2018 has been a tumultuous year on the regulatory front for the blockchain industry.
The year began with news that the SEC had issued dozens of subpoenas for blockchain startups that had issued unregistered token offerings, spreading alarm throughout the crypto world. These investigations have recently resulted in penalties, mandatory securities offering registrations and in some cases reimbursement to investors, for a few blockchain companies.
SEC Director William Hinman issued informal guidelines that bitcoin and ether were not securities because those networks had become “sufficiently decentralized.” Now, as the year winds to a close, we hear that the SEC will issue “plain English” guidance on the security token analysis as soon as early 2019.
In this uncertain regulatory environment, most blockchain startups contemplating token offerings are steering away from the public crypto markets and venturing into the brave new world of security token offerings. The buzz on the street is that “STOs” may be the next big wave for blockchain fundraising.
However, many blockchain startups initially planned their business model around what they perceived to be a utility token – a software license to use the token on a platform, often as the currency to pay for services or earn rewards in a digital marketplace powered by a blockchain.
As these start-ups shift their plans from doing ICOs toward the regulatory landscape of STOs instead, the biggest question is whether the STO is going to be the panacea everyone is looking for: what unresolved legal issues for STOs do we confront in 2019? What cutting edge issues are currently boggling the minds of securities attorneys as they begin to execute these STOs?
Using Security Tokens on a Blockchain
Most STOs that are currently being initiated are private placement securities offerings to accredited investors.
However, the private placement poses a number of unresolved problems for blockchain companies wishing to use the tokens on their platforms. These issues will have to be analyzed carefully under the facts and circumstances of each blockchain platform, but some general considerations include:
- Accreditation: Will the accredited status of investors have to be checked every time that the platform issues tokens, even where the tokens are being issued as rewards earned on the platform?
- One-Year Lockup: Will initial token users have to hold the tokens for a year each time they earn tokens on the platform before using them for functional purposes on the platform such as paying for services?
- State Issuer Dealer Registration: Will blockchain companies have to register as issuer dealers with several states that have such requirements before they can transact in their own securities on their platform? The American Bar Association published a useful article on state issuer dealer registration laws. Although these issuer dealer laws usually affect primarily public offerings of securities rather than private placements, a different novel question is presented by blockchain platforms that deal in their own securities on an ongoing basis after initial issuance.
- Registration as an Alternative Trading System (“ATS”): If the blockchain platform is acting as a marketplace to bring together sellers and purchasers of security tokens, at what point does it need to register as an ATS? The SEC has yet to issue clear guidance regarding the circumstances under which a blockchain platform dealing in security tokens would be regarded as a securities “exchange,” particularly in difficult cases where the platform does not call itself an exchange of any kind.
Brave New Frontier of Reg A+ STOs
For blockchain companies that intended their tokens to be sold to the general public rather than accredited investors, without resale restrictions, all eyes are on the backlog of exempt public security offerings, or Regulation A+ STOs, currently sitting with the SEC awaiting approval.
Although blockchain companies that have filed Form 1-As under Regulation A+ generally regard their discussions with the SEC as confidential, the grapevine has relayed that there are currently unresolved obstacles to SEC compliance for these offerings. Hopefully in 2019, we’ll see the first qualifications of Reg A+ STOs and the exempt public securities offering will no longer be considered an “experimental” area.
Problems for Secondary Trading
Once hurdles with regard to federal securities laws on resales are cleared, blockchain companies will have to figure out some way to comply with state Blue Sky laws regarding secondary trading.
Each state offers a set of exemptions under which secondary trading may take place, with many states offering an “unsolicited brokerage transactions” exemption. 2019 will be the year when issues regarding state securities laws on secondary trading must be resolved.
Conclusion: Looking Ahead
2019 promises to be an exciting and eventful year for security token offerings.
For the first time, the blockchain industry will figure out if there is a way forward from the SEC’s informal guidance that most token offerings will have to be registered or issued under an exemption from registration. Furthermore, a wild card has been thrown into the regulatory mix with the recent introduction of a new bill amending the Securities Act to define cryptocurrencies as not being securities so long as they are utilized on a functioning network.
It is far from clear that STOs will provide an easy solution for blockchain start-ups that planned a utility token model and are now steering clear of the public crypto markets, but undoubtedly securities attorneys will throw in their best efforts to resolve these issues.
SEC’s Hester Peirce promises regulatory clarity; says SEC doesn’t want crypto-businesses like Circle moving offshore
Regulatory developments across the world are forcing crypto-businesses to find homes in lenient geographies. Hester Peirce, Commissioner at the U.S. Securities and Exchange Commission, featured in an interview to clear some of the fog left in the wake of the lack of clarity in U.S. regulations, regarding the crypto ecosystem. Peirce stated,
“One of the benefits of this kind of technology is that it connects people from all across the world. We certainly don’t want people to feel they have to go offshore to put one of those (crypto) projects in place.”
