities. Talking about digital securities can be about traditional crypto assets registered as a security, or it can be solely about security already in existence and was tokenized. A common example of this is a traditional stock that is being traded with cryptocurrency and blockchain technology.

Having explained that it can be agreed or established in/for this guide that digital security offerings and security token offerings have the same meaning, and they are all about the issuance and offering of tokenized assets that are regulated by the SEC and that:

1. represent the response of the SEC (Securities and Exchange Commission) is their clarification of Initial Coin Offerings (ICOs) in 2018 where they established that crypto assets or tokens can also be registered as securities and/or

2. can stand on their own foundation as a new to access the traditional securities market by tokenizing them through the innovative blockchain technology.

Concluding, Securities Token Offerings and Digital Securities Offerings are all about security tokens that are regulated for the novelty of the concept and the vastness of the implications.

What is a Security?

The basic definition of a security is a financial asset that is tradeable and that involves risk. Common examples are stocks. Currently, in the United States, the Security and Exchange Commission (SEC) is in charge of regulating the sale and public offer of these securities. In that context, the security being discussed here is the category regulated and controlled by the SEC, not in the context of computer security or antivirus.

Another thing to note here is that regulated security tokens using the traditional innovative crypto technologies would theoretically be considered a security.

What is an Offering?

In the context of this guide, the term “offering” is talking about an initial offering. For example, initial Public Offering (IPO) as we have it in the stock market.

What is a Token?

In the crypto space, tokens are referred to as cryptographic codes that are used as a stand-in for something. In the simplest term possible, a token is just another name for cryptocurrency or, in a broader term, digital assets.

The Difference Between Security Tokens Offerings and Digital Security Offerings

If you are judging from the names and expressions, you can make a case that digital security offerings are all about the offering of any kind of digital securities while on the other hand, the security token offerings are about the offering of tokenized securities. But there is no difference between the two concepts as of yet. The two terms and concepts can be used interchangeably currently as they are being used to explain or express the same thing. Or, at the very least, the definition of the two concepts points to something similar.

With that said, if there is any difference is STOs and DSOs at all, it will be about the meaning of the verbal expression, in the sense that Security Token is about a specific token that is fundamentally created with the crypto technology with no affiliation with any tradition security and yet is considered a security. Meanwhile, Digital Security can be referred to as the traditional asset that was tokenized even though it might not necessarily be all about tokenized assets or securities but in a wide range can be a name for any security that is digital.

Digital Security Tokens and Initial Coin Offering: Moving from ICO to DSO

Whether you like them or not, or whether you enjoyed them or not, ICOs have been a global phenomenon, especially with the transition of cryptocurrency to being a household name. They have commanded the interest of the entire world and have directed it to blockchain technology. However, they can also represent a speculative and unsustainable bubble that can burse anytime.

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One of the first points about ICOs is this: had the crypto market remained driven by the utility and the unique value proposition it is offering, ICOs would have been popular or at least, as popular as they were. But over time, they transited into what can be charitably described as an unregulated securities market, and since it has had a positive impact on an investor, it went viral and soon be called the digital securities market.

Before looking into the transition and transformation, this guide will consider the common denominator shared by the two concepts.

From the scratch, DSO has always been intended to be a cap management and investment vehicle that can be used mostly for private placements and other asset classes that are considered illiquid. The success of digital securities is owing to the unique features that are inherent in them, and they have shown a vast improvement over the expensive and tedious process of creating, managing, and trading them.

On the other hand, ICOs are mostly traded utilities with the basic aim of incentivizing the contribution of communities in building a certain technology on a public blockchain. Ideally, the token was developed to reward the contribution of people who are working to contribute to the greater good of their community. ICOs were not intended to be a speculative investment vehicle, or at least not in the original form or intention.

And this is while many ICOs will fail even though there are a few of them that seem to be thriving. The model on which most of them are running is not as intended, but the global excitement around tokenization lately and the capital raised also has pushed the failures and the punishments to retail investors who participate in the ICOs.

Mostly because of the frictionless nature of trading cryptocurrencies, every trade taken by investors is premised on speculations, and they rode the market wave all the way to the shore. Over time, new markets are born, prices are shifting and fluctuating (either authentically or artificially), and there are new trading positions opening, but anyone with a solid background in securities will understand that ICOs are just utility markets that are transforming to be an unregulated securities market.

The COO of Augmate, Dana Farbo, has this to say about ICOs: Irrespective of the nature of a token, whether it is built as part of a platform or not, any company insisting on going on the route of utility tokens with their investors who are purely motivated about gaining huge profits upon the tremendous increase of the token, is risking their business. Not just their business, they are risking the relationship with their investors, business partners, and the livelihood of their employees.

However, the silver lining for people investing in ICOs is that they are positioned to be among the first set of investors to explore the early days of the ‘digital securities offering.’ And they have an advantage over people investing in non-crypto assets, including the media they consume, their understanding of the technology used by projects seeking crowdfunding, and the comfort that comes with trading physically-intangible assets.

