There has been confusion in the cryptosphere about which tokens are securities according to the complex U.S Securities and Exchange Commission guidelines. The agency is now trying to clarify this class of assets.
What is a Security Token?
One of the most striking features of security tokens is their tradable value. This means that they can be traded or sold. They are often purchased by companies looking for initial capital to help develop a new concept. Investors are often promised immediate financial returns via the appreciation of asset value. This is somewhat like company shares.
Security tokens are different in that they derive their value via an external tradable asset. The token could be part of real estate or a company, but the underlying blockchain is what makes it a share.
Security Tokens and Utility Tokens
Utility tokens are very different from security tokens. The latter offer investors exclusive access to products and services offered by the issuing company. For example, a start-up might offer pre-orders for certain products or coupons to its service offerings.
Businesses involved in the issuance of security tokens participate in Initial Coin Offering events. However, utility token sellers prefer to call their events token distribution events (TDEs), or token generation events.
SEC Guidelines Concerning Security Tokens
Recently, the SEC issued guidelines that outline which tokens are securities. This framework was created by the agency’s Strategic Hub for Innovation and Financial Technology division (FinHub). It was clearly intended to be a guideline and was not legally binding.
A recent press release by Bill Hinman (Director of Division of Corporation Finance), states that the parameters are intended to be used as an analysis tool to assist investors, SEC staff and market participants in determining whether a token is a security. These procedures provide insight into which tokens are eligible for exemption from this categorization.
Initial Coin Offerings (ICOs), which are offered by enterprises, must be categorized as securities. Because the investment class is directly regulated under federal laws and by the SEC, this is important. Failure to register an Initial Coin Offering is likely to result in penalties. Fines can reach into the millions.
According to the SEC guidelines, tokens can be considered investment contracts if they pass the Howey test. The Howey test is used to determine whether an endeavor is a common enterprise, involves money investment and has a potential for profit. The financing instrument is automatically considered a security token if all three conditions are met.
Anti-Fraud Provisions
Security tokens must comply with the SEC guidelines. This includes its extensive anti-fraud provisions. These are primarily intended to protect investors and zap illegal ICOs. The agency can bring criminal and civil proceedings against violating parties and impose sanctions. Investors can also request a refund under anti-fraud procedures in the event of a breach.
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