How Tokenized Private Placements of Securities and the Development of Markets will Create Trading Liquidity and Enhance Demand.

Athena Blockchain’s look at the emergence of tokenized securities

I. Introduction.

Tokenization promises to introduce automation, increased demand and increased liquidity[1] for certain types of private placements of securities. Although “tokenization” technology comes from the open network cryptocurrency community, which itself has generated significant wealth, the impact of tokenization technology will be greater when used to unlock liquidity and enhance demand in the global private placement markets, which issued more than $2.4 trillion USD in debt and equity securities in 2017 alone.[2]

To understand the impact of tokenization, a return to first principles is useful, starting with the definition of a security under United States law. A variety of financial instruments are included in the United States definition of a security,[3] including stocks, bonds, and investment contracts. Although public company equity trading on stock exchanges like the NYSE and NASDAQ may be familiar to most investors, a variety of regulatory exemptions allow issuers to sell securities without becoming public reporting companies. If a company uses one of those exemptions, their securities are considered private (hence “private placements”), and generally cannot be listed or traded on these well-known public markets. These regulatory exemptions are frequently used by issuers for significant debt offerings and for private fundraising through the sale of equity. Private placement equity sale “rounds” are a popular choice for start-ups seeking to raise capital. Increasingly, significant fast-growing and capital-intensive companies have chosen to access private placement markets for growth capital while remaining private to avoid burdensome public reporting obligations.

These same registration exemptions are now used by issuers of crypto tokens[4] to offer what are termed “STOs” or Security Token Offerings. Although the first widely recognized crypto token sale occurred in 2013[5], the sale of pre-generated tokens did not become popular until the sales conducted by Factom and Ethereum in late 2014, at which point the crypto-industry identified the sale of tokens as a viable alternative to conventional venture funding; by late 2018, some estimate that more than $20 billion USD has been raised selling tokens in what were termed ICOs, or “Initial Coin Offerings.”[6] Tokens sold by ICO generally did not confer typical debt or equity rights upon their purchasers and were generally not offered with the disclosures and disclaimers required by United States securities law; instead, these instruments were marketed to purchasers as “network assets” or “utility tokens” to be used to obtain services and or products from systems to be developed by the issuer in the future.[7] After the SEC issued its Rule 21 Report, [8] concluding that the tokens sold by “the Dao” were investment contracts, [9] ICO issuers began to offer their utility tokens as private placements of investment contracts using existing registration exemptions.

With the exception of network tokens offered for sale as private placements, most other securities are not typically offered in tokenized form. It is in the context of these other assets, as discussed below, that tokenization will positively impact the broad private placement market. Unlike ICOs, which embraced regulatory compliance by necessity, other private placement securities will embrace tokenization because of its benefits.

II. A Proposed Tokenized Securities Taxonomy.

The term “STO” originated from the cryptocurrency community (which tends to embrace imprecise terminology[10]) as a way of differentiating tokenized assets that are offered pursuant to registration exemptions from earlier ICOs which mostly ignored regulatory compliance. As a term to describe the various types of securities that may be offered in tokenized form, it is vague and imprecise. To alleviate the confusion in the coming discussion of tokenized securities caused by insufficient terminology, I propose the following terms to be used to describe the various types of tokenized securities that already exist or are expected to be developed:

1. Security-wrapped ICOs, a/k/a SICOs. These are “network assets” or “utility tokens” that are offered as private placements of securities pursuant to registration exemptions. SICOs typically do not offer equity (i.e. a proportional share of ownership, dividend right, participation in issuer governance) or debt (an enforceable promise to repay) rights, and often provide minimal investor protection, offer minimal issuer disclosures, and afford limited recourse against the issuer. These assets are natively digital unless offered as a secondary product to be distributed by the issuer pursuant to a SAFT[11] agreement.

2. Tokenized Equity or Debt, a/k/a TEDs. These are traditional securities (i.e. equity/debt) issued in token form. These products clearly fall within the definition of securities and would be otherwise unremarkable except that they are provided to the buyer in tokenized form, rather than in the form of a ledger entry maintained by a central actor, or in paper form. Most TEDs, in the short term, will be issued as private placements of securities.[12]

3. Tokenized Asset Backed Securities, a/k/a TABS. These are tokenized assets that represent an ownership claim against, or ownership share in, an asset or pool of assets. This category includes products based on a claim against metals, gems, commodities, securities, real estate, art, unique goods, and other assets maintained by the issuer or issuer’s designee. Like TEDs, most TABS will be private placements of securities.

