Security Token Offering Terminology – Tokenized Assets Terminology

Security Tokens (tokenized assets) are a relatively new concept in the already complicated world of blockchain / cryptocurrency terminology. Our goal with this list is to help clarify surrounding terminology for both technical and finance-oriented audiences, professionals and non-professionals.

Accredited Investor:
An accredited or sophisticated investor is an investor with a special status under financial regulation laws. The definition of an accredited investor, and the consequences of being classified as such, vary between countries. Generally, accredited investors include high-net-worth individuals, banks, financial institutions and other large corporations, who have access to complex and higher-risk investments.
In the United States, to be considered an accredited investor, one must have a net worth of at least $1,000,000, excluding the value of one’s primary residence, or have income at least $200,000 each year for the last two years (or $300,000 combined income if married) and have the expectation to make the same amount this year. The term “accredited investor” is defined in Rule 501 of Regulation D of the U.S. Securities and Exchange Commission (SEC).

Alternative Trading System (ATS):
A US and Canadian regulatory term for a non-exchange trading venue that matches buyers and sellers to find counterparties for transactions. Alternative trading systems are typically regulated as broker-dealers rather than as exchanges (although an alternative trading system can apply to be regulated as a securities exchange). In general, for regulatory purposes, an alternative trading system is an organization or system that provides or maintains a market place or facilities for bringing together purchasers and sellers of securities but does not set rules for subscribers (other than rules for the conduct of subscribers trading on the system). An ATS must be approved by the United States Securities and Exchange Commission (SEC) and is an alternative to a traditional stock exchange.[1] The equivalent term under European legislation is a multilateral trading facility (MTF).

ATS: acronym – Alternative Trading System

Blockchain:
The foundational technology behind the blockchain and cryptocurrency sector. It is a virtual, immutable (unchangeable), distributed store of data stored on servers around the world. This is a new way of distributing both trust and data. It is an alternative to traditional systems where a central organization holds all the data. (No one server or organization controls the data.)

Think of it as a chain of blocks of data, verified by consensus (general agreement) by any computer that chooses to participate. Each block of data containing anything from who has sent money to others to who owns what plot of land in a land registry. – Blockchain is a distributed ledger.

Broker-Dealer:
A broker-dealer is a person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and derivatives trading process.

Many broker-dealers are “independent” firms solely involved in broker-dealer services, and others are business units or subsidiaries of commercial banks, investment banks or investment companies.

When executing trade orders on behalf of a customer, the institution is said to be acting as a broker. When executing trades for its own account, the institution is said to be acting as a dealer. Securities bought from clients or other firms in the capacity of dealer may be sold to clients or other firms acting again in the capacity of dealer, or they may become a part of the firm’s holdings.

CFTC: acronym – U.S. Commodity Futures Trading Commission

Commodity Futures Trading Commission (CFTC):
An independent agency of the US government created in 1974, that regulates futures and option markets. The stated mission of the CFTC is to foster open, transparent, competitive, and financially sound markets, to avoid systemic risk, and to protect the market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices related to derivatives and other products that are subject to the Commodity Exchange Act.

Compliance Services:
These are companies that assist in the verification of online diligence and compliance solutions for private financial markets including STOs, crowdfunding, peer lending, angel, accredited, private equity, and venture capital. Compliance with Federal regulations including SEC Regulation D, Rule 506 accredited investor verification, Bad Actor compliance and Regulation Crowdfunding.

Crowdfunding:
Crowdfunding is the practice of funding a project or venture by raising small amounts of money from many people, typically via the Internet. Crowdfunding is a form of crowdsourcing and alternative finance. Crowdfunding has been used to fund a wide range of for-profit, entrepreneurial ventures such as artistic and creative projects, medical expenses, travel, or community-oriented social entrepreneurship projects.

Custodian:
A custodian is a financial institution that holds customers’ securities for safekeeping to minimize the risk of their theft or loss. A custodian holds securities and other assets in electronic or physical form. In addition to holding securities for safekeeping, most custodians also offer other services, such as account administration, transaction settlements, collection of dividends and interest payments, tax support, and foreign exchange.

DAO:
DAOs or decentralized autonomous organizations are a collective grouping in which smart contracts make choices. The entire organization is run on the blockchain. Shareholders buy tokens that give them the right to vote on future decisions.

DLT: acronym – Distributed Ledger Technology

DSO: acronym – Digital Security Offering

Ended STO:
The fundraising periods of the security token offering have all been completed. The token is awaiting listing on Exchanges and/or ATS’.

