Security Tokens for RegA+

Although security tokens have been around for a while, they have started to gain popularity because they offer several advantages over traditional investment vehicles. In particular, security tokens can be used in RegA+ offerings, allowing companies to raise money from accredited and unaccredited investors. As a result, security tokens have quickly become one of the most popular ways to invest in startups and other high-growth businesses.

 

What are Security Tokens?

 

Security tokens, as the name implies, are securities. And much like traditional securities, they represent an ownership stake in a company or some other asset and are subject to the same SEC oversight as stocks, bonds, mutual funds, and other forms of investment vehicles. Because of this, they share a familiar structure and have regulatory protection that makes them attractive for companies and investors alike. There is a greater assurance for the issuer that their investment will be protected from the volatility often associated with unregulated cryptocurrencies. For the investor, there is the added security of knowing that an asset backs its investment with value outside of the blockchain. 

 

​​”Security tokens are the missing link between the traditional financial world and the blockchain,” says Andrew Bull, founding partner of Bull Blockchain Law and KorePartner. “They provide the benefits of both worlds: the security of regulated securities and the flexibility and opportunity of digital assets.”

 

However, are security tokens the same as digital securities? The short answer is: yes, security tokens are the same as digital securities. Both represent an ownership stake in an entity or property, subject to SEC regulations. Thus, the names can be used interchangeably. The key difference between security tokens and traditional securities is that the former are digital representations that move and exist on a blockchain. 

 

It is also important to consider that while security tokens are cryptocurrencies, they are different from coins. Coins represent value on their own, like Bitcoin or Ethereum, whereas tokens have a function other than storage or exchange alone. And unlike utility tokens, security tokens represent a stake in an asset that has value outside of the blockchain. 

 

“Because security tokens denominate a stake in an asset that already has value outside of the blockchain, their value is not necessarily domain or ecosystem specific, as is the case with utility tokens,” says Bull. “Instead, the assets apportioned through the security tokens exist in the traditional market, in public and private equities. This makes the security token a naturally more attractive investment to both issuers and investors, as it provides a connection between traditional and digital investment assets.”

 

Benefits of Security Tokens for Issuers and Investors

 

Security tokens offer many benefits to companies and investors. Perhaps most importantly, they provide a bridge between traditional and digital investment assets, making it easier for companies to raise money and investors to gain exposure to the blockchain ecosystem. Because security tokens are subject to SEC regulations, issuing companies may benefit from the reassurance that their investment might be protected to a certain extent. The same benefit goes to the investor.

 

“Both parties can expect their ownership stake to be preserved on the blockchain ledger, as well,” said Bull. Investors can benefit from security tokens because they connect traditional and digital investment assets. Security tokens also have the potential to help investors by providing regulatory protection. This is important because it can help to mitigate the risk associated with investing in more experimental, unregulated cryptocurrencies.

 

On the other hand, digital assets not subject to SEC regulation, like utility tokens, have proven vulnerable to volatility and, therefore, challenging to maintain conditions stable enough to run a company. In this case, the investor in the utility token is exposed to a great deal more risk than the investor in the security token.

 

In summary, security tokens offer several benefits to both companies and investors. They provide a bridge between traditional and digital investment assets, making it easier for companies to raise money and investors to gain exposure to the blockchain ecosystem. These characteristics make security tokens less vulnerable to volatility and a more stable form of investment. They are also subject to SEC regulations, which provide some protection for both companies and investors.

Understanding Digital Assets

There has been a lot of talk in recent years about crypto, tokens, blockchain, ICOs, STOs, Digital Securities, etc.  What does it all mean and why should you care?  In order to navigate the new financial digital world, it is important to first understand the terminology.  Below, I have broken down the typical terms being used in this current digital environment.   In certain sections, I have provided the example of the USA, and its primary regulator, but this is globally applicable.

Distinguishing the types of secondary markets or exchanges where you can trade digital or traditional assets also seems to be confusing.  I have created the following chart to try to distinguish these.

Now, why should you care?  What does this mean to you?  Despite what some people say in the press, blockchain is here to stay.  So understanding the types of digital assets that it hosts is going to be important in making business and investment decisions.

As a co-founder of a company that is focused on revolutionizing the private capital markets, I am not going to get into cryptocurrencies as this is not my area of expertise.  This is for currency experts to discuss.  Similarly, while I know the public listed markets well and how they operate, there are plenty of people who know these markets far better than I.

My background is geared towards the issues faced by private companies. Thus, I will elaborate on the fragmented ecosystem of the private capital markets that sorely need solutions.

Since the SEC and other government regulators around the world started stepping in to ban ICO’s, other alternatives have evolved.  The security token offering or STO is one such term that got some wings in 2018. However, the institutional and traditional investment communities were still leary of the idea of a token or blockchain solution being provided by people without an appropriate understanding of the entire market they are trying to disrupt. Many people from the ICO space were just changing the name and using STO as a new hype to sell the same ideas.

Many of the players (intentional choice of word) in the ICO space were trying to circumvent securities regulations saying they know better how the ecosystem should work.  After decades of scams, the securities regulators know that the current system has built-in checks and balances for a reason.  We all understand there are issues and inefficiencies in the private capital markets, but in order to change securities rules you better have a big budget and strong case for it. As an example, the JOBS Act took well over five and likely closer to ten years to come into place.  The use of blockchain has valuable applications that can certainly provide more efficient and cost-effective solutions to current private capital markets, as long as you work within the existing securities regulations.

There is a lot of exciting stuff being built with blockchain technology. I believe that if you are looking at this as a solution to the private capital markets, you need to consider a few things if you are looking at public chains as a potential solution:

  1. Use of private wallets for sole custody of financial instruments will not work. Securities law requires the use of transfer agents in many situations and transfer agents need to have custody of assets in order to manage them. If the digital securities are being held by individuals in their own wallet, there is no way the transfer agents can have custody of them. Think of public markets: you do not hold the securities (share certificates) yourself, they are digitally represented in your brokerage account and held by transfer agents.
  2. Mining of securities: It is generally not acceptable for unknown miners to verify transactions; even known miners must be eligible to perform business validation of a transaction either because they are parties to the transaction, have fiduciary responsibility, or certified subject matter credentials or otherwise registered and regulated entities.

Gas prices are not acceptable when it comes to securities.  In order for a token to move on some blockchains, a gas price needs to be paid to miners. Transaction fees must be contractually fixed in advance and cannot be uncertain or subject to an auction style of payment (which leads to a form of ad-hoc discrimination). For individual investors, transaction prices need to be certain  and follow execution guarantees.