4. Transactional Security Instruments, a/k/a TSIs. These assets are securities, issued in token form, that may be redeemed or accepted by the issuer or the issuer’s designee in direct exchange for products or services. The process of redemption or acceptance of these instruments allows an issuer to directly retire debt or redeem equity in exchange for the performance of services or provision of goods for the investor. Although these products do not yet exist, these represent the future promise of tokenized securities.

Other important baseline understandings that are necessary for our discussion of tokenized securities:

1. Most securities are not bearer instruments and tokenizing a security in compliance with US law will not make that security into a bearer instrument. Issuers are obligated to track ownership of, and in certain cases, replace lost or destroyed shares of securities; this obligation does not change because the form of issuance changes. Legacy bearer securities exist, but no new bearer securities have been issued under US law since 1982.[13]

2. Private placements of securities, regardless of form, are subject to trade restrictions. Transactions of securities require the participation of either (a) broker dealers, (b) alternative trading systems (“ATS”), or (c) national stock exchanges. The issuer of securities stands to potentially lose their exemption from registration if those securities are traded in violation of these restrictions. Thus, tokenized securities will be created on either (a) private blockchains that are controlled by the issuer, or (b) public blockchains subject to restrictive code that allows a central issuer to control and track transactions of these assets.[14] These assets will only trade with the cooperation of a broker dealer, or on an ATS or national securities exchange.

3. “ICO advisors” or “ICO Consultants” without FINRA licenses should not participate in the structuring or offering of securities. “ICO Consultants” who previously designed “token economies” or the “tokenomics” of issuer’s systems must be replaced by licensed professionals who perform “structuring” in compliance with relevant law. These professionals are agents of registered broker dealers called Registered Representatives. These Registered Representatives are licensed to perform these services by passing FINRA and or NASAA financial securities exams, typically identified as a “Series” exam. Issuers of tokenized securities may rely upon technical service providers, but generally should structure, market, and place their securities through Registered Representatives of broker dealers to avoid violating the law.

III. Certain Tokenized Securities Will Thrive.

The various types of securities discussed above will experience differing fates upon tokenization. In short, SICOs will likely fail as a consumer product. TABS will thrive, depending on the underlying assets, the use case, and if the TABS product differs meaningfully from other available products based on the same assets. TEDs that are based upon attractive underlying investment opportunities will succeed irrespective of their form but may be more attractive in tokenized form because of efficiencies and the benefit of Marketplaces, as discussed below, including streamlined/automated transactions, broader marketing, and price discovery. Finally, we are optimistic about TSIs going forward, but acknowledge that they will require significant revision to existing law to thrive.

1. SICO’s Will Fail: Most SICOs will fail. Based upon recent comments from the SEC,[15] it is expected that many ICOs that were issued without compliance with registration requirements or exemption from registration obligations laws will voluntarily (or be compelled to) rescind and register as reporting companies offering equity (and potentially become TEDs). Otherwise, those ICOs will likely be de-listed by US crypto exchanges and be relegated to trading on non-US exchanges, only. SICOs that used regulatory offering exemptions to avoid compliance issues and that remain unconverted into debt or equity will likely fail because of restrictions on their trading velocity, and because of the track record of purchasers and issuers of these products.

SICOs are subject to marketing and sale limitations, which may frustrate their “network” purpose. Under most offering exemptions used by SICOs, issuers must limit their marketing and limit the population of US persons to whom they may sell SICOs. The frequently used Reg D 506(c) exemption allows for general solicitation but only allows the issuer to sell securities to US accredited investors.[16] Thus, SICOs are a poor fit for “network” assets that derive utility from wide distribution to bootstrap into a “network effect.”

