We have seen the blockchain technology revolutionize the perception of investments and fundraising. Usually, tokens were offered in an initial coin offering (ICO) and it provided access to a specific network or services. As opposed to these, security token offerings or STOs are actual financial securities that are backed by something tangible. It could be equity, assets, debts, profits, revenue and even the legal rights of voting in an organization.
What makes the STOs more appealing than the ICOs is that it has the same functionality of conventional security which also facilitates fractional ownership. Unlike ICOs, STOs are subject to Federal laws and are highly regulated, and designed to safeguard the interest of the investor. Security tokens are on the blockchain and the smart contracts enable them to act in a defined way. The smart contract on a blockchain can be programmed to make automatic payments to the bank against a loan.
The Regulations Governing STOs
There are a lot of Government and statutory bodies that have recognized security tokens as valid securities. There are certain bodies like the CFTC that we use Bitcoin as a commodity and the IRS defines cryptocurrency as a property.
Commodity exchanges do not need to be licensed as a regulated entity whereas platforms offering securities are required to register as a national exchange or Alternative Trading System or apply as a broker-dealer. Even more, companies that are involved with financial assets like bonds, stocks, and bank deposit are required to comply with the consumer protection laws like the Bank Secrecy Act and the USA Patriot Act.
The Benefits of Security Tokens
Security tokens have started to gain preference over the traditional IPO route. issuance of security token under the stipulated regulations has been found to be cheaper and cost-effective than the traditional method. Security tokens provide investors with a channel to diversify the portfolio and not compromise much on generating dividends. The security token may also bestow the investors with certain voting rights and owning shares of a publicly traded company.
Since there are no middlemen involved, the security tokens do not have any administrative costs involved. The reduced cost of buying and selling allows people to generate a prized return on investment.
With the KYC and AML checks in place, the process of buying and selling of security Token to accredited investor tend to be fast.
Security tokens promise high levels of liquidity as they do not have any Geographic restrictions when it comes to trading. Anyone around the world can access them, accept them as financial instruments and trade freely. In fact, it is this global acceptance that has contributed to its increase in liquidity.
One of the greatest drawbacks of the current security system is that it is restricted by time. Security tokens, however, do not have this constraint and you can treat them any time of the day which makes them more appealing than other traditional models.
Disadvantages of Security Tokens
Sometimes, not all ‘advantages’ comply with the definition of how advantages are meant to work, and when it comes to security tokens, that is how some ‘advantages’ precisely works. Since the security tokens are regulated, there are a lot of restrictions on who can participate in the STO. The accredited investors are not available in abundance, and it creates a huge demand-supply gap. This is one of the reasons that security tokens have not seen mass adoption yet.
There was a reason why the middlemen were in place when it comes to financial trading. These middlemen took care of validating the investment and facilitating a smooth flow of cash. Since security tokens eliminate the need for middlemen, the responsibility of validating the company on which the investors are investing falls on the investors themselves. This is one more reason that act as a braking force when it comes to STO-acceptance.
How to Launch Your Security Token Offering
Issuing securities require registration with the Securities and Exchanges Commission (SEC), and can be a complex and expensive process that is meant only for established businesses. However, thanks to the constant hunger for loopholes, the project can make use of the JOBS Act of 2012. JOBS, the acronym for Jumpstart Our Business Startup, was aimed at facilitating funds for startups, was not essentially meant but somehow seems to fit the need.
There are different regulations like Reg S, Reg D, Reg A+, and Reg CF that govern the STOs, with each regulation having its own protocol.
Reg S facilitates the non-US companies to raise funds from the US investors, subject to them satisfying the statutory requirements of their jurisdiction.
Reg D defines annual offer limits and the kind of investors who can be solicited the STO. Rule 506 of Reg D defines no limits in annual funds raised but is limited to accredited investors, although one of the sections has permissions for sophisticated and non-accredited investors, capped at 35. Sec 504 of Reg D limits the annual funds raised at $5 million but is open to all kinds of investors.
Reg A+ is in place to facilitate the raising of funds of less than $50 million from non-accredited investors and $20 million from individual willing to invest, irrespective of their investor-status. Since one of the requirements for Reg A+ two years’ financial statements, this can be expected to turn out as bliss for established companies requiring secondary levels of funds. Also, unlike Reg D, there are no restrictions on the resale of the tokens.
Reg CF, as the abbreviation implies, helps startups crowdfund their investments, capped at US$1.07 million. Also, Reg CF mandates a 12-month lock period on secondary trading. While this might seem like a deterrent, the possibility of anyone investing and reaping the funds makes it a welcome avenue for small scale investors.
Blockchain App Factory’s Business Consulting
Blockchain App Factory brings you solutions on security tokens and STOs. Our team creates security tokens for your organization by establishing your compliance with the required regulation. Subject to the legal Framework, we also help you go public with your solicitation. Our deep understanding of the business and the implications of the blockchain enable us to create comprehensive and precise smart contracts that strengthen the value of your tokens. All you need to do is just drop in an inquiry and our team will be happy to get in touch with you and set your security token sailing in the right direction
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