We are getting close to allowing Tags and Restricted Assets to be adopted on the Ravencoin network. It is up to the Ravencoin network participants to adopt the changes. This is the culmination of two years of hard work and pulls together the final pieces of a very elaborate and significant puzzle for Securities Token Offerings (STOs).
As many of you know, an STO is a legal issuance of securities on the blockchain. STOs are like the ICOs of 2017, but they are issued under the legal framework of — and compliant with — the securities laws. In the U.S., specifically the Securities Act of 1933.
Technologists have already shown that the purchasing, issuing, transferring, tracking, and trading of tokens to raise capital is possible. This began with the Mastercoin offering in 2013 and reached its apex in 2017, with billions of dollars raised through ICOs. A few of these ICOs failed because they were scams, and others failed because of enforcement by the SEC of rules that weren’t followed. Still others like EOS and SIA have had SEC enforcement, cooperated and are still pushing their projects along. Some ICOs outside the U.S. have been successful and have resulted in interesting new projects.
Some of the subsequent ICO issuers have moved out of the U.S. to friendlier jurisdictions and left the U.S. investors behind. Others have abandoned their plans because of the complexity of navigating the existing U.S. legal framework.
In the meantime, the Ravencoin developers and community have been writing code and building technology to solve the problems faced by those interested in issuing legally compliant token offerings. There were nine major technological problems that needed to be solved:
- Restricted Assets — These are tokenized assets on the Ravencoin platform that follow rules set by the token issuer. This is just open-source technology and tools, where the rules to follow are set by the issuer, and enforced by the distributed code.
- Tags — Tags are needed so that the movement of Restricted Assets can be restricted to only those addresses that are properly tagged. Tagging can be used for things like KYC, Accreditation, Affiliation, and limits on the number of addresses that can hold tokens.
- KYC Platform — A trusted KYC/AML/OFAC entity that is so good and has such great policies that others can rely on the platform to satisfy their compliance obligations. Finclusive has developed a service that will integrate with the Ravencoin platform to satisfy these requirements.
- Freeze (by asset/address) — This is required for Security Tokens to prevent their movement in the event that the holder is found to be a “bad actor”. This is a compliance requirement. Another use for these features is for Rule 144 restricted stock.
- Freeze (by asset) — This is required for Security Token movement to be completely frozen for a given asset. This is also a compliance requirement.
- Memos — This allows any freeze or tag to have additional immutable metadata identifying the reason. This can be used for normal operations like Rule 144 restrictions, or for extraordinary events like seizure under a court order.
- Dividends or Payments — This allows the payment of profits, royalty stream, or contractually obligated payment to asset holders who are properly KYCed.
- Voting — This optional feature allows equity token holders to vote their shares by sending vote tokens to specific addresses.
- Messaging — This allows the reporting of material information to the token holders. It can also be used to inform the token holders of an impending vote.
These nine technological tools facilitate the building of a compliant ecosystem for Security Tokens.
So let’s walk through how this is done and why these open-source code solutions work together to satisfy the rules and regulations that are in place in the U.S.
I am not a lawyer, but I’ve talked frequently with lawyers, in pursuit of a solution. This is a roadmap, but not legal advice, so check with your own lawyer and contact me if you find any flaws in the solution. If you are a securities lawyer and I have any of this wrong, please let me know.
Under U.S. law, securities offered to the public must be registered, or be issued under an exemption. Some exemptions include:
- Reg D — Selling mostly to wealthy folks who have to hold for six months or a year.
- Reg S — Selling only to non-U.S. citizens that are not in the U.S.
- Reg A+ (Tier 1) — Sell to the public up to $20 million. Requires filing with state securities agencies.
- Reg A+ (Tier 2) — Sell to the public up to $50 million. Requires SEC “blessing” of disclosures.
- Reg Crowdfund — Sell to the public up to $1,070,000. Limits per investor, generally 1-year resale restriction.
So first pick one of these. There will be different rules depending on which you pick. I’ll run through some ways that the Restricted Assets can help with each one.
The other thing about securities is that every security token holder needs to be known. This requirement is largely hidden from the public and is usually handled by a bank, or a broker-dealer such as Schwab, Fidelity, TD Ameritrade, etc. The compliant crypto-exchanges have pushed this KYC (Know Your Customer) requirement into the limelight as they now ask for name, birthday, and photos of your id.
This KYC process comes with some additional checking of persons against databases to make sure that bad guys aren’t allowed to avail themselves of the U.S. financial system.
Ok, here’s where it all comes together. Combining the Tag feature of Ravencoin with a very trustworthy KYC provider (e.g. Finclusive) that will tag Ravencoin addresses with a special tag (#KYC_F) indicating that KYC information is securely stored and the appropriate databases have been checked. That tag can only be applied by Finclusive because as a Ravencoin tag issuer (“Qualifier”), only they have the private keys to assign the tag.
The KYC tag serves four purposes: (1) it indicates to the Ravencoin platform that the Restricted Asset can move to the address; (2) it serves as a guarantee that KYC has been done to legally protect the issuer; 3) it indicates where the documentation is located if the government needed to present a subpoena or warrant for the information; 4) it identifies the address in which the token would be frozen if legally required.
This can all be automated. Once KYC has been done, the tag can be assigned to the address. Proof of address ownership can be done, if needed, by requesting a small amount of RVN sent from the address, or signing a supplied string with the private key of the Ravencoin address.