These assets will also fail because as securities they are subject to trade restrictions and must be traded via broker dealers, on regulated national securities exchanges , or ATS systems, which limit their liquidity. Although the SICO is a utility or network token sold as a package where the package is a security/investment contract coupled with a token that is arguably a commodity (for example, a future entitlement to an amount of file storage), there is no law that expressly defines how and under what circumstances the utility/network asset may be separated from the promises made by the issuer to induce the sale of the utility/network asset as an investment contract. Director Hinman’s speech from June 2018 explained a potential work around for this problem, suggesting that “[i]f the network on which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract.” [17] Dir. Hinman’s comments, however, do not explain when some “sufficiently decentralized” threshold is met (and presumably, when the requirements to transact the instrument in accordance with securities laws no longer applies), who decides it is met, and the practical implications of meeting that threshold for issuers, purchasers, and traders of SICOs. Dir. Hinman’s comments, although intriguing, did not change existing law, or create any new enforceable legal rights.[18] Given that there is no legally recognized way to decouple the utility instrument packaged in the SICO from its security status,[19] SICOs that seek to create a network effect that requires widespread distribution or frequent trading will likely fail.

Given that the actual utility of ICOs and SICOs are expected to be available in the future, many of these instruments are currently useless as products.[20] ICOs have shown value as instruments for trading. ICOs were used primarily as assets to trade on a variety of unregulated retail-facing markets. These markets allowed traders to engage in manipulation tactics, such as wash trading or pump and dump schemes, which are unavailable or illegal on regulated markets. The manipulation of these markets is assumed or implied to have contributed to the spikes in value of ICOs and other crypto assets observed in 2017. SICOs, which are limited in their liquidity, must stand on their own, and cannot benefit from price manipulation on unregulated markets.

SICOs are likewise falling out of favor due to their current lack of actual utility. (The irony is deep.) A significant number of projects that raised funds via ICO have not (and presumably will not) create usable products and systems. In the case of an ICO or SICO that purportedly provides a future entitlement to a service or product, the lack of that system to provide that future service or product should eliminate any expectation of value in the product. Already, companies funded by ICO-generated revenues have contracted workforces,[21] reportedly lost key researchers, and or reportedly failed to meet development deadlines.[22] Where no future utility can be reasonably expected to exist, ICO tokens will probably never have value independent of the holder’s ability to sell them to someone else. Even for issuers that have launched live systems, like Ethereum, there is little evidence of existing commercially viable use of those systems, much less commercial use which would support hefty valuations. (Of course, markets trade with the future, not the past or present, in mind, but, given that most ICOs offered the promise of brand new technologies using new concepts, and that many companies funded by ICO have already failed, investors who base valuations on data may have difficulty forecasting robust future enterprise value.)

SICOs generally do not provide the rights, powers, or benefits of equity or debt to their purchasers. Increasingly, investors have realized that tokens that do not confer upon the investor any control over the entity, provide a yield, or impose a binding obligation on the issuer are often useless as investments.

Because foreign laws[23] governing issuance in foreign jurisdictions are in some instances markedly less restrictive, it is likely that most SICOs that are really “utility tokens” or “network assets” will be offered abroad and may exclude US investors from primary issuance.

2. TEDS Beat Traditional Private Placements of Debt and Equity: TEDS appear poised for success. These assets will succeed initially based upon the merits of the underlying security; if a TEDS would sell as a traditional-form security, it will sell as a tokenized security as well. However, tokenization of equity and debt will benefit issuers by allowing for streamlined internal governance, and benefit buyers and traders by providing enhanced trading liquidity, demand, and price discovery.

In the short term, tokenization of equity and debt will be a net neutral factor, as any perceived complications due to unfamiliarity with the asset type and questions regarding custody will be cancelled out by the visibility and attention garnered by issuers using new technology, and the benefits created by these assets being issued and or traded on regulated Marketplaces, described below.

Theoretically, the form of the instrument should not drive demand, unless form itself confers some benefit, cost savings, or efficiency for the issuer, buyer at primary issuance, or buyer on the secondary market. Tokenization in conjunction with Marketplaces, as described below, will provide benefits in each of these situations for TEDS.

