Offering a token of confidence

'Lots of restrictions'

Despite all its advantages, an STO doesn't provide a shortcut for companies, said Jennings, pointing to the process that companies still need to undergo before tokenization. "You still need due diligence and provision of information. But having said that, it is not as onerous as it seems."

"It's just the beginning. There are still lots of restrictions and control for good reasons," Tong said, referring to the efforts being made against money laundering and terrorism financing.

In Hong Kong, security tokens are classified as securities and are subject to securities laws, according to the Securities and Futures Commission, the city's financial watchdog. Virtual assets trading platforms require a Type 1 license for dealing in securities and a Type 7 license for providing automated trading services to trade in security tokens. Any person engaged in distribution or broker-dealing activities involving an STO needs to have a Type 1 permit regardless of whether that person is based in Hong Kong or not. Trading is also confined to "professional investors" - defined by the SFC as "high-net-worth" institutional, corporate and individual investors.

The SFC said investors should also be mindful of the risks in trading virtual assets on unregulated platforms. "If the platform ceases operation, collapses or is hacked, investors may face the possible risk of losing their entire investments held on the platform," warned Thomas Atkinson, the commission's executive director of enforcement.

Tong, however, believes the high entry barrier could hurt liquidity. "Only qualified investors can participate, and ordinary investors are shut out," he said, pointing out that liquidity is a major hurdle in the development of STOs. "The STO market actually doesn't seem to develop as fast as expected although people see a lot of good things about it.

"The main reason is that you don't have adequate liquidity," Tong pointed out, attributing it to the immature global regulatory environment that hinders the free flow of security tokens and the investment education that is yet to catch up. "A platform that is acceptable to one market doesn't mean it is acceptable to other markets," he said. The global standardization vacuum has imposed limitations on STOs as the nature of tokens is seen as "borderless virtual assets", he said.

Although the distribution and exchange activities of virtual assets are regulated in all analyzed markets, 45 percent of them do not regulate payment activities, while 23 percent do not regulate storage activities, according to research by the Cambridge Centre for Alternative Finance after analyzing 23 selected jurisdictions and international organizations, including Hong Kong, the Chinese mainland, the United States and the European Union.

The lack of investor education is restricting market liquidity, said Tong, blaming the tendency of both domestic and overseas investors to allocate the majority of their portfolios to domestic equities. "Typically, investors are attracted by stocks that are well-known to everybody. Investors in one market would normally focus on stocks in their own markets rather than those in other markets although you may want to diversify," he explained.

Benefiting from a mature stock market, Hong Kong investors have a long-held tradition of trading stocks, which may affect their decisions on whether to make an STO investment, Tong said. "The STO market may not be as attractive as other financial markets. It remains to be seen how Hong Kong investors would choose between shares in the stock market and tokens in the STO market."

Tong said he doesn't foresee STOs becoming a big thing in the near future. "I don't expect a significant STO market emerging in the short term. Liquidity is an issue and STOs are still new in Hong Kong."

Another worry for investors is the quality of the companies seeking an STO. They are usually small, not well established and are unable to meet the requirements for an IPO. This could increase the investment risk. "If you have these small and newly established enterprises in the market, their rate of survival could be quite low," said Tong, warning it could turn into a risky investment. The quality of these companies is questionable, and market capital would be wasted. "Many of their projects may not be able to survive."

"STOs are a nascent form of raising funds and the market is still evolving," the SFC said in March 2019. The commission has repeatedly warned investors of the risks of trading in virtual assets, such as insufficient liquidity, volatility, opaque pricing, hacking and fraud.

Independent fintech analyst Muneeb Jan said he doubts that STOs could become an alternative method of financing.

"It's just an update of the ledger and the account technology. There really isn't any venue for alternative financing," Jan said, citing the ICO bubble of 2018. "That model of financing is heavily operated," he added.