Security Token Offerings (STOs) refer to the issuance of digital tokens using blockchain technology in the form of securities.
Tokens represent ownership of digital assets, such as Intellectual Property (IP) or real estate, while securities are defined as collateral or guarantees. STOs offer the owners of these tangible and intangible assets an opportunity to increase their liquidity options by allowing them to trade them.
For these tokens to be sold as securities to investors, they must meet the requirements stipulated by the securities laws of the countries they are recognized in.
Globally, the International Organization of Securities Commission (IOSCO) harmonizes cooperation on the regulatory and supervisory approaches regarding securities. Security tokens are distinguishable from utility tokens since the former are used as investment vehicles, such as Tesla’s security token which was listed on Binance, while the latter are used to give early users access to a product or service that will be launched in future by the issuing company.
For organizations or individuals to launch STOs, they need to ensure a number of factors are taken into account, such as:
- The relevant country of incorporation and its laws
- The most suitable blockchain platform
- The appropriate structure of the token in terms of value, quantity, and period of the issuance, and
- Competent service providers to secure the assets
Notably, they need to involve legal professionals in the process to ensure legal and regulatory compliance.
More importantly, asset owners should identify their target investors and follow up on any required approvals before they commence the process of offering, marketing, and listing on trading platforms.
In the United States, for an offer to be considered an investment contract and consequently as a security, it must pass the famously known Howey Test which takes into consideration the following:
- Whether the investment is an investment of money or other forms of asset
- Whether there is an expectation of profit from the investment
- Whether the investment of money is a common enterprise – did the investors contribute their assets together and invest towards a project?
- Whether the profits came from a third party or promoter, hence out of the investors’ control
Once satisfied that all the questions are answered in the affirmative, the offer is considered an investment contract, hence, a security for purposes of the Securities Act.
The same applies to crypto assets which easily meet all the aforementioned conditions making them fall under the jurisdiction of the Securities and Exchange Commission (SEC).
In Kenya, the law applicable is the Capital Markets Act and its Amendment Act, while the regulatory body is the Capital Markets Authority (CMA).
STOs are becoming more popular due to the flexibility they provide to asset owners in terms of allowing the assets to be divided into smaller tradable fractions in the form of tokens.
For instance, real estate property or paintings can be issued in smaller units in the form of tokens such that the owners do not need to commit the whole asset in order to raise cash. As a result, the owners can raise a larger amount of cash from various investors with different fractions of ownership of the same asset. Supposedly, this process is easier and saves the asset owners the complicated process of getting listed publicly as a Real Estate Investment Trust (REIT).
In addition to that, they provide startup founders with an opportunity to raise funds from investors who prefer high levels of safety and liquidity STOs provide when traded. As with traditional securities, these investors ought to be extended the same levels of protection by regulatory bodies.
Regulatory and supervisory laws can be tweaked to cover the ambit of digital assets in order to incentivize investors and drive up adoption of blockchain technology.
With time, we shall see how the Capital Markets Authority (CMA Kenya) categorizes and regulates these offerings.
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