As I begin to craft this post, I am reminded of an adage by Laurent Baheux that says, rules of the wildlife are simple and clear, but that’s never the case for men — especially when it comes to understanding the mechanics of digital currencies.

A lot of lawyers and financial specialists are cashing in on various security token projects simply because the laws affecting securities are quite stringent and, to some extent, unclear.

Security tokens are a very interesting digital asset, and they are also quite lucrative and affordable to issue.

According to Tatiana Koffman, founder of Fourblocks Ventures, the issuance of security tokens is much cheaper compared to other forms of securities due to the fact that they are operated on decentralized markets. This also means that they attract lower legal and accountancy fees, among other costs. To better understand how security tokens operate, a video of her interview is available through this YouTube link.

It has taken time for crypto products to fall under formal laws. We all know how chaotic things can get when investments lack clear rules.

Today, cryptocurrency activities are starting to follow set regulations. These are meant to make online trading safer and more attractive to both new and existing investors.

The original idea behind crypto was to allow trading with minimal or no rules. However, over time, stakeholders have realized that some structure is necessary. Formal guidance is now seen as essential for certain aspects of crypto projects.

While STO regulations are not new in traditional investing, crypto-related securities are a different story.

In this article, we’ll explore the regulatory framework for STOs in the crypto space. There’s a lot of misleading information online about STO regulations. We’ll start by clearing that up.

Confusion Surrounding STO Regulations

There has been a lot of confusion around cryptocurrency regulations. Authorities in several countries, including the U.S., are trying to bring crypto under their regulatory frameworks to benefit from the technology.

Some financial moguls have often promoted the idea of “Blockchain, not Bitcoin.” This narrative aims to shift the focus toward broader digital assets.

The stakes are high for everyone involved. As a result, some players believe that certain authorities want to eliminate crypto assets from the digital space entirely.

In reality, regulators are trying to protect the public. At the same time, they aim to avoid blocking innovation across various sectors.

That’s why it’s crucial for regulators to closely monitor crypto activity. It helps them assess the industry’s growth and its impact on the economy.

The State of STO Regulations

The CFTC considers digital assets such as Bitcoin as a commodity, while the IRS considers cryptocurrencies to be some form of property.

SEC, on the other hand, defines digital projects such ICOs as some form of security.

Commodity vs. Security

The law states that platforms offering a spot market for currencies or commodities don’t need a license. However, securities must be listed on a national exchange or an Alternative Trading System. They also need to be registered as an exchange.

Some of these regulations can be expensive, intrusive, and time-consuming. This explains why many crypto stakeholders are hesitant to fully embrace them.

As a result, the SEC has faced strong resistance from the crypto community. Many oppose the agency’s move to classify certain cryptocurrencies and ICO tokens as securities. This classification brings them under direct government oversight.

Companies in the financial assets sector must also follow financial services and consumer protection laws. Understanding the mechanics of digital currencies is essential for complying with these regulations, which include the US Patriot Act and the Bank Secrecy Act.

Security Tokens

Given the keenness of the SEC, a large number of the ICOs currently being issued will be categorized as securities; this, therefore, subjects them to the same laws as other conventional securities of the real-world companies. That said, let us be reminded of these two defining moments in the history of security tokens:

Sometime in July 2017, SEC announced that it would henceforth consider the Decentralized Autonomous Organization (DAO) token as a security. In the report, the regulators claimed that they had arrived at the decision due to the fact that the token satisfied all four parameters of the Howey Test.

The Howey Test is a formulation by the Supreme Court in a case involving Howey Co vs. SEC. The decision by the court sought to clear the air on whether certain transactions qualify as investment contracts, which forms part of a security.

In June 2017, about a month earlier, the SEC Corporate Finance Director made an announcement that the regulator would not categorize the offers and sales of Ether as securities. A copy of the full report can be viewed here.

Some Key Definitions Relating to the STO Regulations

If you’ve interacted with one or two regulations regarding STOs, then you might have come across one or more of these phrases.

General Solicitation

General solicitation, as the phrase suggests, is a mode of raising capital from the general public through openly advertising using the available media sources, calling on potential investors to invest in a certain company.

However, general solicitation doesn’t include:

• Demonstration time is exempt only if details about the security, including the price, are not discussed.
• Stating facts about a company—such as its financial climate, business environment, products, or services—without making direct predictions about the security does not count as general solicitation.
• Pre-existing business associations occur when current stakeholders talk to their associates about a security. If those associates choose to invest, it is not considered general solicitation.

Restricted Securities

These are securities that cannot be traded freely as they have certain limitations. For these securities to be traded on an open market, they have to meet certain conditions:

• They need to have a holding period of between 6 – 12 months.
• The details regarding the security need to be made available to anyone with an interest in them. These include the nature of the issuing company, the team behind it including the directors and the top management, its updated financial statement, among other things.
• The trading formula needs to be: <1% of the outstanding shares.
• Must provide Ordinary Brokerage Transactions
• Must file a notice of proposed sale with the Securities and Exchange Commission

Preemption

Some of the exemptions and conditions discussed above “preempt” what is contained in the SEC laws, highlighting the complexity involved in regulating the mechanics of digital currencies across federal and state levels.

Essentially, companies wishing to issue their securities are required to comply with state laws as well as federal laws. In addition, such issuers may need to comply with additional laws relating to the particular state they wish to sell their securities.

In case a preemption of an offering occurs, such a security won’t necessarily need to register with a state regulator in order for them to comply with the related laws.

Conclusion

We hope this article puts to rest a number of issues relating to STO regulations including the perceived ambiguity in the way STOs are regulated and so on. As you’ve seen, the US continues to put in place clearer laws pertaining to the way crypto security tokens are traded and how they are treated under different circumstances.

Ultimately, we hope the regulators can provide more structured guidelines relating to security tokens as the market continues to warm up to the idea of cryptocurrencies.

What do you think about the STO regulatory framework? Do you think the regulators have done enough in terms of regulating trade and addressing the mechanics of digital currencies?