5 Things to Know About Security Token Offerings

A security token offering (STO) is, as its name indicates, a public or private sale of a “security,” evidenced by a digital token transferable on a blockchain to investors to raise capital. Giving an asset another name (like “token”) does not transform it into something other than a security or exempt an issuer from compliance with securities laws.

(1) STOs are subject to the same securities framework that has existed for decades.

As the seminal case “SEC v. Howey Co.” explains, even an orange tree can be sold in a way that constitutes the sale of a security. The sale of a digital asset by any name will generally be deemed a security when it is touted as an investment opportunity or otherwise has features akin to stocks, such as the payment of dividends or voting rights.

The U.S. Securities and Exchange Commission (SEC) has repeatedly echoed this sentiment in its public statements and enforcement actions. SEC Chairman Jay Clayton stated that selling a digital token “does not change the fundamental point that when a security is being offered, our securities laws must be followed.”

At its core, an STO is simply new wine in an old bottle and must, therefore, comply with existing securities laws.

(2) A security token sold in an STO will not have immediate liquidity.

Most security tokens acquired in an STO cannot be transferred immediately because they are “restricted securities” sold in an unregistered, private sale, often under Regulation D, under the Securities Act of 1933. In fact, most security tokens will need to be held for a year before being sold in the public market. While the lock-up period may be reduced to six months if the issuer of the security token is a reporting company under the Securities Exchange Act of 1934, issuers usually seek to avoid reporting company status. Blockchain technology provides a more elegant solution to this problem than the legends customarily placed on paper certificates, as the token can be “locked” in the purchaser’s wallet until the expiration of the applicable holding period.

(3) A security token cannot be sold anonymously.

Anonymity, or at least pseudonymity, may be a hallmark feature of distributed ledger technology, but it is inappropriate in an STO. An issuer must know to whom it is selling security tokens to comply with anti-money laundering laws, Office of Foreign Assets Control sanctions programs and its obligation to “know its customers.” Penalties for noncompliance can be severe and are unlikely to be worth any advantages associated with conducting anonymous transactions.

Additionally, issuers who want to promote their STOs via the internet will need to ascertain the “accredited” status of their investors prior to consummating any sale of a security token.

(4) A properly structured STO will be highly technical.

Finding an exemption from registration under the Securities Act of 1933 and applicable state law is but one hurdle standing between an issuer and a compliant STO. Two notable issues commonly encountered are as follows:

  • Structuring a concurrent, domestic and international offering
  • Implementing safeguards to avoid reporting requirements under the Securities Exchange Act of 1934

As for the latter, an issuer will generally be considered a reporting company under Rule 12g-1 of the Securities Exchange Act of 1934 (meaning it will have to file regular and periodic reports with the SEC) if the issuer has more than 2,000 investors or more than $10 million in assets. An issuer can build protections into its offering documents, such as investor caps and buyback options, to avoid becoming subject to onerous Exchange Act reporting requirements.

(5) You should not go it alone.

The complexity of existing securities laws makes advice of counsel a crucial component of a successful STO. Implemented correctly, however, an STO can be an excellent source of capital for a new or expanding company in the tokenisation, blockchain or broader distributed ledger space. Late last year, SEC Commissioner Hester Peirce highlighted the “growing eagerness” of U.S. regulatory agencies to better understand tokenised assets and enable legitimate projects to flourish.

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Blockchain technology will revolutionise these 5 industries

You’ve probably heard about blockchain technology through cryptocurrency, but did you know that blockchain technology is expected to revolutionise industries like real estate, transportation and even social justice?

Blockchain technology may have been made for bitcoin, but its potential to make transactions more secure is one of the most exciting possibilities for using this powerful technology. Innovation is most commonly known as the underlying algorithm of cryptocurrency. One day, businesses in every industry may use blockchain to record and verify every transaction. The decentralised characteristic of the utility makes it an appealing business resource, and enterprises covet the transparency and finality the digital recordkeeping application.

