Op-ed

Token Securitisation- a Double-Edged Sword

Problems begin when the norms forced upon the crypto world are not symbiotic with its characteristics.

This article was written by Aviya Arika, Managing Director of Aviya Law.

The Utility Era (honeymoon phase)

A lot of money has been raised through ICOs so far. It’s funny to think now that during 2014-2017, most token issuers didn’t even go to see a lawyer prior to launching their token sale. It was a very wild west (and east).

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The market was bullish, regulatory awareness was nearly obsolete and the money was flowing freely from investors to token issuers. As I see it, the bull/bear state of the crypto market is in high correlation with the level of securitisation and regulation.

The relationship between the two is a curious chicken and egg cycle: bullish investors / no regulatory awareness / many frauds, scams, or just solemnly failed projects / severe losses / investors becoming bearish / regulatory awareness increases / moving from utility token sales to security token sales, from ease of issuance to higher complexity / accredited / to save the legal hassle, token issuers are moving away form targeting retail investors to a greater focus on qualified and institutional investors.

The Security Era (post-honeymoon phase)

As 2017 was unfolding, it was becoming clear that the utility honeymoon had reached a dead end. There prevailed a widespread realisation that regulators would not stand by anymore and watch IPO-bypasses pocketing retail investors’ money by the billions.

Understandably, due to most tokens being investment vehicles, the natural legal go-to realm was securities law. But how natural is this, really?

The securities laws of most countries were written at the inception of their financial law codices. This means that these laws were written decades ago, in a world which was inconceivably different to the new world of crypto finance.

In that world, the world of ‘old’ finance, if a company is about to raise 100 million USD it must have a formidable team with astute track records, and the product must at the very least be at POC stage. In that world, when an angel invests several millions in a company, he is going to place himself and/or his representatives on the board, to keep a close eye on his money. In that world, if a company is going public then it is usually better established than a nascent startup.

Crypto finance has undermined these norms. The lack of hierarchy, the unmethodical growth phases of a company, compared to the sums of money that are being raised – these are anomalies in the eyes of old finance. 2018 has been and 2019 is going to be the time when the institutional players are coming in, through the door of all-encompassing securitisation.

The old finance world and the crypto finance world are consolidating and securities laws are gradually forcing the old world norms onto crypto finance.

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Mis-match

The problem begins when the norms that are being forced upon the crypto world are not symbiotic with its characteristics.

STOs (security token offerings) and TAOs (tokenized asset offerings) could be a wonderful way to make security investments more accessible to the public, but the reality is that most crypto startups are not ready to go public, so what happens is they turn to private placements, which means they stay away from retail investors and sell their tokens only to qualified/accredited investors.

This creates a ridiculous situation, where instead of having security tokens incarnate revolutionary investment vehicles which are less constraining and far more flexible than traditional securities, they are forced to swim in the same ocean as the big fish.

The cause for this is the fact that in most countries, there is no appropriate solution in their securities law. Securities laws are mostly aimed at companies issuing equity or debt securities, i.e. shares or bonds.

However, in the STO/TAO world, most token issuers are selling neither. They are selling a new species of a scalable security- usually either a tokenised asset (an actual underlying asset which ownership is represented by tokens) or a token distributing to its holders a portion of the company’s profits.

The token holders in these cases do not become shareholders, equity partners or debtors of the company. The issuing companies and the people behind them are also very different from traditional security issuers: they are usually younger, less structured, less experienced, more accessible.

Progressive Legislation

Regulators and legislatures realise the dissonance. Some countries’ financial regulators (e.g. the UK, Canada, Israel) have put in place ‘sandboxes’ or ‘fintech innovation hubs’ which invite blockchain (or other fintech) startups to submit their business model before applying for authorization or a license, and converse with the regulator about the best course of action. While this is a useful mindset, it’s rather limited.

A regulator operating within a sandbox still relies on existing laws, and there’s a limit to how much it can stretch them. The sandbox can usually provide the startup with the best framework out of the given choice of frameworks that exist, but not to re-invent the wheel and spontaneously craft completely new legal frameworks.

Beyond that, personnel limitations usually lead to a rather low capacity for the number of companies that can ‘play’ in the sandbox at the same time.

Canada is an example for a more accommodating securities laws framework. Canadian securities laws (which vary slightly from canton to canton) offer ways to sell to retail investors, subject to investment limits imposed individually, per investor (in the EU and the US the sale limits are relatively low and are calculated according to the aggregated sales).

In British Colombia, an issuer can even sell securities to retail investors with no limit, subject to a ‘light’ prospectus requirement. In Ontario, there’s a ‘launchpad’ which is similar to a sandbox, which usually takes only 4-6 weeks to approve a project.

A live example is ‘tokenfunder’, a security tokens crowdfunding platform with an intrinsic token, which crafted its regulatory framework and and offering memorandum with the help of the Ontario Securities Commission’s launchpad.

Blockchain and crypto startups are a positive phenomena. Just like Teslas, they have all the elements required to make a real change in the world, but they need the right infrastructure to achieve it. Smart regulatory action and the avoidance of over-regulation should be the cornerstones of this infrastructure.

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