She suggested that an increase in “regulatory certainty” would not only help companies maintain their home base within U.S. territories, but also “draw people back to the U.S.” Her statement came in light of the Jeremy Allaire-led Circle moving a majority of its operations to Bermuda, citing regulatory uncertainty in the United States.
Additionally, Peirce advised crypto-businesses to “go into the SEC and tell them about their business plan,” and in turn, receive guidance from the SEC to give impetus to their business goals. While displaying a welcoming attitude towards crypto-adoption, the Commissioner also warned crypto-businesses that intend to undertake fraud or unregistered offerings. She added,
“We need to be proactive in providing clear rules and guidance so that people know what to comply with. And then, we can hold them accountable for not complying with it.”
While admitting the government’s delay in establishing clear crypto-regulations, Peirce added that the SEC is currently working on building a “level playing field” which will ensure that regulations don’t pose as barriers to any form of crypto-industry. Hester Peirce concluded the interview by welcoming further participation from the crypto-community. She said,
“I encourage people to come talk to us. If you think we don’t understand something or have gotten something wrong, come talk to us.”
SEC Begins Green-Lighting Token Offerings
The U.S. Securities and Exchange Commission recently made history when it green-lighted two token offerings under Regulation A+. “This is the first time in U.S. history that a crypto token offering has received SEC qualification,” one of the two qualified issuers proclaims.
Historic Event for Crypto Industry
The U.S. Securities and Exchange Commission (SEC) began qualifying token offerings under Regulation A+ (Reg A+) last week. The application by Blockstack PBC was approved on July 10 for Stacks tokens. The other application was approved the following day for Props tokens by Younow, a live streaming app which claims to have 46 million users.
Under the U.S. Securities Act of 1933, companies seeking to offer or sell securities to potential investors must either register the offer and sale or qualify for a registration exemption, such as under Regulation A.
The Jumpstart Our Business Startups (Jobs) Act, signed into law by former President Barack Obama on April 5, 2012, directed the SEC to amend the Securities Act and expand exemptions provided by Regulation A. The resulting final rules, often referred to as Reg A+, were adopted by the commission on March 25, 2015, and became effective on June 19 of the same year. The exemptions are aimed at facilitating small companies’ access to capital. However, the SEC never approved any token issuers’ Reg A+ applications until now.
Muneeb Ali, co-founder of decentralized app ecosystem Blockstack and CEO of Blockstack PBC, announced on July 10 that his company’s “upcoming token offering has been qualified by the SEC under Regulation A+,” elaborating:
This is the first time in U.S. history that a crypto token offering has received SEC qualification. We believe this is a huge step forward for decentralized applications, internet security, and privacy … It is a truly groundbreaking day for decentralized technology.
Ali added that there are currently over 165 applications built on the Blockstack decentralized computing network, including bitcoin-friendly web services such as Dmail, Bitpatron, and Graphite Docs. Blockstack PBC is a technology company that, together with its affiliates, develops an open-source peer-to-peer network using blockchain technologies to build a new network for decentralized applications, the Blockstack network.
The Blockstack team worked with the SEC over the past 10 months prior to qualifying for Reg A+, Ali said on Fyiam Tuesday. Under the Reg A+ framework, the company began conducting a $28 million cash offering on July 11. The sale is open to anyone globally “subject to a small number of geographical restrictions,” the CEO confirmed. Prior to obtaining the Reg A+ qualification, only accredited investors could participate in the company’s 2017 offering under Regulation D.
According to its offering circular filed with the SEC, Blockstack’s current offering is limited to $50 million in Stacks tokens each year. The circular details that Blockstack currently offers 40 million of these tokens to non-U.S. persons in a private placement exempt from the registration requirements under Regulation S. “We plan to continue our offering under Regulation S concurrently with this offering under Regulation A,” the filing notes. Blockstack also intends to offer its tokens to residents of the State of New York. “We have, however, taken the position that the State of New York’s Bitlicense regulatory framework does not apply to the offer and sale of securities like the Stacks tokens,” the filing explains.
Props Project and Younow
The day after Blockstack’s announcement, the Props Project announced that it has also been qualified by the SEC to distribute Props tokens under Reg A+. Its SEC filing states that “A Reg A+ filing would enable us to bring Props to our entire community of users.” The team wrote on July 11:
We are proud to announce that the Props offering statement on Form 1-A has been qualified by the U.S. Securities and Exchange Commission (SEC), enabling us to grant Props to both accredited and unaccredited Props Network users in the United States and around the world.
“This is a landmark moment for our community,” the team continued, adding that Props tokens are now available to registered users of Younow, the first app on the Props Network.