ERC-1404 – Simple Restricted Token Standard:
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/

ERC20:
A set of standards based on the Ethereum blockchain. ERC20 allows anybody to create a token built on top of Ethereum’s blockchain. ERC stands for Ethereum Request for Comment, and 20 is the number that was assigned to this request. Most tokens issued on the Ethereum blockchain are ERC-20 compliant. ERC-20 defines a common list of rules for Ethereum tokens to follow within the larger Ethereum ecosystem, allowing developers to accurately predict interaction between tokens. These rules include how the tokens are transferred between addresses and how data within each token is accessed

ETO: acronym – Equity Token Offering

Fund Administration:
Fund administration is the name given to the set of activities that are carried out in support of the actual process of running a collective investment scheme, whether the scheme is a traditional mutual fund, a hedge fund, Pension fund, unit trust, STO or something in between. Managers of funds often choose to outsource some or all these activities to external specialist companies such as a fund’s custodian bank; these companies are known as fund administrators.

Exchange:
An exchange, or bourse also known as a trading exchange or trading venue, is an organized market where tradable securities, commodities, foreign exchange, futures, and options contracts are sold and bought.

Financial Conduct Authority (FCA): – U.K. financial regulator.
FCA – Regulatory sandbox: The regulatory sandbox allows businesses to test innovative propositions in the market, with real consumers. https://www.fca.org.uk/firms/regulatory-sandbox
Global Financial Innovation Network (GFIN) – https://www.fca.org.uk/publication/consultation/gfin-consultation-document.pdf

Hard-cap:
A hard cap is defined as the maximum amount of funding an STO will receive based on the number of token available and the issuing price.

ICO:acronym – Initial Coin Offering

Initial Coin Offering (ICO):
An initial coin offering (ICO) or initial currency offering is a type of funding using cryptocurrencies. The process is done by crowdfunding but private ICO’s are becoming more common. In an ICO, a quantity of cryptocurrency is sold in the form of “tokens” (“coins”) to speculators or investors, in exchange for legal tender or other cryptocurrencies such as Bitcoin or Ethereum. The tokens sold are promoted as future functional units of currency if or when the ICO’s funding goal is met and the project launches. In some cases, like Ethereum the tokens are required to use the system for its purposes.

An ICO can be a source of capital for startup companies. ICOs can allow startups to avoid regulatory compliance and intermediaries such as venture capitalists, banks and stock exchanges. ICOs may fall outside existing regulations, depending on the nature of the project, or be banned altogether in some jurisdictions, such as China and South Korea.

Issuing Platform:
Issuing platforms provide the technical and legal solutions for securitizing (tokenizing) assets on a blockchain. This may include: manage the processing of the solicited investors from login to capital received, as well as the issuance and management of the security tokens throughout the lifetime of the asset. These platforms use proprietary and/or standardized protocols and templates.

ITO: acronym – Initial Token Offering

Jumpstart Our Business Startups Act (JOBS Act):
The JOBS Act substantially changed several laws and regulations making it easier for companies to both go public and to raise capital privately and stay private longer. Changes include exemptions for crowdfunding, a more useful version of Regulation A, generally solicited Regulation D Rule 506 offerings, and an easier path to registration of an initial public offering (IPO) or securities token offering (STO) for emerging growth companies.

The Jumpstart Our Business Startups Act, or JOBS Act, is a law intended to encourage funding of small businesses in the United States by easing many of the country’s securities regulations.

Title III, also known as the CROWDFUND Act, has drawn the most public attention because it creates a way for companies to use crowdfunding to issue securities, something that was not previously permitted. Title II went into effect on September 23, 2013. On October 30, 2015, the SEC adopted final rules allowing Title III equity crowdfunding. These rules went into effect on May 16, 2016. Other titles of the Act had previously become effective in the years since the Act’s passage

KYC/AML:
Know Your Customer (KYC) is the process of a business verifying the identity of its clients and assessing potential risks of illegal intentions for the business relationship. The term is also used to refer to the bank regulations and anti-money laundering regulations which govern these activities.

Anti-Money Laundering (AML) is a term mainly used in the financial and legal industries to describe the legal controls that require financial institutions and other regulated entities to prevent, detect, and report money laundering activities.

Liquidity Risk:
Liquidity risk is a financial risk that for a certain period of time a given financial asset, security or commodity cannot be traded quickly enough in the market without impacting the market price.

Live STO:
The security offering is actively taking place. Investors may participate until the hard-cap is reached or the final day of sale.

MultiSig:
MultiSig is a permissions system for crypto wallets. Most cryptocurrency wallets are single-signature. This means you only need one person’s private key to control the balance within it.

MultiSig means you need more than one private key to spend funds. It is useful for corporate wallets, where many owners and employees must approve before a transaction is sent.

