2019: The year of the Security Token Offering (STO)?
2019 could be the year of the SEC-compliant ICOs, aka Security Token Offerings (STOs), Yahoo Finance reports.
From ICOs to STOs
Some high profile projects have raised a lot of money with Initial Coin Offerings (ICOs), which for a while have been seen as a revolution in fundraising.
But ICOs are becoming less popular, due to the decreasing value of most cryptocurrencies (including Ethereum, upon which many ICOs are based) and, especially, the increasing hostility of regulatory authorities like the Securities and Exchange Commission (SEC) in the US.
The point of the regulators is that the tokens offered by many ICOs are really securities, and must be subject to securities regulations. Actually, the SEC “said that most ICO tokens in fact qualify as securities. As a result, companies that issued them are breaking the law by offering unregistered securities.”
The Howey test is used to determine whether ICOs qualify as securities. If, under the terms of an ICO, “a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party,” then the ICO tokens will likely be considered as securities, regardless of claims that the tokens are only “utility tokens.”
Lawyers and crypto advocates “now see a new market for SEC-compliant ICOs,” notes Yahoo Finance.
“These have been dubbed ‘security token offerings,’ to reflect the fact that they are now classified as securities. As well as offering the potential for legally compliant ICOs, advocates argue that STOs allow companies to put existing securities such as stocks and bonds on to a cryptographic blockchain. This would allow people to trade these securities without the need for a middleman.”
Several projects are currently advertising plans to launch STOs in 2019 and the Swiss Stock Exchange is building its own platform to issue and trade security tokens in anticipation of a boom. “2019 could be the year of the STO,” concludes Yahoo Finance.
A study titled “Security Token Offerings: The Evolution of Capital Formation,” produced by Node Blockchain, defines STOs as:
“A Security Token Offering (‘STO’) is a financial security issued in the form of a digital asset; which typically represent ownership rights in an underlying company and/or its assets. This is distinctly different than the aforementioned ICOs, which were “Utility Tokens” or digital tokens that provided access to a project’s future product/service with no tangible claim to an asset or equity ownership.”
First steps toward regulated STOs
The regulators often have good intentions. They feel the need to protect small investors from fraud, and there is plenty of fraud and scams in the crypto space indeed. Therefore, securities regulations in the US insist that securities should be offered only to “qualified investors” with enough money to lose.
The developing regulatory framework for security tokens and STOs is outlined in a post by Pierre Villenave in the LGO Group blog. According to Villenave, the safest approach for ICO promoters is to assume that their ICO falls under securities regulations, and launch an explicit STO taking advantage of the flexibility and exemptions offered by the Jumpstart Our Business Startups Act (JOBS Act):
“With this constant noise around cryptocurrency regulations, it is easy to lose track of the existing solution: The safest and most conservative approach is issuing a security using one of the exemptions of the JOBS (Jumpstart our Business Startups) Act. These rules were established to help small businesses raise capital and could provide token issuers with a solution for the time being.”
Possible exemptions from the full, very demanding securities regulations fall into different use cases. For example, STOs below $5 million, registered with state regulators, don’t have restrictions on investor status. Alternatively, unregistered STOs with no capital limits are only open to accredited investors.
“[To] be considered an accredited investor, one must have a net worth of at least $1,000,000, excluding the value of one’s primary residence, or have income at least $200,000 each year for the last two years and have the expectation to make the same amount this year.”
Intermediate use cases are covered by other rules, and the possibility to resell tokens is regulated. An issuer “can raise unlimited amounts of capital through institutional investors and have resale restrictions OR raise up to $50 million with all investors without resale restrictions OR limited amounts of capital with little restrictions.” However, Villenave emphasizes that:
“Even for projects looking to issue a utility token, the token could start as a security, and as the platform decentralizes and the token fails the Howey Test, it could turn into a utility and become available for resale to the public.”
To the Moon, anonymously
Regulations won’t go away anytime soon, and light flexible regulations are certainly better than heavy unforgiving regulations. Therefore, I praise the effort of regulators in the US and elsewhere to simplify and streamline their legacy legal frameworks in light of emerging options like blockchain technology.
At the same time, SEC-compliant STOs seem to me essentially equivalent to traditional forms of private investment offers, with some added flexibility and a little crypto-flavor.
To me, a really revolutionary application of cryptocurrencies and blockchain technology would be allowing people all over the planet to invest anonymously in promising projects. Ownership rights and returns would be automatically guaranteed by smart contracts in a trustless environment, and shared would be traded anonymously in open markets.
Of course, the regulators hate and will continue to hate this concept. But I am persuaded that anonymous blockchain-based investment platforms could permit raising real money (that means billions) for worthy projects with commercial potential, like colonizing the Moon and the planets.
Picture from GoodFreePhotos.