Issuers of TEDS benefit from innovative state regulation that allows internal corporate governance to be conducted on blockchains. Issuance can be streamlined and made more efficient when the instrument is issued as a token. Delaware, Wyoming, and California have already passed laws that permit corporation share registers to be maintained on blockchains, which facilitate the issuance of tokenized shares, allowing for instantaneous settlement of trades, on demand real time auditability of shareholder records, and enhanced fraud detection/prevention. Further legislation to permit corporate governance (i.e. share voting, proxies, direct communication with shareholders via wallets) to be conducted on share-issuing blockchains is anticipated. These innovations can save issuers millions, avoid expensive evidentiary contests in litigation,[24] and avoid expensive shareholder voting mishaps.[25]

On a longer-term basis, investors in TEDS will benefit from the creation and use of Marketplaces for trading, and from expected regulatory guidance clarifying custody of tokenized securities.

3. TABS Allow Tradeable Liquidity for Otherwise Illiquid Assets: Some, but not all, TABS will be successful traded products. TABS that provide access to otherwise illiquid assets or that provide more efficient access to existing products will succeed. TABS that merely repackage existing assets without providing any additional efficiency will likely cannibalize existing market share for other products based upon the same assets and can at best hope to replace an existing product. Finally, TABS that market themselves as liquid products for exchange will fail based upon regulatory limitation.

TABS based on desirable items that are (a) not available in broadly investable form, (b) are generally illiquid, or (c) are available at lower cost, or at greater convenience when tokenized, will likely succeed. Assets like standardized-grade precious gems, real estate, or art are logical assets to issue as TABS. These assets are generally illiquid because of economic or regulatory impediments to widespread commercialization and trading but may benefit from tokenization and Marketplaces to facilitate trading, as discussed in section IV, infra.

TABS offering exposure to products already available through other mechanisms may dilute or cannibalize existing overall market demand, rather than expand demand. For instance, a TABS instrument offering a tokenized version of gold that does not introduce a novel function, cost savings, or regulatory arbitrage will compete against existing assets based on gold that are already available to investors, including physical gold, traded gold (i.e. SPDR Gold Shares ETF (GLD)), gold options, gold futures, etc… Offering another way to hold gold, alone, without any other benefit, new feature or novel efficiency, does not expand demand for gold or gold based products. However, a tradeable gold-based TABS that is tradeable across borders into populations where other efficient forms of gold ownership are otherwise not available may be a successful TABS product.

TABS, however marketed, are not viable replacements for fiat currencies as a medium of exchange because of trading limitations. Many TABS (such as tokenized gold) are marketed as instruments to be used for transactional purposes, but securities are not designed to function as media of exchange; transactions of securities must be conducted through broker dealers, ATS or national securities exchanges, each of which narrow the pool of potential buyers and introduce time and cost friction.[27] Thus, TABS that seek to replace fiat for transactional purposes will fail.

IV. Operating Marketplaces Will Unlock New Liquidity for Certain Tokenized Securities

United States securities regulation requires marketplaces or facilities that bring together purchasers and sellers of securities to include intermediaries like broker dealers, or to qualify as ATSs, or national stock exchanges. Broker dealers facilitate (a) issuances of securities (sometimes with an ATS or national securities exchange) and (b) discrete transactions of securities. ATS and national securities exchanges (together “Marketplaces”) create public platforms that (1) bring together the orders for securities of multiple buyers and sellers; and (2) use established, non-discretionary methods (whether by providing a trading facility or by setting rules) under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of the trade.[28]

The creation of Marketplaces for tokenized private placements will create additional liquidity and additional primary and secondary demand for TEDs and TABS because of (a) customer prequalification, (b) automation of elements of secondary trading, (c) efficient marketing of private placements, (d) product description standardization[28] and (e) price discovery. These features and factors will benefit issuers, purchasers at primary issuance, and secondary buyers.

a. Customer prequalification.

Marketplaces are required to vet and pre-screen investors during their onboarding process, which will include collection of AML/KYC data to satisfy United States CIP requirements, and collection of investor accreditation information. This pre-qualification of investors builds in the demand side for tokenized securities issuance and secondary trading. Private placements also provide a unique opportunity for securities markets to be unchained from traditional national boundaries. Marketplace investors may come from around the globe, provided that the investor’s participation does not violate applicable United States law or the applicable law of the investor’s home jurisdiction.[29] The onboarding process conducted by Marketplaces will reduce the cost of ad hoc identification of potential investors,[30] and gathering AML/KYC and accreditation information, reducing the cost of capital for issuers, and broadening the scope of secondary trading.

b. Automation of private placement transactions.