MTF:acronym – multilateral trading facility

Multilateral Trading Facility (MTF)
A multilateral trading facility is a European regulatory term for a self-regulated financial trading venue. These are alternatives to the traditional stock exchanges where a market is made in securities, typically using electronic systems. The MTF can be operated by a market operator or an investment firm whereas the operation of a regulated market is not considered an investment service and is carried out exclusively by market operators that are authorized to do so. The United States equivalent is an alternative trading system (ATS).

Pending STO:
The details of an upcoming STO have been released by a company but the securities are not available for purchase. (They may be available to private investors and other preferential parties.)

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. Some of the existing platforms and protocols include: ST20: Polymath, SRC20: SWARM.FUND, S3: Open Finance Network, DS: SECURITIZE, R-Token: HARBOR, CAT-20: SECURRENCY

Pre-Sale STO:
A token sale before the main crowdfunding campaign. The fund-raising targets for Pre-STOs are often lower as compared to that of the main STO and tokens are usually sold at a discount or with bonuses.

Regulation A (Reg A):
Regulation A (or Reg A) contains rules providing exemptions from the registration requirements, allowing some companies to use equity crowdfunding to offer and sell their securities without having to register the securities with the SEC.[1] Regulation A offerings are intended to make access to capital possible for small and medium-sized companies that could not otherwise bear the costs of a normal SEC registration and to allow non-accredited investors to participate in the offering.

Regulation A+:
Regulation A allows companies to conduct a publicity campaign and to solicit indications of interest from the public to assess the level of interest in investing in the company. This is intended to help the company decide whether to proceed with a Reg A offering.

The Securities and Exchange Commission adopted final rules to implement Section 401 of the Jumpstart Our Business Startups Act by expanding Regulation A into two tiers.

  • Tier 1, for securities offerings of up to $20 million in a 12-month period
  • Tier 2, for securities offerings of up to $50 million in a 12-month period

An issuer of $20 million or less of securities can elect to proceed under either Tier 1 or Tier 2. The final rules for offerings under Tier 1 and Tier 2 build on current Regulation A and preserve, with some modifications, existing provisions regarding issuer eligibility, Offering circular contents, testing the waters, and “bad actor” disqualification. The new rules modernize the Regulation A filing process for all offerings, align practice in certain areas with prevailing practice for registered offerings, create additional flexibility for issuers in the offering process, and establish an ongoing reporting regime for certain Regulation A issuers. Under the final rules, Tier 2 issuers are required to include audited financial statements in their offering documents and to file annual, semiannual, and current reports with the SEC on an ongoing basis.

Regulation D (Reg D, Rule 506):
In the United States under the Securities Act of 1933, any offer to sell securities must either be registered with the United States Securities and Exchange Commission (SEC) or meet certain qualifications to exempt them from such registration. Regulation D (or Reg D) contains the rules providing exemptions from the registration requirements, allowing some companies to offer and sell their securities without having to register the securities with the SEC. A Regulation D offering is intended to make access to the capital markets possible for small companies that could not otherwise bear the costs of a normal SEC registration.

Rule 506

A company (STO) that satisfies the following standards may qualify for an exemption under this rule:

  • Can raise an unlimited amount of capital;
  • Seller must be available to answer questions by prospective purchasers;
  • Financial statement requirements as for Rule 505; and
  • Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering.

The rule is split into two options based on whether the issuer will engage in general solicitation or advertising to market the securities.

If the issuer will not use general solicitation or advertising to market the securities, then the sale of securities can be issued under Rule 506(b) to an unlimited number of accredited investors and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated – that is, they must have enough knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.

In July 2013, the SEC issued new regulations as required by 2012 Jumpstart Our Business Startups Act (JOBS). These new regulations add Rule 506(c) to allow general solicitation and advertising for a private placement offering. However, in a Rule 506(c) private offering all of the purchasers must be accredited investors and the issuer must take reasonable steps to determine that the purchaser is an accredited investor.

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.

Restricted Securities:
Restricted stock, also known as letter stock or restricted securities, is stock of a company that is not fully transferable (from the stock-issuing company to the person receiving the stock award) until certain conditions (restrictions) have been met. Upon satisfaction of those conditions, the stock is no longer restricted, and becomes transferable to the person holding the award. Generally the security tokens offerings (STOs) have a 12 month restriction on actively trading to non-accredited investors.

Security:
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In the United States, a security is a tradable financial asset of any kind.[2] Securities are broadly categorized into: debt securities (e.g., banknotes, bonds and debentures), equity securities (e.g., common stocks), derivatives (e.g., forwards, futures, options, and swaps). The company or other entity issuing the security is called the issuer. A country’s regulatory structure determines what qualifies as a security.

Securities and Exchange Commission (SEC):
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation’s stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United States. The SEC has a three-part mission: to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation.

