Hype & Uncertainty Around Security Token Offerings
During the past few months, the noise around security token grew very quickly. People understood its better to invest into something that can be held accountable then something that can take your money and do what it wants.
In the previous article, we explained what a security token is. Now we want to look into who is offering security tokens and under what regulations. There are two main ways of going about raising funds through a security token sale, but the safest and easiest approach is issuing a security using one of the exemptions of the JOBS (Jumpstart Our Business Startups) Act. These laws were introduced to help small businesses raise capital. The idea was it, to reduce friction and not cripple innovation. Small business bootstrap the economy and should have methods of raising funds for new ideas and concepts.
To understand security regulations we first need to define what Bitcoin is in the eyes of regulators, and who those regulators are.
What Regulations Affect Security Token Offerings
The CFTC (Commodity Futures Trading Commission is an independent agency of the US government) views Bitcoin as a commodity, the IRS (Internal Revenue Service is the revenue service) defines cryptocurrency as property, and the SEC (Securities and Exchange Commission) indicated that many ICOs were securities.
Commodities exchanges providing a spot market or currencies do not need to be licensed as a regulated entity, while a platform that offers securities are required to register as a national exchange or Alternative Trading System (ATS) or apply as a broker-dealer.
Companies that are involved with financial assets, such as stocks, bonds, bank deposits and the like are examples of financial assets, are required to comply with consumer protection laws and the Bank Secrecy Act and the USA Patriot Act.
Simply put, if your a currency or utility token exchange, you can do whatever you feel like, but as soon as securities or financial assets are involved things become a lot more complicated.
How to Offer a Security Token
If you want to issue a security, you will need to register it with the SEC. Most blockchain based digital securities do not get registered. It is a complex and expensive process meant for the established business. Once registered it’s now known as an IPO.
To avoid this time-consuming projects can make use of the JOBS Act from 2012. The JOBS Act was not made for STOs specifically, but it seems to fit the needs of security token issuers. Issuers in the U.S. can apply for three distinct exemptions: Reg D, Reg A+ and Reg CF. Before going further, we need to define three key terms:
Security Token Offering Reg D,
Issuers have to work with the following three rules: Rule 506 (b), Rule 506 (c), and Rule 504
Rule 506(b) and Rule 506(c) have no limit for the fundraising but allow only accredited Investors in the U.S. Rule 504 do not have restrictions on investor status. Rule 503, issuers are limited to $5 million of capital raise and are required to register the security with state regulators. Reg D also allows for General Solicitation, which allows the companies to advertise their fundraising and projects.
Security Token Offering Reg A
Reg A+ seems appropriate for businesses looking to raise under $50 million and looking to solicit non-accredited investors. Given the restriction to provide two years of financial statements, we could assume that Reg A+ would be a better match for established startups. In contrast to Reg D, securities issued under Reg A+ do not have restriction on resale, which should result in more liquid markets.
Security Token Offering Reg CF
When raising funds with Reg CF startups can raise up to USD $1.07 million. This is meant to quickly fund small projects to boost innovation. We would argue that a lot of projects can be started with USD $1 Million if done right. The downside is the 12-month lock on secondary markets.
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