Secondary transactions of private placement securities are by design balky, slow, and expensive.[31] The process of a single transaction often costs the trading parties tens of thousands of dollars and may take months to complete. Marketplaces can automate private placement transactions to increase efficiencies and lower transaction costs. Smart contracts[32] that can interact with tokenized securities will reduce the time and expense created by verifying proof of ownership, AML/KYC collection, accreditation verification, and extrinsic transfers of value (i.e. bank wires), simplify and expedite ministerial communication between the parties and their vendors, and streamline compliance and regulatory and tax reporting for these transactions.

c. Enhanced marketing.

While cheaper and faster transactions may marginally increase demand, if there was existing latent demand for streamlined trading, smart market actors would already have focused on creating more efficient markets for these transactions. (This assumption is, in a way, already established as correct given that at least one of these Marketplaces, Templum, was focused on the problem of inefficiency in private placement trading before the concept of tokenizing securities became chic.) To expand demand and liquidity, more buyers need to be identified, and more offerings need to reach those buyers. Marketplaces will expand existing demand by offering simplified, streamlined, automated marketing to a prequalified set of investors.

Private placements of securities are not typically broadly marketed. Because of regulatory restraints and issues of scale (the marketing budget for a $15million dollar private placement sale of equity, is likely to be less than 10% of the amount sought to be raised), private placements are typically marketed to (a) the issuer’s friends and family, (b) others in the issuer’s business community, (c) people geographically proximate to the issuer, and (d) others who have previously purchased securities from similar issuers.

Marketplaces with prequalified investors facilitate marketing to broader or more geographically diverse sets of potential investors who may otherwise never hear of the investment opportunity. By targeting pre-screened investors, issuers can reach broader investor pools, which should increase demand on primary issuance and in secondary trading.

d. Product Description Standardization.

Private placements of securities usually provide less fulsome disclosure than is required of public offerings of securities. Without information from the issuer, or about the security itself, potential investors cannot effectively compare covenants, leverage ratios of the underlying issuers, or expenses associated with the securities. Standardized data collection about products will facilitate valuation algorithms and enhance price discovery. Marketplaces may standardize and disclose information about various securities to allow investors to readily compare and assess these offerings against one another.

e. Price discovery.

Private placements generally are not traded on organized markets, and thus current buy/sell data is generally not available for potential traders, which complicates trader’s ability to fairly and accurately determine prices for these assets. This lack of data also prevents traders from implementing algorithm-driven trading strategies. Marketplaces will disclose investor buy and sell activity (whether by posting completed trades, as is typical of ATS, or by showing open unfilled orders, which is typical of stock exchanges) which will facilitate price discovery for these assets.

Through the combination of (a) efficient, faster, and cheaper transactions, (b) a broader set of pre-qualified investors, (c) enhanced ability to effectively market to those investors, (d) more readily comparable products, and (e) enhanced price discovery, Marketplaces will create more demand for issuances of TEDs and TABS.

Higher demand for primary issuances of these types of securities can spur higher demand for secondary trading of those assets, and presumably increase the price of the security at issuance. Pre-qualified international investors will help expand demand for TEDS and TABS in secondary trading markets. Because of increased transaction order transparency and enhanced comparability among products, traders will have better pricing and trading volume data.

V. Coming Soon: TSIs Capture the Promise of ICOs with the Compliance of Securities.

What if social media participants were paid for their content with ownership in the hosting platform?[33] TSIs leverage tokenization to broaden the spectrum of functionalities that can be associated with regulated securities. They are the “holy grail” that merges complaint fundraising with the promise of instruments that can be negotiated by the purchaser to the issuer (or issuer’s designee) for products or services. For instance, a TSI may provide its purchaser with a non-voting equity share of a company that may also be negotiated back to the issuer in exchange for access to the issuer’s smart contract platform in lieu of payment of money. Likewise, a TSI may allow its purchaser to hold a zero-coupon debt obligation, or to negotiate that instrument back to the issuer who will retire that debt in exchange for delivery of some product. These instruments can also work in the opposite direction to leverage the network effect into security value or debt. This captures the promise of network assets or “utility tokens” but with a compliant means of fundraising.

