What are Security Tokens?
Blockchain (decentralized ledger technology) led to the creation of cryptocurrencies…tokens.
Tokens have 3 variations:
- Payment Tokens – used as a means of currency or payment (ie. Bitcoin)
- Utility Tokens – intended to provide digital access to an application or service (ie. BAT)
- Security Tokens (Asset Tokens)
Security Tokens, tokenized securities or investment tokens, are digital assets compliant with federal security regulations. They combine the benefits of ledger technology with traditional financial products. These improvements include: fractionalization of larger assets, increased liquidity, lower issuance fees, greater market efficiency, and access to a global pool of capital.
Security Tokens can provide an array of financial rights to an investor such as equity, dividends, profit share rights, voting rights, buy-back rights, etc.
Security Tokens can represent a right to an underlying asset such as a pool of real estate, cash flow, or holdings in another fund. These rights are written into a smart contract and the tokens are traded on a blockchain-powered exchange.
What is an STO (Security Toke Offering)?
STO, stands for Security Token Offering. An STO is a sale of cryptocurrency coins/tokens in a manner that complies with U.S. Securities laws. Security tokens are financial securities and are backed by tangible assets, profits, or company revenue. The STO approach resolves the compliance and licensing requirement concerning securities laws.
STOs must pass the scrutiny of the SEC. It is also important to note that there are both federal and state laws for securities. State laws are known as blue sky laws and they apply when a state’s specific provisions are met.
The European Union also has regulations for the issuance of securities. States within the EU have their own specific rules based upon directives, which is s similar to the United States’ federal and state-specific securities model.
“STOs are a form of “programmable ownership” into which a company can program all of the material information into the software managing the securities. For example, when an investor acquires an STO representing an equity interest, the STO can be pre-programmed with the company’s cap table, as well as voting rights, dividend schedules, etc. of the subject STO. As a result, investors purchasing such STOs will know what their interest is in the company at any given time. No more vague contracts or lack of regulations.
STOs are an excellent option for companies looking to raise industry capital from individuals and institutional investors in a way that’s both fully compliant with securities laws and also allows for a highly tailored form of investment vehicle. For startups seeking capital, STOs are a viable and attractive option. – Darren Marble, founder of CrowdfundX
What are the Different Security Token Platforms & Protocols?
Security Token Platforms 1.0 which enabled the tokenization of assets via smart contracts coupled with basic know-your-customer(KYC) and anti-money-laundering(AML) regulations.
Security Token Platforms 2.0 take into consideration the entire life cycle of a token including on-chain and off-chain solutions for: Smart-Contract Generation, KYC-AML, Voting, Privacy, Derivatives, etc.
Below is a list of some of the existing platforms and protocols at the time of writing:
Polymath’s ST20 token standard simplifies the process of creating and investing in. Polymath’s Security Token Standard Protocol, ST-20, simplifies the process of creating and investing in security tokens, while embedding legal and regulatory compliance into the token themselves.
Polymath launched the first securities token platform that enables the creation, issuance and trading of financial instruments on the blockchain. Polymath’s mission is to help issue security tokens in a safe and regulated manner while reducing the problems caused in capital markets (e.g., exorbitant fees, long settlement delays, limited market hours). Polymath and its ST-20 protocol enables companies to create and issue tokenized securities with the complex technical and legal functions of a token sale, Know-Your-Customer/Anti-Money Laundering (KYC/AML), investor accreditation checks, and development built-in.
SRC20 PROTOCOL – SRC20 defines a common set of rules that a security token must follow and gives developers the ability to build applications that utilize the properties of tokenized assets. Applications built in the Swarm ecosystem can communicate with each other and pay for transactions using SWM, an ERC20 compliant utility token. Investment platforms, asset management suites, and crypto exchanges are examples of the types of applications that can be built using the SRC20 protocol.
SRC20 SECURITY TOKENS:
- represent ownership of part of an object or “asset”,
- allow holders to manage that asset through voting,
- secure a right to any revenue streams from the asset, and
- are tradable in a regulatory compliant manner.