Security Token:
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.

Security Toke Offering (STO):
A Security Token Offering 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.

Securities Trading Asset Classification Settlement Protocol (STACS):
A unique public/permissioned hybrid global blockchain that will support the issuance, trading, clearing and settling of digital securities. Developed by Hashstacs Inc.

Self-Regulatory Organization (SRO):
A self-regulatory organization (SRO) is a non-governmental organization which has the power to create and enforce stand-alone industry and professional regulations and standards. In the case of a financial SROs, such as a stock exchange, the priority is to protect the investor by establishing rules, regulations, and set standards of procedures which promote ethics, equality, and professionalism.
Examples of an SRO include; New York Stock Exchange (NYSE) and Financial Industry Regulatory Authority, Inc. (FINRA)

Settlement Risk:
Settlement risk is the risk that a counterparty (or intermediary agent) fails to deliver a security or its value in cash as per agreement when the security was traded after the other counterparty or counterparties have already delivered security or cash value as per the trade agreement. The term covers factors incidental to the settlement process which may suspend or prevent a trade from completing, even though the parties themselves are in agreement, are acting in good faith, and otherwise competent to perform.

Smart Contracts:
Smart contracts refer to code that is placed on a blockchain and is then executed on it. The code can be audited by the public. Smart contracts are often regarded as a compliment or a replacement to traditional legal contracts.

Smart Security:
A smart security is a blockchain-based digital interest that represents an ownership claim in an underlying asset which may include real estate, private placements, equities, debt, derivatives, and other instruments of value.

Soft-cap:
Soft cap is the minimum amount of funds a company can receive from investors in its Security Token Offering (STO). If the soft cap is not met, the money is generally returned to investors.

SSO: acronym – Smart Security Offering

STO: acronym – Security Token Offering

SEC: acronym – U.S. Securities and Exchange Commission

TAO: acronym – Tokenized Asset Offering

TOKEN

What is a Token? – A token is a utility, an asset or a unit of value issued by a company. In most cases, tokens are issued when a company launches an initial coin offering (ICO) — that works like an initial public offering (IPO). The difference between an STO and an IPO is that in an IPO you receive stock in exchange for the investment you make while in an STO you receive a token in exchange for your investment.

Types of Security Tokens

  • Equity Tokens: Equity tokens are a type of security tokens which state ownership of an asset like company stock or debt.
  • Debt Tokens: Debt tokens are equivalent to the short-term loan on an interest rate on the amount loaned to a company.
  • Utility Tokens: Utility tokens provide users with the later access to a product/service. With utility tokens, companies can raise funds for the development of the blockchain projects.
  • Asset-backed Tokens: An asset-backed token is a token built on the blockchain platform which is associated with a tangible or intangible object of certain value.

Tokenized Asset:
Tokenization is the process of converting rights to an asset into a digital token on a blockchain. All tokenized assets are classified as security tokens. If a security token is tied to an asset, then it is an asset-backed token.

Tokenizing an asset is to make the storage and management of it digitally represented by tokens. When someone is tokenizing an asset or security, they aren’t doing anything to the asset itself, they’re just changing the way that ownership of that asset is managed.

Benefits of Tokenizing Assets:

  • Liquidity Premium – the increase in value derived from the higher liquidity of an asset. Tokenizing an asset opens up the potential investor base to a much larger audience by lowering the barriers to entry and making the process of buying and selling securities more accessible. The liquidity premium for security tokens is typically around 20-30%
  • Issuance Costs – By removing third-parties from the process, tokenizing assets and using security tokens to represent ownership of them can dramatically decrease issuance costs.
  • Faster Settlements – Faster trade settlements are a byproduct of higher liquidity. The increase in speed is also derived from blockchain technology. Security token trade settlements can occur in minutes and the Exchanges will operate 24/7 globally.
  • Compliance – is a concern when dealing with securities. Ensuring compliance across all regions or jurisdictions can be automated through smart contracts and coded into the token.
  • Governance – the token can be used to represent voting rights and streamline the governance of assets.

Tokenized Asset Offerings (TAO):
This is simply another term used to represent a Security Token Offering.

Trading STO:
All fundraising has been completed, the tokens have been registered and distributed. The STO is actively being traded on Exchanges.

Transfer Agent:
A stock transfer agent or share registry or Transfer Agency is a company, usually a third party unrelated to stock transactions, which cancels the name and certificate of the shareholder who sold the shares of stock and substitutes the new owner’s name on the official master shareholder listing. Stock transfer agent is the term used in the United States and Canada. Share registry is used in the United Kingdom, Australia and New Zealand.

We will continue to add to this list as the security token ecosphere matures and standardizes.

Please feel free to suggest additional terminology by contacting us