UPRETS RESEARCH | Blockchain Application Trend — Real Estate Industry Research
Research of American Blockchain Application: Security Tokens Offering
Research of American Blockchain Application: Security Tokens Offering
Author：Xun Shuo、Ke Yan
（XIN Real Estate Fintech Research Center）
At first, unregulated is the biggest selling point of digital encrypted currency, but the emergence of ICO air currency fraud, hacker theft, Bitcoin’s participation in covert network transactions, money laundering and other issues has also become its biggest weakness. In view of the chaos caused by ICO to the market and the absence of regulatory rules, many governments have stopped, banned or formulated rules for financing activities in the form of ICO. From the end of 2018 to the first half of 2019, the U.S. regulatory authorities have gradually clarified their monetary policy on encryption. The SEC of the U.S. Securities Regulatory Commission has issued a number of litigation and investigation reports on whether large digital asset intermediaries violate federal securities laws. Digital Security Offering has become another emerging concept after ICO and USDT. Some people think that digital security offering is a “supervised ICO” and a new financing method. There are also views that digital security offeringcan be used for private asset securitization and venture capital financing and is an effective alternative.
At present, there is no uniform definition of digital assets related concepts such as digital securities, digital security offering, etc. in the supervision and industry of various countries. Therefore, this report selects a relatively recognized and stable concept from the definition of U.S. regulators, especially the U.S. Securities Regulatory Commission, and introduces the digital security offering concept, characteristics and business model based on the U.S. securitized token issuance case. It also analyzes digital security offering’s main participants and issuance process and the differences between digital security offering and traditional REITs with a special case, St. Regis Aspen Resort Property Share digital security offering.
However, it should be noted that digital security offering is in an emerging stage, the quality of digital security offering projects in the market is mixed, and the uncertainty in supervision and distribution still exists. The issuer of the project needs to set up according to the factors such as the securities exemption rules to be applied for, the asset structure, the financing scale, etc., and employ legal or commercial service agencies to formulate specific service plans. Therefore, the CASE-BY-CASE analysis is more accurate, and this article only selects a representative category.
I. Digital Securities
1.1 Regulatory Background
The starting point for US regulation of the digital cash industry can be considered as the SEC’s investigation report on the DAO (Decentralized Autonomy Organization) released in July 2017. As SEC Chairman Jay Clayton stressed, “Securities must be issued in accordance with the securities legal system, regardless of changes in the way securities are issued.” DAO’s investigation report states that “as long as securities are traded in the United States, securities regulations must be complied with or qualified exemptions must be sought, including transactions through electronic means.” Thereinto, “electronic transactions” are intended to be digital assets or digital cash derived from block chain technology. The SEC has identified digital cash or ICO as essential and has begun to effectively supervise their issuance, sale and brokers.
In November 2018, the SEC issued the Statement on Digital Asset Securities Issuance and Trading. For the issue and sale of digital assets, the SEC focuses on two issues. The first is how to determine whether digital assets are “securities” under the definition of federal securities law. Second, if the digital assets are securities, what requirements must be met for registration? For digital cash’s “brokers” or “dealers” trading in the secondary market, they must register with the FINRA Committee and become members of the self-regulatory organization to operate brokerage activities. The SEC also fined Airfox and Paragon for violating regulations on the sale of digital securities in its statement and forced the two companies to register ICO sales as securities issuance.
1.2 Definition and Characteristics of Digital Securitiies
1.2.1 Digital Security and Functional Token
According to the classification of SEC, the digital encrypted digital securities currently circulating in the market are divided into two types. According to the issuance of digital securities and the source of operating income, it is judged whether they can pass the Howey test. If they pass, they are deemed as “securities” and belong to “utility digital securities”, otherwise they are “functional digital securities”. In other words, the U.S. regulatory authorities recognize the essence of various digital securities with financial attributes and judge whether a certain financial product is “securities”. The issuance, sale, trading and investor protection of “securities-type digital securities” must abide by the U.S. securities laws. Bitcoin, Ethernet, Ripple and other digital cash have all been incorporated into the US securities regulatory system. The comparison between the two is shown in Table 1.1 below.
Functional digital securities is similar to a gateway or application coin. Token holders can only enjoy product services or voting rights. Its value is theoretical until the digital securities issuer completes the development and application.
The value of securities digital securities needs to be supported by marketable assets, and the rights and interests they represent are biased towards the ownership represented by traditional equity and the future income repayment rights represented by creditor’s rights. Technically, digital securities is generated based on ERC1400 protocol or ERC20 protocol and other protocols (it can be understood as a string of encrypted digital certificates, and the rights and interests of the certificates are defined by the protocol frame), which makes it have the advantages of traceability, non-tampering and easy flow of transactions brought by the block chain. At present, many companies that issue encrypted digital securities through compliance channels are trying to replace the high cost of private equity and the huge uncertainty in ICO by raising project funds through such methods.
