This is the second of a two piece article series regarding Security Token Offerings (“STO"). The first explains why STOs are becoming increasingly popular. The second explains how to properly perform an STO.
ICOs and STOs
The world of initial coin offerings have raised over $22Bn in just 2 years . After 2 years, the SEC has finally put forth a framework for determining whether or not a token sold in an ICO is under their regulatory purview. Anticipating this long-time coming guidance, the industry has already began to move towards compliant security token offerings . With a current rising cryptocurrency market reminiscent of 2016 , the year before the meteoric rise of Bitcoin and ICOs, it's important to start preparing for the next big fundraising opportunity.
This will be a guide that addresses how to prepare for a security token offering, issues you need to consider, and an overall primer on getting started with your token offering journey.
From my own work advising companies on running security token offerings, there are three major considerations regarding STOs: Regulation, Technology Infrastructure, and Secondary Markets
Regulation governs how to conduct your offering, who you can raise money from, and restrictions on your new tradable asset once it is out in the wild. Technology infrastructure ensures secure storage and transaction execution, determines ecosystem interoperability, and enables capabilities for the token being generated. Finally, secondary markets are the platforms required for your investors to be able to trade tokens, arguably the most important relationship to keep your investors happy.
Regulation When it comes to raising money through a security token offering, the goal is to raise money from a broad set of investors without the registration burden of an initial public offering.
However, just because tokens attract new kinds of investors does not mean you can create an offering with complete disregard towards regulation. Depending on who you raise money from, how much you plan to raise, and how you plan to do it, there are varying degrees of regulation.
With the help of Gordon Einstein, a US securities lawyer, chief legal officer of Distributed Labs, and advisor to over 20 Blockchain companies, I’ve compiled the most popular exemptions when conducting a compliant security token offering. Note that you should consult a lawyer for more precise legal information, and should consider the follow as general guidance.
Security Token Regulation Table
Jonathan Chester & Gordon Einstein For those who don't know , a US accredited investor is anyone with over $1MM net worth or a salary above $200,000 a year for the past two years.
There are many choices out there, and it might be hard to decide which path to pursue. When considering which route to choose, Einstein has the following to say,
https://tokengraph.org/2018/08/28/gordon-einstein-blockchain-should-be-cool-life-is-too-short-for-boring-things/ It's important to ask yourself why you are doing the STO. Are you doing this to raise money or are you doing this to get tokens in the hands of customers? If it is just to raise money, then you are doing under Reg D or Reg A. If you want tokens in the hands of customers so they use it, you have two options: Reg A+ or a public IPO of your tokens. Once you make the fundamental decision, it highly informs everything else you are going to do.
Remember that Utility tokens are not securities, but rather transferrable software licenses. Another strategy to get utility tokens into the hands of people is to conduct a separate ICO of utility tokens once the platform is built and then maybe get the investors of your security tokens to convert into utility tokens once the ICO is complete. No need to become a reporting company when you held a security offering for a utility token.
It is possible to have a combination of various exemptions. For instance, tZero, the most well-funded and compliant US-based digital asset and digital securities exchange and subsidiary of public company, Overstock.com, raised money through both a Reg D 506c and Reg S offering.
Technology When considering your technology stack, the first consideration is which blockchain will your token live on. Once this is figured out, the next decision is how will the token be designed in order to be both secure and interoperable with the market. I spoke with Saum Noursalehi, CEO of tZero, to learn more,
tZERO CEO Saum Noursalehi
tZero Most of the industry has rallied around ERC-20 tokens. This standard is a smart contract technology designed for security tokens, based on the Ethereum blockchain. Several standards built on top of the ERC-20 protocol exist, including our open source t0ken protocol.
For those that don't know, a smart contract is an immutable and technologically-enforced contract that lives on the blockchain. It cannot be changed or altered except as originally coded and deployed in the open sou...