Blockchain Can Increase Trust & Accountability

Privacy issues are a concern for every American. With most businesses in the United States keeping their records and transactions mostly online, Americans have begun to become jaded as data breaches hit the news. While blockchain technology can’t prevent all data theft and cybercrime, it could help make transactions more secure, improving trust in businesses’ ability to protect consumer data. With cybercrime on the rise, the technology has arrived just in time. The first applications that will give way to blockchain are the most insecure transaction methods. From all of the disruption I’ve seen already in various industries, I believe that blockchain technology is a viable resource for any industry or field that conducts transactions.

Here are the five industries, institutions and fields that will experience the most exciting disruption due to blockchain technology in the near future.

The Finance Industry

Governments and large corporations are researching blockchain technology closely to unearth ways to utilise the resource. The finance industry is investigating blockchain intensely since fraud is a huge problem for banks and other financial organisations. Finance executives believe that the technology is a potentially ideal solution for security when transferring money from one account to another—always the most vulnerable point in any transaction. Blockchain may disrupt not only the field of digital security but also that of logistics and other fields across many industries. Cryptocurrency has also made its way into the crowdfunding and investment markets and led to the birth of crypto exchanges such as Okcoin, Poloniex and ShapeShift. This shift has not only opened up a number of new opportunities for individuals to invest, but also has created new job opportunities such as a crypto-investment banker. Although new, projections say that this position can expect to make as much as traditional investment bankers who have a median salary of approximately $81,339.

Another new feature brought on by blockchain tech is that investors can now buy into initial coin offerings (ICOs) in the same way that they buy into initial public offerings (IPOs). This is reshaping the investment world by eliminating geographical boundaries and speeding up the investment transaction process.

Social Justice

Enterprises and agencies could potentially use blockchain technology to securely record and verify inventories, monitor resources and redistribute assets. Via these means, the technology can pave the way toward a sharing economy. Inequality, income disparities and consistent income are serious problems in modern capitalist societies around the globe, and new technologies threaten to enhance these problems. Blockchain is a resource that can empower a sharing economy, and it can potentially accelerate the process of ensuring full inclusion in economic prosperity, rather than contribute to conditions that promote inequality and conflicts.

American Energy Grids

Energy grids in the United States are deteriorating and outdated. Today’s energy networks are vulnerable to elements such as natural disasters and climate changes. Many researchers are working on solutions to replace the outmoded system, and some believe that blockchain will provide the answer.

In Brooklyn, New York and other municipalities, participants in an energy experiment collect power using solar panels and exchange it using computerised “smart contracts.” The participants also install smart power meters as a part of the project. They use blockchain to secure and verify all transactions sans utility companies or any other third-party, saving on costs and increasing efficiency.

Blockchain technology could also help to fend off attacks from more than just Mother Nature. In 2018, information came to light that Russian hackers were able to gain access to United States electric grids, giving them the ability to cut off and control power. With our massive dependency on electricity, potential attacks could cause mayhem and economic damage. More secure networks, like those offered by the blockchain, could reduce the likelihood that hackers would be able to gain access to American energy grids.

The Real Estate Field

The real estate industry exemplifies the disruptive potential of blockchain technology. The transfer of real property is a complicated and extensive process, but blockchain technology can potentially allow property buyers and sellers to transfer property rights instantaneously. Sellers could use the technology to securely transfer titles and deeds to new owners, and buyers could pay for the transactions via cryptocurrency. Stakeholders could also use blockchain to send property information to the appropriate government agencies.

Closing costs are a big expense for homeowners and buyers alike. While blockchain technology won’t cut out commissions and related expenses, a simpler buying process could potentially reduce the cost and hassle of buying a home, making it more realistic for young people to get into the real estate market.

The Transportation Industry

Researchers imagine a future where blockchain and the Internet of Things (IoT) combine to make smart cities a reality. Municipalities could connect sensors for street signs, traffic lights, vehicles and other items to the IoT, enabling the rerouting of traffic for maximum efficiency. Scientists hope that by using blockchain in this manner they can reduce commute times, traffic congestion and vehicle emissions. The blockchain technology can also provide potential conveniences such as vehicle parking and be charging location and payment; traffic ticket payment; and accident and maintenance monitoring services.