The Key Components of Digital Securities Offerings

1. Regulatory Compliance

The first key components of digital security offerings which serve as a huge advantage over the ICOs are the management and the issuance of the digital securities. This asset class is managed and issued by reputable platforms like PolyMath or Securitize, which apply global security regulatory rules to the lifecycle of the digital token or share.

ICO tokens, on the other hand, are often sold without much clarity on regulations. In many cases, there is nothing protecting token owners legally from the ignorant or heinous acts of the token issuers.

2. Asset-Backed

Compared to ICO tokens, digital securities are backed by assets with real value. They can be backed by the equity of a company, the payout dividends from a company’s profit, or the fractional ownership of an apartment complex.

Tokens acquired through ICOs, however, don’t have any assets backing their value. They are, most often, offered as a utility which is a means of accessing a service on the public blockchain or a communication network. It is more like paying money for tokens that give you access to a company’s services.

3. Digital Securities are Not Paired with Bitcoin

The value of digital securities is derived from the NAV – Net Asset Value – of the asset backing the token. Sometimes, they can trade as a discount or premium from their net asset value (NAV). This is perhaps the best practice and behavior you can expect from any asset-backed security. In the market, digital securities are paired with fiat currencies, not Bitcoin or any other tokens.

However, tokens acquired through ICOs and listed on exchanges often have a value correlated with the price of Bitcoin. This can be a tricky situation to be in as an investor. Only a few tokens from ICOs can establish a dependence on the blockchain tech that underpins Bitcoin.

And also, because of the dominance of Bitcoin in the crypto market, the value of ICO-acquired tokens often follows the fluctuations of the price of Bitcoin. The truth is, ICO cannot stand on its own, so whatever market value you are seeing is distorted. This is the reality; if crypto projects can be dissociated from Bitcoin and Ethereum as well, the current picture in the market will be different.

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4. Project Management

It has been proven that platforms in charge of the issuance of digital securities are more qualified and reputable. They are in charge of managing the complete end-to-end lifecycle of the digital securities and the codes that ensure regulatory compliance. Part of the service of these platforms is the upgrade support they provided and the swift adjustment to the change in code of the regulatory framework and the business model.

However, ICO tokens are individually managed by project owners and they are often ill-equipped to effectively managed a project or to effect a change in the project, and that is even if they are working on improving the project in the first place. Over time, the original entity that issues a token might even cease to exist.

These key components listed above can be considered are the reason for the rapid transformation from ICO to digital securities markets. Within the span of 18 months, the ICO market has seen rapid growth, which was subsequently followed by a massive downfall. The buildup of the market was easy and quick because the regulations were not clearly established or were ignored.

On the other hand, the digital securities market is built carefully and methodically and even though the regulatory requirements seem burdensome, they are not impossible. Also, the Code is created to fully support the issuance, management, storage, and exchange of digital securities. With this, the market cannot be considered as an explosive boom or bubble that can burst later, but rather it is an intentional drive and build-up to creating an ecosystem fully compliant with regulations and also built to be sustainable for generations to come.

The Potential Disadvantages of Digital Securities Against ICO tokens

With the benefits and the key components listed above, digital securities can be considered flawless compared to ICO tokens, but it is not true. One of the drawbacks of digital securities compared to ICO tokens is that they are limited to accredited investors and this means that the issuance, trading, and management of digital securities has oligarchy as its potential problem, which in the real sense, has defeated the concept behind decentralization that the blockchain and the crypto space stands for.

To eradicate oligarchy in the digital securities market, every early investor should be able to earn a fair deal in every digital security offering, creating a kind of IPO – initial public offering – that is not already excavated in different ways.

With that said, the truth and the reality in our current world of ours are that the token pre-sales are quite rampant in the crypto space and are geared at giving early investors a chance to be a part of a crypto project before it becomes popular or before it is ever known.

However, in the non-crypto world, for an investor to benefit maximally from their early investments, the path goes from the VC (venture capitalist) money to private equity, to pre-initial public offering (IPO), to the public IPO which most often tends take years before getting to IPO and may not even happen forever. And the prices are related generally to the price action and the fundamentals in a private market.

On the other hand, the crypto version happens in months and can involve arbitrary mark-ups sometimes. Also, it always seems to work whether there is a viable product or asset backing it or not. By implication, the early investors in ICOs take almost the same risk in terms of tech as the late investors but take more risk in terms of the price.

Conclusion

Above all that was listed, the benefit of DSOs is the strict compliance to standards and rules that could demand transparency from them – making them fairer than most ICOs in terms of fundraising and other financial activities.

Also, the ideas of digital security offering and the security tokens offering are still in their pilot stage, and there can be more unveiling information and details in the future. However, this guide is not financial advice but was compiled for educational purposes. Therefore, any financial decision taken on account of the content is the sole readers’ responsibility.


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Mubashar Nawaz (United Arab Emirates)

Mubashar Nawaz is an experienced crypto writer working for Tokenhell. Having passion for writing, he covers news articles from blockchain to cryptocurrency.

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