Blockchain Legal & News

CSOs – A new financing model

Alexia Pollacco 08 Apr 2020

Fairmint, a Decentralized Finance (DeFi) startup, has launched a Continuous Securities Offering platform which is aimed at providing a new way for companies to raise capital. This is a new blockchain based financing model, following ICOs, IEOs, and STOs.

ICOs

Initial Coin Offerings (ICOs) involve raising funds through creating and distributing a new token to investors in exchange for cryptocurrency or fiat. The token’s use is limited to the issuer’s product or service; thus it is merely a utility token which does not represent equity rights. To this end, ICOs are largely unregulated.

IEOs

An Initial Exchange Offering (IEO) is similar to an ICO, with the main difference being that the company seeking to make the offer sells its tokens on an existing cryptocurrency exchange platform against payment of a listing fee.

STOs

Security Token Offerings (STOs) involve the issuance of tokens which represent an underlying asset such as stocks and bonds, thus these tokens are classified as security tokens. STOs are subject to traditional securities legislation, imposing much more onerous requirements on issuers than in the case of ICOs.

CSOs - How it works

In order to launch a CSO, a portion of the company’s revenue is taken out and put in a reserve held in escrow. Through the implementation of Fairmint’s turnkey platform on the company’s own website or application, the company’s investors and other stakeholders may participate by purchasing ERC-20 tokens which are backed by the revenue held in reserve. The value of the tokens is determined by an algorithm depending on the amount held in the reserve. Tokens may then be traded on the decentralized exchange uniswap, with the token’s price being determined by market demand. The revenue held in the reserve may be increased by the company, however it cannot be decreased. Through CSOs, investment opportunities are extended to all stakeholders, without requiring the company to go public. This is because private companies are traditionally prevented from selling shares to many outside stakeholders by securities regulations. By the time the company goes public, early stakeholders may no longer afford to participate through purchasing shares in an Initial Public Offering (IPO). Thus, CSOs bridge this gap by allowing anyone to invest in the company’s revenue, without forcing founders to give up control over their company.

CSO vs Equity Investment

The main contrast between CSOs and equity investment is that in CSOs investors buy a share of the value held in reserve, whereas equity investment involves buying ownership in the company. Thus, while the value in CSOs depends on the amount held in reserve, in equity investment value is based on the company’s profit. For example, in an STO the token’s value is tied to the company’s future revenue.

CSOs thus require companies to have enough capital to segregate and place into a reserve, and also solid plans for long-term revenue generation, which might prove to be a burden on start-up companies and projects. That being said, this financial requirement could potentially filter out those projects which do not have a sustainable plan for growth and stability.

CSOs also allows investors to create and redeem tokens throughout the pre-determined period of the CSO. Thus, tokens can be bought or sold even when there are no sellers or buyers since the transaction is carried out with the reserve itself. Investors are free to redeem tokens at any given time at the price generated by the algorithm, which means that the token’s value is ultimately secured since it represents a claim on the value of the amount held in the reserve. Although the amount of compensation will be relative to whether other investors have already redeemed their tokens, investors are still afforded more protection than in equity investment as some compensation is always guaranteed.

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