S3: Open Finance Network
Smart Securities Standard (S3) Contract. S3 is comprised of three different layers: the interface, compliance, and data layers. The compliance layer is built on top of public blockchain technology, which permits an exchange of tokens only when jurisdiction-based regulatory compliance has been met.
DS Protocol – Securitize’s Digital Ownership Architecture for Complete Lifecycle Management of Digital Securities. This protocol provides value to stakeholders while addressing compliance by leveraging the immutable, public, distributed ledger nature of the blockchain.
The DS Protocol Ecosystem:
- DS Tokens: ERC-20 compliant tokens, extended with the capabilities of the DS Protocol.
- DS Apps: Smart Contracts designed to manage specific lifecycle events for a Digital Security. Examples for this are issuance DS Apps, exchange-specific DS Apps, voting rights DS Apps or dividend issuance DS Apps.
- DS Services: The basic infrastructure of the DS Protocol, enabling lifecycle management and compliance to DS Tokens. DS Apps can access these services to fulfill their goals. The DS Services include:
- Trust Service: managing the relationships between the different stakeholders.
- Registry Service: an on-chain register of investor information.
- Compliance Service: which implements specific compliance rules applicable to a DS Token as per the Issuer requirements.
- Comms Service: enabling communication of relevant events to investors.
The Regulated Token Standard – The Regulated Token standard addresses the need for compliance on secondary transfers. The R-Token Standard embeds compliance at the token level and allows for decentralized trading of private securities across any platform that supports ERC-20 tokens. The R-Token Standard includes three core services on the Ethereum blockchain: (1) R-Token, (2) the Regulator Service, and (3) the Service Registry.
R-Token Security Token – R-Token is a permissioned ERC-20 smart contract that can represent ownership of securities. It is compatible with all existing wallets and exchanges that support the ERC-20 token standard, but it overrides the existing ERC-20 transfer method to check with an on-chain Regulator Service for trade approval.
The Compliance Aware Token™ (CAT-20 and CAT-721) standards, the world’s first truly interoperable ledger-agnostic security token protocol. Security tokens minted with the CAT protocols are self-governing and ensure compliance throughout their life-cycle using Securrency’s innovative regulatory technology. The company’s patent-pending, token key-lock structure ensures that tokens may not be traded or transferred to or from a wallet that does not have the appropriate qualifications.
CAT-20 and CAT-721 tokens can be issued from and transferred across any distributed ledger, including Ethereum, Stellar, Ripple, GoChain, and EoS among others. Securrency establishes compliance in primary offerings through features such as:
- Individual and entity automated Know Your Customer (KYC) and Know Your Business (KYB) across 160+ jurisdictions, with non-documentary verification available in 37 jurisdictions
- Transaction checks through a Know Your Wallet (KYW) service that automatically proofs and scores digital wallets and associated cryptocurrency
- Automated source of funds (SoF) verification services through an easy-to-manage administration service
- Validation of an investor’s accreditation or qualification according to jurisdiction
Securrency’s proprietary multi-venue identity services and Rules Engine can ensure that compliance is maintained during secondary-market trading, through on- and off-chain movement and throughout the lifecycle of these security tokens. In both primary and secondary market activity, the attribute-mapped wallet (the “key”) must fit the policy linked to the token (the “lock”) for the CAT-20/721 token to be transferred into a wallet. The Rules Engine allows for extremely simplified mapping of relevant regulatory and transactional policies to a CAT-20/721 token by an issuer or that issuer’s advisors via a simple, user-friendly interface. In the event of changing regulations or shifting issuer requirements, Rules Engine updates can be applied directly by issuer/counsel to automatically update the handling of tokens in circulation.
The CAT-20 and CAT-721 protocols are fully supported through Securrency’s proprietary Decentralized Investment Banking Services (DIBS), a complete suite of security token issuance and maintenance tools and services that can be easily deployed by investment banks, accessed via Application Programming Interface (API) by developers, and directly utilized by issuers. In addition, Securrency will make its CAT-20 and CAT-721 protocols available to other security token issuance platforms and service providers to help to pave the way toward global adoption of security tokens to promote capital formation and enhanced global liquidity.
