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What Is an STO, Explained

Blockchain

What Is an STO, Explained

A detailed look of what an STO is, how it compares to ICOs and IPOs, and what challenges these platforms face

This will very much depend on the individual jurisdictions.

The Securities and Exchange Commission (SEC) in the United States is perhaps the most vocal on the issue of how a security token is defined, and whether or not certain utility tokens are, in fact, security tokens that should be regulated.

In their Decentralized Autonomous Organization (DOA) report in July 2017, the SEC concluded that the DAO ICO was, in fact, a security offering under the qualification of an investment contract.

According to the SEC, ICOs will be classified as a security if they fall under the definition of an investment contract, which was established by the Supreme Court and derived from a landmark case between the SEC and The Howey Company.

Now known as the Howey Test, it states that:

“An investment contract is (1) an investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) to be derived from the entrepreneurial or managerial efforts of others.”

The DAO report also concluded that “the investment of ‘money’ need not take the form of cash.” and in a Senate hearing on Feb. 6, 2018, SEC Chairman Jay Clayton also said:

“I believe every ICO I’ve seen is a security.”

However, a bill that seeks to exempt digital tokens from securities law and taxes will be reintroduced to the U.S. Congress “soon,” according to a Feb. 14 tweet from U.S. Congressman Warren Davidson.

#TokenTaxonomyAct Thanks to all who have shared input. @RepDarrenSoto & I are excited about the revisions and look forward to reintroducing this bipartisan bill soon. We continue to inform our colleagues about the urgent need for light-touch regulatory certainty. #blockchain

— Warren Davidson (@WarrenDavidson) February 14, 2019

In January 2019, the United Kingdom’s Financial Conduct Authority (FCA) released a 50-page consultation paper called “Guidance on Cryptoassets.”

In it, the FCA distinguishes between three types of tokens:

  1. Exchange tokens — “These are not issued or backed by any central authority and are intended and designed to be used as a means of exchange.“ They fall outside the regulator’s governing perimeter.
  2. Utility tokens — “These tokens grant holders access to a current or prospective product or service but do not grant holders rights that are the same as those granted by Specified Investments.” They may be within perimeter if they meet the definition of “e-money.”
  3. Security tokens — “These are tokens with specific characteristics that mean they meet the definition of a Specified Investment like a share or a debt instrument.” They are fully under the scope of the FCA’s regulations, if they meet the definition of a “Specified Investment.”

Switzerland’s Financial Market Supervisory Authority (FINMA) released its ICO guidelines on Feb. 16, 2018, stating each case must be decided on its individual merits but, similar to the FCA, also categorized tokens into three groups:

  1. Payment tokens — “Tokens may in some cases only develop the necessary functionality and become accepted as a means of payment over a period of time.” FINMA will not treat such tokens as securities but will require compliance with Anti-Money Laundering (AML) regulations.
  2. Utility tokens — “Intended to provide digital access to an application or service.” These tokens do not qualify as securities if their sole purpose is only to confer digital access rights to an application or service, and if the utility token can already be used in this way at the point of issue.
  3. Asset tokens — “Represent assets such as participations in real physical underlyings, companies, or earnings streams, or an entitlement to dividends or interest payments.” FINMA regards asset tokens as securities, which means that there are securities law requirements for trading in such tokens.

Other jurisdictions that allow regulated STOs include Singapore, Estonia and Malta.

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