Understanding Security Token Offerings (STO)
Would-be issuers of “utility” crypto tokens can be expected to encounter high costs, middling raises and regulatory risk. But there’s a solution.
In the beginning, ICOs were magic. Young projects without a legal entity, domicile or identifiable management team were able to raise millions of dollars. They promised to build infrastructure that would unseat corporate titans without so much as saying hello to regulators and taxing authorities. Smash the banks, change the world, and bring about some sort of libertarian crypto-utopia. Obviously that hasn’t happened.
Regulators are increasingly cracking down and taking interest in the blockchain space. While governments vary in their response to blockchain projects, it is clear that they will respond and that they will hold projects accountable to their laws. “Utility” token offerings designed as an end run around securities laws are unlikely to hold up, with the SEC saying openly that they haven’t seen a true “utility” yet. In this space, just about every project is likely in violation of securities laws.
But there is an exit, a way forward that’s better for projects and investors and helps relieve the threat of government interference: Security Token Offerings (STOs)
The Transition from Utility to Security Tokens
Let’s start with the reasons why. Why are security tokens so important?
The reasons are primarily legal, but not just regulatory. While it’s true that regulatory authorities increasingly view utility tokens as securities despite the protests of issuers, there is another good reason for security tokens: Investor rights.
So far, the majority of crypto projects have gone bust. When this happens, where does investor money go? If the token is truly just a utility like a carnival token or playing card then the purchaser has no recourse at all. The company can issue tokens, take the money, close down and never lift another finger to improve the ecosystem regardless of the amount of money raised. A buyer of a true utility token is not an investor, but a collector. Your token is no different than buying bubble gum, and the closure of the manufacturer along with all the money you paid should have no meaning. Right? Obviously this is not why or how people buy crypto tokens which is why the utility argument is clearly garbage.
If the current landscape of “utilities” with no recourse for buyers sounds like a recipe for fraud and failed investments, you’d be right. However, if the tokens were to represent something more like stock or equity, then the purchasers have legal rights their investment and the issuers have legal obligations to do well by their investors. Which, frankly, they should.
If a company closes, it has to liquidate its assets. Anyone who has studied finance knows the sequence: on liquidation, debt secured by assets is paid first. Then bondholders, mezzanine debt, and owners of common stock, if there’s anything left. A token, unless it represents equity or another specific type of security, entitles you to nothing on liquidation.
Double Bonus: Regulatory Certainty, Investor confidence
It’s a misconception that a token is either a utility or a security. A token can absolutely be both. However, if a token is a security then it must abide by securities laws or the project risks the wrath of government regulators and officials — regardless of any additional utility the token may offer.
Token issuers do not get to choose.
It’s important for investors to understand that the issuers of tokens do not get to choose if they are a security or not, regulators do. The assurances of a project that they are a utility are worth absolutely nothing. At any time, regulators can take a look at the offering and decide that it was really a security at issuance and begin imposing fines and other remedies.
Would you like your project to have the investment money drained by government fines? Or how about having the leaders jailed or sued while they are supposed to be working on the project?
By proactively issuing a security token and jumping through the appropriate hoops set by regulators, STO issuers reduce risk of regulatory interference and also help secure the rights of investors by taking on the legal and financial obligations of traditional security issuers.
Quite frankly, any project unwilling to take on these legal obligations should probably not be trusted. The time when projects were just a bunch of geeks creating technology on the internet is over. There are no more excuses.
If you want a raise to be successful, forget about utility tokens, appcoins, whatever. Those days are over. STO is the way to go.
Author: Brenn, software engineer & entrepreneur
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