ERC-1404 – Simple Restricted Token Standard: Tokensoft
ERC-1404 is designed for security tokens, tokenized securities and other tokens that carry complex compliance requirements. ERC-1404 is a token standard developed with corporate governance, banking, and securities laws in mind. It is fully open source, which is paramount to ensuring its security, quality and interoperability.
Token issuers can enforce transfer restrictions within their smart-contract, enabling them to control when those tokens can be transferred, how many tokens can be transferred, and under what conditions. This function can be extremely valuable in many situations, including when issuers are looking to confirm if the token recipient is whitelisted, or checking if a sender’s tokens are frozen in a lock-up period. Learn more here (https://erc1404.org/)
ERC-1400: Security Token Standard (Ethereum)
A proposed standard for security tokens – incorporating differentiated ownership, error signalling, document references, gate keeper (operator) access control and issuance / redemption semantics.
Additional details are available here: https://thesecuritytokenstandard.org/
T0ken: tZERO – undefined
What is the Difference Between a Private Sale, Presale and Public STO?
STOS may have 3 parts to their token sale, these are: private sale, presale and crowdsale.
Private Sale, (institutional round) – is typically defined as a sale of tokens to early investors that is not open to the public or not announced.
Presale – is a sale of tokens conducted prior to the main STO Crowdsale. Presales are announced and promoted via a company’s website, social media and possibly thru advertising. An STO presale provides investors the opportunity to obtain a higher discount or bonus compared to the official STO crowdsale without the drawbacks or the high risks associated in participating in private sale. Various bonuses or discounts may be offered based on how early you invest and the size of your investment.
STO Crowdsale – is the main token sale event of the STO
How Can I Participate in an STO?
Unlike ICOs, not anyone can participate. For example, In the United States only ‘accredited investors’ can participate in an STO (see next FAQ). Each country has its own rules concerning who can participate and what identification procedures are required. This will evolve over time as global regulations are standardized.
What is an Accredited Investor (US)?
Certain securities offerings that are exempt from registration may only be offered to, or purchased by, persons who are “accredited investors.” An “accredited investor” is:
- a bank, insurance company, registered investment company, business development company, or small business investment company
- an employee benefit plan (within the meaning of the Employee Retirement Income Security Act) if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million
- a tax-exempt charitable organization, corporation or partnership with assets in excess of $5 million
- a director, executive officer, or general partner of the company selling the securities
- an enterprise in which all the equity owners are accredited investors
- an individual with a net worth of at least $1 million, not including the value of his or her primary residence
- an individual with income exceeding $200,000 in each of the two most recent calendar years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year or
- a trust with assets of at least $5 million, not formed only to acquire the securities offered, and whose purchases are directed by a person who meets the legal standard of having sufficient knowledge and experience in financial and business matters to be capable of evaluating the merits and risks of the prospective investment
Regulation A – (and A+) which has been on the SEC books for over half a century now provides the preferred pathway for STOs. To fully understand the appeal and benefits of STOs, it’s necessary to understand Regulation A+. Updated in 2015, Regulation A+ (Reg A+) is an exemption from SEC registration which allows a company to issue and sell, to the general public, up to $50 million worth of securities in any given 12 month period. Given the high cap and well defined regulatory guidance, Reg A+ has opened the door for companies to issue securities outside of traditional IPOs and stock offerings, effectively making it a vehicle to bring freely tradable STOs to all investors. Plus, it’s better for companies hoping to attract quality investors who are serious about their portfolios.
Regulation D – (Reg D) is a Securities and Exchange Commission (SEC) regulation governing private placement exemptions. Reg D allows usually smaller companies to raise capital through the sale of equity or debt securities without having to register their securities with the SEC.
Regulation S – This is when an offering of securities is deemed to be executed in a country other than the US and therefore not subjected to the registration requirement under section 5 of the 1933 Act. Issuers of the security are still required to abide by the security regulations in each country where they offer their security.