Final Thoughts

Analysts forecast that bitcoin will achieve a total value of $1.2 trillion towards the end of 2018. However, forward-thinking individuals see the value of blockchain beyond its original application for digital currency transactions. Bitcoin took off rapidly as more people brought into the idea of a currency that’s free of government or institutional regulation and valued based on quantifiable, although highly complex, supply and demand. While the excitement about bitcoin is tempering, there’s great interest in its underlying blockchain technology. It’s hard to not see the value in cutting out middlemen, increasing security and saving precious time and expenses.

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R3 talks legal loopholes for blockchain-based trade finance

Blockchain-based trade finance awaits one crucial component before it can fully realise its potential: the legal recognition of electronic instruments.

So say Alisa DiCaprio and Gabriella Zak from blockchain firm R3 in conversation with GTR.

While regulators are aware of this need and have begun considering updates to the governing rules around electronic instruments, bureaucratic barriers mean that legal changes could take years to adopt.

In the meantime, antiquated rules from a paper-based age could be supplemented with other existing legal documents or with a rulebook.

DiCaprio, who is global head of research and trade, and Zak, research analyst at R3, share their views on the optimal path forward.

GTR: How well equipped is current legislation when it comes to blockchain-based trade finance documents?

DiCaprio: Inconsistent best characterises the current legal governance of electronic instruments within trade finance. In the US, there are two contrasting situations under the Uniform Commercial Code (UCC), which provides standardised rules and regulations governing commercial business transactions across states.

Letters of credit have been allowed in electronic format since 1995. UCC Article 5 was revised to reflect accommodations to technological innovation and provide substantial legal coverage for electronic letters of credit. Including broader definitions of what deems a “record” or a “signature”, UCC Article 5 provides clear language that extends the domain of the law onto electronic instruments.

Negotiable instruments, in contrast, are governed by a rule that has not been updated since 2002. The definitive language contained within UCC Article 3 tethers legal jurisdiction to exclusively paper instruments. Notes or bills of exchanges registered on a blockchain fall outside the governance of the current law.

Thus, the term ‘negotiable instrument’ [within UCC Article 3] is limited to a signed writing that orders or promises payment of money.

Because blockchain-based trade finance solutions require electronic versions of negotiable instruments like bills of exchange and promissory notes, UCC Article 3 is currently insufficient.

GTR: What could be the possible solutions to this challenge, and how easy are they to implement?

Zak: A solution for blockchain-based trade finance may come in various forms: amend UCC Article 3, supplement it with the Uniform Electronic Transactions Act (UETA), or create a legal rulebook.

Amending UCC Article 3 presents the ideal solution. By redefining paper-based definitions, such as the meaning of “signature” and “possession”, to encompass electronic vernacular and context, most of the existing legal framework can be retained. This seems like a quick, easy solution, right?

Not quite. While amending UCC Article 3 may appear to be the most straightforward remedy, bureaucratic barriers could result in an estimated three to five years until revisions might be enacted. This estimate is based on the revision of UCC Article 5 which took eight years (1987-1995) to be enacted. This illustrates the immense challenge of updating laws. While UCC Article 3 will eventually need to be amended, there needs to be a solution in the interim.

What if we supplement UCC Article 3 with the UETA which has expanded legal recognition of electronic signatures? While the UETA extends the language within UCC Article 3 to have electronic meaning, there are numerous issues still left unaddressed including enforceability against intermediate transferors.

A third solution, and one most reasonable in the short term, is the creation of a legal rulebook. A rulebook could incorporate three major components: a detailed statement of agreed upon rules describing the rights and obligations of negotiable-instrument transactions on a blockchain, residual rules for the governance on unresolved issues, and a choice of forum.

As of 2018, rulebooks are being pursued by most blockchain solutions in trade finance.

GTR: What other moves are you seeing towards creating regulatory change around electronic trade finance documentation?

