How Regulators Embrace Security Tokens
With the continued maturation of the digital asset space from the 2017 bull run, digital securities or security tokens have quickly become the most popular theme in the financial blockchain business. At Tritum Digital Assets we view this as a very positive step forward for the industry, versus prior legally ambiguous platforms and products. Unfortunately, some of the fast and loose moves of the recent past have resulted in numerous scandals and failures, demonstrating the reasons regulations were introduced in the first place: Investor protection.
Recently, two significant regulators have issued consultation papers for digital assets, one from the UK Financial Conduct Authority (FCA), and one joint paper from the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC).
Interestingly the two papers take two separate point of departures for their consultations. The FCA questions all center around the type of tokens traded, whereas the CSA/IIROC questions take the perspective of the trading platforms.
The FCA have clarified their definition of a security token in their Guidance on Cryptoassets (currently as consultation paper). I support the increased clarity from the regulators, which is necessary and should be emulated by authorities of other jurisdictions. Their paper also recommended that the regulators work together to create common definitions and rules in this truly global market.
The FCA definition closely ties the security token to a traditional security, which is a very logical path to take. There is little reason to consider the technical format of a security to define its legal status as a security.
“Security tokens are securities because they grant certain rights associated with traditional securities.”
With this definition the FCA clarifies that the security token should give rights to ownership or profit. This could also include the right to vote.
The way tokens are used today makes me raise the question if we need a further expansion of the definition of security tokens. Many tokens fall outside of the definition of a security token, while the intention of the issuer is in many ways identical to that of a security issuer. A non-security token would not be regulated, and consumer protection would be undefined, and may not exist at all.
A token that is issued in order to raise money for its issuer, and naturally is being bought by investors with the intention to earn profit commensurate with the success of the issuer. Classically, this should be a security and be regulated as such. A security token needn’t necessarily include voting rights or rights to dividend.
With tokens we have a new way of capitalizing from investments, which may only have been possible in limited circumstances, or at much more significant cost in the pre-blockchain era. Regulation of these new asset formats should as much as possible utilize existing definitions, but we also have to accept that our markets are developing and sometimes we need to rethink our old truths. In my view I can clearly invest in a token because I believe in the team and business model behind it, just as I would with a security. I may not receive dividend, but I hope that when the business is successful the token’s price will increase. That token is very closely linked to the company. It could represent many assets or products of the company such as intellectual property. We can compare it to buying a share of a patent owned by the company. If the company does well, the value of the patent increases, but I may not get a dividend or a voting right. With the new token economy we have for the first time built the tools to enable this market to reach its potential to become liquid and easily accessible for everyone. Now the regulators have to step up and ensure continued consumer protection.
The CSA/IIROC consultation paper “Proposed Framework for Crypto-Asset Trading Platforms” take the perspective of the exchanges, or Platforms, facilitating the trading of crypto assets. While they recognize the fact that not all Platforms will be subject to securities regulation, they seem to welcome innovation and recognize the fact that regulation need to keep pace with the evolving markets. The CSA have also found that most offerings of utility tokens have involved a distribution of securities. Platforms trading these tokens would therefore be subject to securities regulatory requirements. My interpretation is that CSA/IIROC are taking a broader view, than the FCA, on what to regulate in the crypto asset space. While not directly mentioning it, they are likely looking for a wider adoption of the security token concept. I believe this is the right approach in order to build trust in the token economy.
For security tokens, a substantial departure from existing utility, or other non-security format tokens, is the need for certain external controls to exist for the management of a token. In the securities industry, this may be as part of an action by the issuer themselves, such as the payment of a dividend, a corporate action such as a split, or redemption. For a regulator, this may be the ability to dictate the freezing of movement of assets in a given account for legal reasons, such as sales by insiders during restricted periods.
In order to truly create a viable security token regulated ecosystem, these critical components need to be made available with the ecosystem, and adopted by issuers and other market participants such as exchanges or service providers. Tritum recognizes this, and endeavors to seek and participate in the development of the industry leading solutions in that respect.
Tritum plans to become a fully regulated securities trading platform as a EU regulated Multilateral Trading Facility, bringing trading of tokens to the next level, helping the securities market becoming more efficient and transparent and presenting investors with new opportunities.
We are building the new ecosystem for efficient issuing and trading of digital securities. Built in compliance, self-executing dividends and fractional ownership are some examples of the security tokens benefits. Combined with the trust of trading on Tritum, with protocols, performance and regulation from the traditional securities market, we can fully explore the benefits of the blockchain.
The author is a co-founder of Tritum Digital Assets and a former Vice President of Nasdaq and Head of Economic Research, responsible for reporting all volumes of Nasdaq’s Nordic Exchanges. He is also a former Finance Director of the US Consolidated Plan, the UTP Plan. The plan governs transaction information from all US securities exchanges, is approved by the SEC and provides millions of investors with reliable data.
