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Security Token Offerings: STOs Replacing ICOs?

JL Law

Based on a strong legacy of investor protection and oversight by regulators, security token offerings (STOs) are poised to overtake initial coin offerings (ICOs) that were conducted without regard to regulations. Understanding why and how this shift is happening is key to positioning your company to attract investors while protecting it from risk.

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Understanding the Difference Between STOs and ICOs

With an initial coin offering (ICO), companies receive investor funding in exchange for cryptocurrency tokens. Most of these were done out of compliance with regulations.  Investors buy into these offerings in hopes that those tokens will increase in value, at which point, they can be traded for a profit. This is a classic example of a securities offering, which is supposed to be regulated, but ICOs were conducted largely as if they were unregulated.  While they offer a lot in the way of convenience and speed, ICOs were also a prime area for fraud when bad actors created ICOs with the intent to take the money and defraud the investors.  Even the good actors of ICOs often broke securities laws because they mistakenly thought that ICOs were unregulated.

A security token offering, or STO, is also a type of cryptocurrency token, but one that recognizes that the tokens or the token offering is regulated by securities laws. STOs can either be tokens that were sold as securities but is often thought of as relating to tokens that give their owners a share of the business profits, a stake in the business itself, or some other offering that is based on the business or asset itself. Because STOs are securities, they are regulated by the securities laws and the applicable securities regulators. These factors make it far less likely that investors will encounter fraud. The reality is that almost all ICOs were actually just illegal STOs, a notion that the SEC has often stated.

STOs, Regulation D, and Accredited Investor Verification

As the market moves away from ICOs as a means of raising capital, companies who have previously relied on this method may find that itis more work to operate within the regulatory framework of an STO. That being said, that very framework is what provides more public and investor trust in your business, so it is ultimately worth the effort.

STOs may rely on many different securities exemptions to conduct a sale, but it’s most often done in reliance on the Rule 506(c) exemption with a Form D filed with the SEC. These types of offerings may solicit anyone, but can only sell to accredited investors. For Rule 506(c) offerings, STO issuers are required to take reasonable steps to verify that investors are accredited investors.

Investor verification is vital to the success of a project involving an STO. Failing to properly verify your investors may result in serious consequences, as non-compliance may result in the SEC requiring the issuer to return all the investors’ monies as well as face potential legal actions.

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