There are obvious regulatory hurdles to overcome to make TSI’s function under US law. How do we get there from here? These are a few necessary steps:

1. Clean up the fraud in the existing crypto world. The Cease and Desist orders entered into by the SEC with Airfox and Paragon, and the SEC’s statements that followed thereafter laid a clear path for non-compliant ICOs to reach compliance. Large players in the crypto community following the procedures for rescission and registration would be significant and would help pivot regulators from prioritizing enforcement to considering new approaches.

2. Buyers of securities need to be educated about the impact of tokenization and Marketplaces.

3. Buyers and issuers of securities need to use Marketplaces for issuance and trading of TEDs and TABS.

4. AFTER steps 1, 2, and 3, lobbying efforts will be critical. To realize the promise of TSIs, Congress and state legislators need to amend existing laws to create more expansive private placement issuance exceptions, to permit automation of broker dealer functions “on chain,” or “on market,” to expand existing state statutes that permit on chain corporate governance, and to revise federal and state reporting requirements to handle the high-speed nature of expected TSI transactions.

VI. Conclusion

Securities tokenization, in combination with aspects of blockchain technology and new compliant Marketplaces, holds the promise of a revolution in the multi-trillion dollar private placement markets. How to unlock it? Education remains paramount. Issuers, buyers of financial instruments, and regulators must understand the implications of tokenization to unlock liquidity and demand for these previously illiquid assets. On the federal level, clarifying custody of these assets, and openness to automating certain gatekeeping functions played by intermediaries like broker dealers would be significant. States need to continue to innovate the law of corporate governance to allow issuers to realize the potential benefit created by tokenizing their equity shares. Not all tokenized securities will flourish, but securities that comply with regulation and offer attractive products should succeed and lay the groundwork for new, innovative products to come.

[1] According to a recent survey by Holden, Jacobsen, and Subrahmanyam (2013), liquidity is “the ability to trade a significant quantity of a security at a low cost in a short time.” (Yermack, https://academic.oup.com/rof/article/21/1/7/2888422 )

[2] https://www.wsj.com/articles/stock-and-bond-markets-dethroned-private-fundraising-is-now-dominant-1522683249

[3] See 15 USC §77b.

[4] “Token” or “tokenized” as used herein being defined as assets issued on a cryptographically secured blockchain network that facilitates transactions of that token by users of that network.

[5]https://www.forbes.com/sites/laurashin/2017/09/21/heres-the-man-who-created-icos-and-this-is-the-new-token-hes-backing/#112b08081183

[6] https://cointelegraph.com/news/research-20-billion-raised-through-icos-since-2017

[7] This “network” or “utility” classification was applied to these assets by lawyers who argued that because the tokens had consumption for non-investment purpose as their primary purpose or function, they are consumer products, and may be exempted from securities law compliance.

[8] https://www.sec.gov/litigation/investreport/34-81207.pdf

[9] The term “investment contract” was not defined in the Securities Act of 1933 or Securities Exchange Act of 1934; the term was inherited from various states which had their own definitions, and was included, without definition, in the definition of Security, which is taken from the Investment Company Act of 1940. The term was later defined by the four-prong test explained in SEC v. W.T. Howey, which was decided in 1947. Investment contract is currently used as the “catch-all” term, and the Howey Test appropriately created a hyper-flexible framework; it is expressly intended to address the many forms and schemes through which securities may be sold, determining the status of the instrument by its substance over its form.

[10] I have personally argued that the term “blockchain” should be abandoned because the term has been so abused by marketers and includes so many different types of technology within its scope that the term itself has become meaningless. Prof. Angela Walch has written at length about this issue: https://www.bu.edu/rbfl/files/2017/02/The-Path-of-the-Blockchain-Lexicon-Feb-13-2017-Draft.pdf

[11] https://saftproject.com/

[12] Many of the benefits for private placement issuers, in the form of new markets facilitating new liquidity and price discovery discussed in Section IV, infra, already exist for public reporting companies which trade their securities on orderly public markets.