DiCaprio: Amendments to existing regulation have already begun, with groups include the International Chamber of Commerce Banking Commission (ICC), the Bankers Association for Finance and Trade (BAFT), and the United Nations Commission on International Trade Law (UNCITRAL) initiating the process of revising their respective international trade rules.

Law firms and industry leaders have also become increasingly involved. Shearman & Sterling lawyers are leading the way on prevalent fintech-related elements such as blockchain, cryptocurrency and artificial intelligence, innovating solutions for the “new normal” of ever-changing regulations, non-traditional competitors, cybersecurity threats and the need to increase capital for new revenue streams.

In 2018, many law firms joined R3’s Legal Centre of Excellence. The initiative arms the global legal community to best engage with the changing legal definitions forming around blockchain technology, as well as positions them to partner with the growing R3 ecosystem.

GTR: What if the necessary regulatory change does not happen? What will this mean for the adoption of blockchain in trade finance?

DiCaprio: The broad reach of blockchain means that regulators and lawmakers across the globe have published reports, provided guidance and engaged in activities to understand how regulation can be updated to meet the needs of trade finance on blockchain.

A lack of regulatory change does not necessarily inhibit the adoption of blockchain in trade finance. Though it is not ideal, a rulebook solution accomplishes many of the same aims. Entities seek assurance in the enforceability of their agreement with other parties, and a robust rulebook with a proper choice-of-forum can provide this confidence. The benefits of blockchain within trade finance far overshadow the concerns of regulatory revision if an alternative solution exists.

GTR: What can banks – and other players keen to get involved in blockchain – do in the meantime?

Zak: For entities who intend to embrace blockchain but are hesitant due to its current legal state, an interim rulebook solution can be used. It provides greater assurance in blockchain-based trade without the need for immediate regulatory change. While revisions to UCC Article 3 may take years, rulebooks can be created at any time without speed constraints. Its progression from idea to reality only depends on the co-operation of the network actors involved. Ultimately, a rulebook solution will speed up the application of blockchain to trade finance.


Lykke Creates Investment and Advisory Spinoff BVV

Swiss fintech group Lykke on Friday launched a spin-off company, Blockchain Valley Ventures (BVV), which will operate as a venture capital investor and accelerator in addition to providing advisory services for blockchain enabled businesses and exchange listing.

Based in Zug, Switzerland’s ‘Crypto Valley’, BVV said its partners include Heinrich Zetlmayer, former Vice President and Country Leader of IBM Global Business Services in Switzerland and Oliver Bussmann, former UBS and SAP Group CIO.

According to a statement, the company will make capital investments through its own funds and vehicles, such as the “Blockchain Investment Opportunities Note”, in cooperation with Swiss asset management company Vicenda, a boutique firm with a focus on private debt investing. Other services will focus on business, financial, initial coin offering (ICO), and marketing support until projects have reached critical size and can operate independently. Additionally BVV will assist in token technology design and creation, and implementation of Lykke’s Open Source Technology.

According to the company’s statement, BVV’s hybrid funding model combines traditional venture capital with ICO’s. This will optimize the capital-raising of BVV portfolio companies but also accelerate growth and business development, offering significant benefits to conventional investment, the company said.

BVV, supported by Lykke, will give portfolio companies assistance and advice in launching and scaling blockchain-enabled businesses. By collaborating with partner companies, BVV said it will be an integral part of their respective business models, resulting in an ecosystem of promising blockchain-based projects, which maximizes each partner’s success potential.

“As ICOs have become the new normal, it is no longer necessary to wait until you have accumulated significant revenue to make your dreams into reality,” said Richard Olsen, Founder and CEO of Lykke Corporation, in the statement. “However, many would-be token-issuers need guidance which is neutral, independent, and unbiased. BVV provides this quality support, offering the necessary advice and assistance so that inspired businesses may fully recognize their potential.”

“Blockchain technology has already shown itself to be a highly disruptive force across all manners of the industry – from supply chain management to e-commerce, and fintech,” stated Heinrich Zetlmayer, BVV General Partner. “Our long-term vision is to develop BVV into a leading management holding in the crypto space, offering assistance to projects we believe have real potential to have lasting effects on industries primed for disruption.”