Issuing Security Tokens
How can you issue tokens without getting in trouble with the law? Andrew Dix, the founder of Crowded Media Group, which wholly owns Crowdfund Insider, opened the panel with a quick rundown of the ways in which you can issue tokens to the public within US regulation:
Regulation D 506(c), in which you can generally solicit the public for capital, with no cap limit, but only to accredited investors
Regulation Crowdfunding, in which you can raise $1.07M from both accredited and non-accredited investors in a given year
Regulation A, in which you can raise $50M from both accredited and non-accredited investors in a given year, and the tokens are available to trade immediately (no 12-month lock-up period).
When asked to define the difference between an ICO (Initial Coin Offering) and an STO (Security Token Offering), Andy Bromberg, Co-Founder & President of CoinList, took a step back and said, “there’s two regulatory classifications that matter. One is the classification of what you are selling at the time of the offering, and the other is the intended regulatory status of what you are offering.” Bromberg is referring to a SAFT, a Simple Agreement for Future Tokens, a structure that Filecoin used on CoinList, in which a company, e.g. Filecoin, offers a security that later (hopefully) converts to a utility.
An ICO, in Bromberg’s opinion, is the sale of a tokenized security that may or may not eventually be securities. STOs are a subset of that: offerings in which the end product is always a security, such as an asset-backed token. Because of the strictness of US securities laws, Mason Borda, the CEO of Tokensoft, said many of his clients have chosen to exclude the US from their offering.
Why tokenize at all?
Bromberg points to Stephen McKeon’s The Security Token Thesis as a starting point (McKeon also moderated one of the panels at the StartEngine Summit), but in essence the argument is this: tokenization creates “more liquid and more efficient markets for securities that don’t have hyper efficient, hyper liquid markets today.” It also allows for interoperability, where different security tokens can interact with each other, and you can create unique contracts that reference multiple securities and create new financial products on top of that. For example, if you wanted to invest in real estate, you could pick and choose which buildings you wanted to invest in as opposed to taking an entire basket in a REIT, organized by a bank or institution.
Put more simply, Josh Amster, the VP of Sales & Business Development, said “tokenization allows for transparency and easy access to liquidation.”
However, tokenization gets tricky once you the offering becomes global. Borda discussed how every country has different laws for issuance, but it increases in complexity after issuance. Some countries have investor limits, some regions aren’t supposed to trade with others, and the list goes on. Borda’s platform Tokensoft helps companies navigate international regulations and how to do a compliant sale overseas.
The other big regulatory issue that many entrepreneurs are unaware of is Rule 12g. Amster walked the crowd through 12g, which states that if you have over 2,000 investors or over 500 non-accredited investors, you have to be a fully reporting company, which is very expensive. However, Regulation Crowdfunding and Regulation A are both exempt from 12g if the company meets a few requirements: they must have less than $25M or $75M in assets (depending on the exemption used), they need to be ongoing with reporting, and they must use a Registered Transfer Agent, that is registered with the SEC. These exemptions mean a company can have tens of thousands of investors, and that sheer volume is necessary to create real liquidity for your tokens.
At the end of the panel, the question was posed: who should tokenize their securities? In response, Amster said, “people assume you have to be a blockchain-oriented business to do an STO, but you really don’t. You have to want to tokenize your security…the question is “do you need capital, and do you want liquidity for your investors? If those are true, then this is a space you want to play in.”
Bromberg and Borda were more guarded with their answers, both pointing to the fact that the security token space is so new. In Borda’s words, “the market is young. People have figured out that these tokens should be offered as securities late last year. Doing a security token offering is a lot harder than doing a traditional round. Not only is hard to attract the investment, as it traditionally is, but the infrastructure is still very young. There are maybe two exchanges in the US that can support security tokens. None of them have much liquidity.”
But in time, all the panelists believe that will change.