According to Younow’s offering circular filed with the SEC on July 12, Props tokens will be used to reward users of the apps for in-app activities. “As a Tier 2 issuer under Regulation A, we will be subject to scaled disclosure and reporting requirements, and we will not be required to make the same level of public reporting required of issuers in traditional public offerings,” the company elaborated.
Rules and Eligibility
Reg A+ provides for two tiers of offerings. Tier 1 allows securities offerings of up to $20 million in a 12-month period while Tier 2 allows up to $50 million within the same time period. For offerings of up to $20 million, the issuer could elect either tier. Both Blockstack and Younow have opted for Tier 2 offerings. The SEC reiterated:
The updated exemption will enable smaller companies to offer and sell up to $50 million of securities in a 12-month period, subject to eligibility, disclosure and reporting requirements.
Both tiers are subject to basic requirements. However, Tier 2 issuers have additional rules to follow such as providing audited financial statements, filing annual, semiannual and current event reports, and “A limitation on the amount of securities non-accredited investors can purchase … of no more than 10 percent of the greater of the investor’s annual income or net worth.” Furthermore, issuers in Tier 2 offerings are not required to register or qualify their offerings with state securities regulators.
Exemptions under Reg A+ are limited to companies organized in and with their principal place of business in the U.S. or Canada. The exemptions are unavailable for companies that already report to the SEC and certain types of investment companies. Other criteria that could disqualify a company include not having a specific business plan, having been subject to any order of the commission entered within the past five years, or not filing ongoing reports required by the rules during the preceding two years.
Unprecedented: Blockstack Gets SEC Nod for U.S. Public Token Sale
The first token offering to be approved by the U.S. Securities and Exchange Commission (SEC) is coming to America and beyond, courtesy of decentralized computing and dapp firm Blockstack PBC.
Announced by the company’s leadership on July 10th, the approval means Blockstack will begin its public sale of Stacks (STX) tokens in accordance with the regulator’s Regulation A+ framework, an IPO alternative used by startups to raise funds.
The qualification has immediately paved the way for the STX offering to start, the firm said:
“Blockstack will conduct a $28 million cash offering. The token offering will open on Thursday, July 11th […] It will be open to any purchaser who would like to take part in the Blockstack next-generation computing network, subject to a small number of geographical restrictions. This means everyone from general enthusiasts, to longstanding Blockstack supporters, to accredited or non-accredited investors alike […] can participate in the sale.”
Participants will be able to register for the offering through the stackstoken.com portal, where STX will be on sale while supplies last via payments in dollars, bitcoin, or ether. $100 USD or the cryptocurrency equivalent is the minimum purchase amount allowed.
A Page Has Been Turned
For his part, Blockstack chief operating officer Muneeb Ali hailed the SEC qualification as a milestone in the wider cryptoeconomic fight to build a new, better internet:
“By inviting everyone, not just accredited investors, to contribute to Blockstack, we can effectively drive the long-term growth of our vision to build a decentralized computing network that will replace the current, siloed version of the internet with one that is open, fair, and user-controlled.”
In the very least the qualification is a milestone insofar as it is unprecedented in America’s nook of the cryptoverse — no ICO has ever achieved similar SEC approval before, with the Commission having proven to be a daunting chokepoint for U.S. token projects in the past.
As legal expert Katherine Wu explained on Twitter, the development indicates Blockstack has been coordinating with the securities watchdog at length — with the effort now having paid off, if the greenlight is any indication.
Zooming out, Blockstack has provided a blueprint for other token projects keen on bringing their assets into the hands of U.S. investors in full regulatory compliance. The takeaway? Deeply engage with the Commission and its requests (and be a viable project, of course), and you’ll be able to play ball in America.
Now, this isn’t to say that ICO season will come ripping back. But it does show there’s a viable new way to bring token offerings toward the mainstream.
What Is STX?
The Stacks token is the native asset of the Stacks blockchain, which is the heart of the Blockstack network.
In being the platform’s native asset, Stacks tokens work like ether works in Ethereum: as gas to pay for the execution of transactions and smart contract activities. So for those building dapps on top of Blockstack, STX will be used to make those dapps run and help the network’s users manage their data.
Notably, preregistered Blockstack voucher holders who have been approved will be allowed to purchase an initial lot of $3,000 worth of STX at a price of $0.12 per token.
Beyond the 78,333,333 STX set aside for voucher owners, an additional 62,000,000 STX have been earmarked for the token’s general offering valuation of $0.30 and another 40,000,000 for “non-cash consideration,” i.e. to pay for the development of dapps through the Blockstack “App Mining” program.
Of all those tokens, only $50 million worth will be portioned out for retail investors, though that’s $50 million more than what would be allowed in a regular securities offering. Such offerings are open only to accredited investors in the U.S.