Issuing security tokens
This can be done in under a minute by the issuer using the Ravencoin-Qt wallet. With 1500 RVN + 0.01 RVN for miner fees, create the unique Restricted Asset name that represents the security. Include legal documentation and disclosure information relating to the security by putting a disclosure PDF into IPFS and include the IPFS hash when issuing the token. Set the token qty, and set to re-issuable. Set the Rule to “#KYC_F” to restrict the token to only KYCed addresses.
If issuing under Reg D, then include a rule like “#KYC_F & #ACCREDITED_F” to restrict the token to only individuals that are KYCed and Accredited. The tags and Restricted Asset rule allows the token to remain fully compliant while on-chain.
If issuing under Reg A+ or Reg Crowdfund, the accredited tag isn’t needed.
Depending on which exemption you’ve selected, make sure you’ve complied with any disclosure rules before selling tokens.
Once the Ravencoin address is tagged and the holder pays for the security token via RVN or USD, the security token issuer can send security tokens to the tagged address. The Ravencoin system will prevent the tokens from moving to addresses that don’t have the appropriate tags.
If the token can’t be traded because of restrictions imposed by the type of issuance (Reg D, Reg S, etc.), then all of the tokens can be frozen so that no transfers can be done until the restrictions are lifted and the token trading is unfrozen.
For Reg A+, selling is allowed immediately, for Reg D the token should be frozen for at least six months. Ravencoin-qt can be used to freeze and unfreeze your Restricted Asset if you are the issuer.
Rule 144 requires that some shares owned by folks that are affiliated with the company can’t be traded. The Ravencoin Restricted Assets can be frozen by address (individually), with a memo that specifies the reason. This is the digital equivalent of a legend on a stock certificate.
Freeze or Seize (Court ordered)
In the rare event that a security token must not be used, an individual address’ security token can be frozen and marked (via memos) as lost or seized such that the issuer will not redeem or honor those tokens.
Secondary Market (Trading and Liquidity)
Once a token is allowed to be sold, it is important to make sure that any token that is considered a security token as determined by the Howey test, is traded on a venue that is properly licensed and regulated. There aren’t very many of these in the U.S. yet. Eventually, there will likely be many choices, but currently, tZero ATS, an SEC-registered broker-dealer that operates an alternative trading system, is a good choice.
Any significant and legally issued security token is a candidate to trade on the tZero ATS.
As more tokens are issued on the Ravencoin platform, an ecosystem will develop of verified and accredited investors that can invest in additional tokens with a minimal amount of additional verification.
This lends itself to the creation of an issuance platform that makes STO issuance easy and helps guide issuers through the legal nuances of using STOs.
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Frequently Asked Questions
Q: Can the issuer change the rules for a token?
A: Yes. Provided the token is set to ‘reissuable’ when created, the token rules can be changed. A great example would be to remove the #ACCREDITED tag after the 1-year expiration of the requirement.
Q: Aren’t these built-in transfer restrictions at odds with the permissionless ethos of Bitcoin?
A: Yes, but this is not for BTC, RVN, or LTC which are not securities. These new technical capabilities of the Ravencoin network are for securities which are investment contracts, and by their very nature, securities are ultimately “redeemed” or “honored” by the issuer. The securities laws exist to ensure that those issuers are doing proper disclosure, and accounting and honoring their commitments. If the securities laws don’t apply, either because of the nature of the token or the jurisdiction of the token holders, then use the regular Ravencoin assets instead of the Restricted Assets. The Restricted Assets will always start with a $ so they can be easily distinguished from the regular assets, and regular assets will never start with a $.
Q: Can the Ravencoin address holder remove the tag?
A: No, only the qualifier can add or remove the tag by signing a transaction with their private key.
Q: Is the tagging expensive?
A: No, the tag will burn one RVN, which at the moment is under five cents.
Q: Who can freeze the trading of Restricted Assets?
A: Only the issuer of the Restricted Asset. When issuing a Restricted Asset or a regular asset, the issuer gets an admin token that ends with a “!”. The holder of this token is the one that can freeze and unfreeze. If the token is left as ‘reissuable’, then it also allows updating of the metadata, updating the restriction rules, and issuing additional tokens.
Q: Why should I create a security token or asset on Ravencoin compared to another option?
A: Options like the ERC-20 contract on Ethereum do not have the necessary capabilities for on-chain compliance. The smart contracts that do have compliance built-in use whitelisting instead of tagging, but don’t have the meta-data layer that can be used for disclosures and self-discovery of the tokens. Tell me more…
Q: Is Ravencoin a secure chain to issue security tokens and other assets?
A: Ravencoin uses proof-of-work to secure the blockchain, and added NLR to protect the blockchain from 51% attacks. The blockchain can’t be automatically rewritten by a hidden mining attack after sixty confirmations.
Q: How does Ravencoin make money?
A: Ravencoin is not a company, it is ideas expressed in open-source code. It is also a network of folks choosing to run the Ravencoin software. Ravencoin doesn’t make money, or charge any fees. You can download and run Ravencoin at no charge.
Q: How scalable is Ravencoin?
A: At the time of this writing, there are no scalability issues. Ravencoin has 20 times the transaction capacity of Bitcoin, and as we approach these limits, we have plans on how we can increase capacity.
Q: Now that all these ideas have been coded, and since Ravencoin is open-source, can I just copy it?
A: Yes, you can copy the code by cloning or forking the Ravencoin GitHub repo. What you can’t easily copy is the community of volunteers, miners, exchanges, tools, browsers, wallets, projects, and supporters of the project. A better approach is joining the community and help make Ravencoin even better.