[13] See Tax Equity and Fiscal Responsibility Act of 1982 (Pub.L. 97–248).

[14] It is unclear whether public proof of work blockchains or “private” or “permissioned” ledger systems will emerge as the standard for the issuance of tokenized securities. Although public proof of work systems can provide tamper resistant features, they come with high infrastructure costs and require the issuer to rely upon miners to support the network, which introduces new costs for issuers and new technical risk. Private blockchains typically do not use proof of work and thus do not require reliance upon (and a mechanism to compensate) external support by miners. Private blockchains, however, do not provide “immutability” and typically result in some party or group of parties assuming governance control over the blockchain, which may permit a bad actor to improperly alter records. It is assumed that market forces and regulatory compliance would compel trustworthy behavior in the private network context, as owners of securities issued on a private chain who discover that share ledgers are being wrongfully manipulated will either notify law enforcement/regulators, bring suit, or sell their assets. Initially, shares will be issued on platforms that comply with facilitating regulation and are offered by Marketplaces, discussed in Section IV, infra.

[15] https://www.sec.gov/news/public-statement/digital-asset-securites-issuuance-and-trading.

[16] If a Regulation S exemption is used in tandem with a Regulation D offering, issuers may also sell securities to non-US investors who are qualified under their national securities regulation to purchase US securities. Regulation A+ may allow sales to both accredited and non-accredited investors but to date, no tokenized Regulation A+ issuances have been qualified for sale.

[17] https://www.sec.gov/news/speech/speech-hinman-061418

[18] https://www.sec.gov/news/public-statement/statement-clayton-091318 (“The Commission’s longstanding position is that all staff statements are nonbinding and create no enforceable legal rights or obligations of the Commission or other parties.”)

[19] If the promises made by the issuer were to be decoupled from the instrument when sold, those promises would need to stay with the buyer, or otherwise be independently and separately conveyed. There is no clear understanding of where the legally enforceable promises made by the issuer would be sited in that case.

[20] Because the presumptive value was based upon future utility, ICOs may have been futures when issued.

[21] Consensys, for example, has laid off about 13% of its workforce after the price of Ether plummeted. https://www.coindesk.com/consensys-confirms-layoffs-projecting-13-of-staff-at-startups-to-be-cut

[22] OmiseGo has been reported as an exemplar of ICO-funded projects that have failed to meet development goals, lost researchers and developers and essentially stagnated. https://captainaltcoin.com/disaster-called-omisego-omg-lackluster-performance-overpromising-and-underdelivering-epitome-for-the-whole-altcoin-world/

[23] See, for example, FINMA regulations describing utility tokens as distinct from securities under Swiss law. https://www.finma.ch/en/~/media/finma/dokumente/dokumentencenter/myfinma/1bewilligung/fintech/wegleitung-ico.pdf?la=en

[24]https://www.nytimes.com/2017/03/21/business/dealbook/dole-case-illustrates-problems-in-shareholder-system.html

[25] https://www.bloomberg.com/opinion/articles/2016-05-13/t-rowe-price-voted-for-the-dell-buyout-by-accident

[26] Basis, an asset that was marketed as a “stablecoin,” was apparently unable to avoid security classification by the SEC as a security, which limited its utility as a medium of exchange. See https://www.forbes.com/sites/michaeldelcastillo/2018/12/13/sec-rules-kill-cryptos-top-funded-startup/#6eeec2542918

[27] See 17 CFR 240.3b-16(a)

[28] As suggested by Prof. Sylvain Chassang.

[29] Although international investors will have a different set of investment opportunities, these investors are already active participants in private placement markets and should be expected to be more active participants in the future.

[30] See discussion in part c, supra.

[31] The relevant exemptions used to trade private placements of securities (Rules 144, 144a, 4(a)(7) and the informal 4(a)(1½)) require the transacting parties (and in certain cases, the issuer) to hire their own lawyers, require the participation of regulated actors called transfer agents, in some cases require reporting to the SEC, and may require a complex price discovery process that involves third party vendors, all before the transaction may close.

[32]https://www2.deloitte.com/nl/nl/pages/financial-services/articles/blockchain-technology-use-cases-in-financial-services.html

[33] “Pay me in equity.” Beyoncé.