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4 Facts to Know About Security Token Offerings

Security Token Offerings combine the technology of blockchain with the requirements of regulated securities markets to support liquidity of assets and wider availability of finance. STOs are typically the issuance of digital tokens in a blockchain environment in the form of regulated securities.

A security token offering 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 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

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.

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 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 pseudonymise, 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 will need to ascertain the “accredited” status of their investors prior to consummating any sale of a security token.

4. 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, Hester Peirce highlighted the “growing eagerness” of United States regulatory agencies to better understand tokenised assets and enable legitimate projects to flourish.