EMURGO, as the official and commercial venture arm of Cardano — the first third generation blockchain to evolve out of a research-driven approach — offers customers a complete start-to-finish advisory solution when it comes to understanding the necessary regulations their companies and security tokens must adhere to, as well as in understanding how to implement their offerings.
If you have been actively following the cryptocurrency space then you are likely already familiar with Initial Coin Offerings (ICOs) and have probably even participated in one, or more, yourself. These are basically an unregulated way for a company, or project, to raise investor funds. There were so many scams associated with ICOs in 2016 and 2017 that the SEC has identified a new category of securities for companies seeking regulated fundraising in the cryptocurrency space: security tokens . Unlike ICOs, security tokens have stringent rules about who can purchase, and trade them, and how they can be advertised.
The SEC is doing its best to navigate the new blockchain space that has emerged, even as it proves to be a challenge, given a variety of political pressures and the likelihood that they are still learning how the underlying technology actually works. For example, Distributed Autonomous Organizations have thrown a bit of a wrench in their traditional definitions of securities.
A 2017 investigation of Ethereum’s DAO clearly states that, “the Commission has determined that DAO Tokens are securities under the Securities Act of 1933.” Then, in June of 2018, William Hinman, the SEC’s Division of Corporate Finance director came out and claimed that Ethereum was not a security. And although SEC chairman Jay Clayton said that, “I believe that every ICO I have seen is a security,” he had decided to agree “with Director Hinman’s explanation of how a digital asset transaction may no longer represent an investment contract.” This proved to be confusing for many people. Clayton humbly, and tacitly, admitted that the SEC could use more employees who are capable of understanding the technologies they are assessing.
A security is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” In other words, if an investment contract passes the famous Howey test, it is considered a security. However, some blockchain tokens function as both utilities and securities; and their use cases can change over time. So, while real world implementations may blur stringent categories into a spectrum of use cases, digital security tokens are the SEC’s attempt to bring compliance into the blockchain and ICO space.
However, a Security Token Offering (STO) under Regulation D requires accredited investors to wait a minimum of one year before selling their tokens; on top of that, the counterparties for those trades must also be accredited investors. Additionally, exchanges that want to list compliant tokens need to have a special license. Barriers to entry mean that retail investors will not be able to participate in Regulation D offerings. Although this is unfortunate for some, Security Token Offerings will definitely change the cryptocurrency landscape and offer legitimacy in terms of regulation; they will also offer tremendous expansion in terms of adoption for Cardano.
Charles Hoskinson said in a recent CoinDesk interview that, “There’s a tremendous desire for STOs; you have tons of illiquid assets all around the world — trillions and trillions of dollars of real estate, [and] small business, in jurisdictions like Mongolia or Ethiopia that are incredibly investible because they’re led by great entrepreneurs, the economies are growing at ten percent per year, they have wonderful fundamentals from cash flow to business relationships — hundreds of millions of customers — but they haven’t been able to get access to the global financial markets because of regulatory barriers as well as just bad infrastructure in those jurisdictions. So, in the pursuit of securitizing these trillions of dollars, it’s creating a definite strong demand to change the regulations, change the underlying infrastructure, and it gives us a great opportunity to build something that can be part of that conversation.” There are a tremendous number of illiquid assets that traditional “emerging market” investing does not cover.