1.2.2 Exempted Security
According to the U.S. Securities Law of 1933, every company must register the securities it sells with the SEC. At the same time, it also provides exemption from registration regulations, most commonly Regulation D (Private Equity Financing Regulations). Regulation D is an exemption for securities registration stipulated by the SEC for the purpose of allowing small companies to raise funds through the sale of equity or creditor’s rights to specific accredited investors[1]. Issuers do not need to register with the SEC and publicly issue costs. Rule 506(c) in Regulation D is the most important, and this rule is also an important basis for the legal public issuance of digital securities.
Digital securities are consistent with the traditional exemption requirements for securities. The exemption considerations mainly focus on the qualifications of the issuer and investors, the ceiling of the amount of funds raised, the number of investors, the scope of funds raised for the group and restrictions on sales. According to Regulation D 506(c), the issuer shall submit Form D and Private Placement Memorandum PPM on exemption from registration to the CSRC. Form D includes the information of the company’s executive officers, directors and the company itself. PPM is most important to provide investment contracts and subscription agreements.
506(c) allows issuers to raise unlimited capital from specific “accredited investors”, but with a maximum of 2,000 investors, and can conduct public publicity; There is a one-year lock-in period before participating in secondary market transactions. Regulation S allows non-U.S. investors to invest in U.S. companies on a basis similar to Regulation D without the approval of “accredited investors”, which provides a way for foreign and U.S. pedestrians to obtain capital from outside the United States. For example, Table 1.2 below shows the relationship between the two regulations.
Table 1.2 Terms of Compliance for Token Application for Exemption from Issuance
1.3 Auxiliary Digital Securities Compliance and Issuance
From the traditional chain of assets to the fragmentation of assets, to the issuance of digital securities and their sale to qualified investors, while meeting KYC/AML and tax regulations, the process is a complete business closed loop, thus creating a digital security generation and issuance service platform that provides a package of solutions. The main responsibilities are to help the assets to be digitalized based on block chain technology, and to issue the digitalized assets to specific investors. Polymath, Securitize, and Habor have high market shares. The platform is described in Table 1.3 belowTaking Polymath for example; According to official website (polymath.network), Polymath is a platform to help asset securitization pass certificates. It integrates legal and compliance token securities initiation and issuance block chain agreements. Its system ensures that only qualified investors can participate and meet regulatory requirements. Polymath’s ST will be supported by companies, real estate or other physical assets. The platform connects investors, project sponsors and service providers to establish an ecosystem of asset sharing, token generation, compliance and sales transactions.
The SEC-regulated custodian Prime Trust provides hosting services for Polymath (POLY) coins and ST-20 digital securities issued on Ethernet that are lower than ERC-20 standards. In the block chain environment, the assets held by clients of the custodian are mainly encrypted assets such as digital securities to ensure their safety. At present, Coinbase, Nomura of Japan and Six Swiss Exchange have all introduced special custody of encrypted currencies to institutional investors.
Digital securities after asset sharing do not support issuance/transaction. The issuer must also select legal agents through the platform, formulate transaction restrictions and compliance investigations that conform to the securities law, and design standardized intelligent contracts by technical service providers. For example, the ST-20 agreement imposes restrictions on the lock-up period of digital securities, the upper limit of the number of investors, and the qualifications of investors. For example, digital securities issued by the ST-20 agreement can only flow among investors passing through KYC, as shown in Figure 1.1.
The service providers involved in the above process include six categories: advisor/broker-dealer, legal, KYC/AML, marketing, custodianship and coin sales. Take KYC/AML as an example (Figure 1.2). Polymath and Identity Mind cooperate to implement KYC and AML procedures for investors. Investors are added to the white list of Ethereum after they have passed the identity verification for compliance when digital securities trading starts. The whole service distribution process can be fully displayed through the digital securities circulation roadmap shown in Figure 1.3
I. Digital Security Case of Real Estate: St. Regis Aspen Resort Property
In this chapter, we will choose a specific case study. The selected example is St. Regis Aspen Resort digital securities in the United States. At first, the project chose to register publicly issued traditional REITs products and then switched to digital securities offerings to complete financing. Aspen Coin digital security offerings project is a representative case of landing in the real estate field. it has received wide attention since its issuance. we can see the application and exploration in the traditional real estate industry.
In August 2018, Aspen Coin went online on the trading platform Indiegogo, a digital securities project with real estate as its underlying asset. The issuance of Aspen Coin relies on the property of St. Regis Aspen Resort. Investors can purchase Aspen Coin through virtual currencies such as US dollars or bitcoin, and indirectly hold shares of the property through holding digital securities.
In September 2018, Aspen Coin raised 18 million US dollars at an issue price of 1.00 US dollars.
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