Potential issuers of “utility” crypto tokens can be expected to encounter high costs, middling raises and regulatory risk. But there’s a solution.
In the beginning, initial coin offerings (ICOs) were magic. Young projects without a legal entity or identifiable management team were able to raise millions of dollars. They promised to build infrastructure that would unseat corporate titans, smash the banks and even change the world. Obviously that hasn’t happened.
Regulators are increasingly cracking down and taking interest in the blockchain area. While governments vary in their response to blockchain projects, it is clear that they will respond and that they will hold projects accountable to their laws. “Utility” token offerings are unlikely to hold up, with the SEC saying openly that they haven’t seen a true “utility” yet. In this area, just about every project is likely in violation of securities laws.
But there is a solution, a way forward that’s better for projects and investors and helps relieve the threat of government interference: Security Token Offerings (STOs).
Why are security tokens so important?
The reasons are primarily legal, but not just regulatory. Regulatory authorities increasingly view utility tokens as securities despite the protests of issuers, but there is another good reason for security tokens: Investor rights.
So far, a lot of crypto projects have gone bust. When this happens, where does investor money go? The project can issue tokens, take the money, close down and never improve the ecosystem regardless of the amount of money raised. The closure of the manufacturer along with all the money you paid should have no meaning.
However, if the tokens were to represent something more like stock or equity, then the purchasers have legal rights their investment and the issuers have legal obligations to do well by their investors.
If a company closes, it has to liquidate its assets. On liquidation, debt secured by assets is paid first. Then bondholders, mezzanine debt, and owners of common stock, if there’s anything left. A token, unless it represents equity or another specific type of security, entitles you to nothing on liquidation.
It’s a misconception that a token is either a utility or a security. A token can absolutely be both. However, if a token is a security then it must abide by securities laws or the project risks the wrath of government regulators and officials — regardless of any additional utility the token may offer.
It’s important for investors to understand that the issuers of tokens do not get to choose if they are a security or not, regulators do. The assurances of a project that they are a utility are worth nothing. At any time, regulators can take a look at the offering and decide that it was really a security at issuance and begin imposing fines and other remedies. Nobody wants his investment money drained by government fines.
By proactively issuing a security token, STO issuers reduce risk of regulatory interference and also help secure the rights of investors by taking on the legal and financial obligations of traditional security issuers.
Looking at the pressure from regulators on ICOs, we can assume that STOs will replace them.
