Security Tokens Don’t Solve The Regulatory Mess of Utility Tokens

They instead cause infinite more problems to worry about by Petros Ring

Itcame out recently that ICOs by size were equivalent to 45% of IPOs created in the Q2 of 2018¹. These mostly unregulated securities offerings were growing exponentially, yet many of them are now private deals done with large institutional investors for the sake of making a buck rather than creating a true decentralized product and ecosystem.

To go even further into the fray of the traditional world many companies are attempting to do a STO (Security Token Offering) which they believe will allow them to have greater regulatory safety. Many of these STO’s look identical to a regular traditional security financing though — meaning it’s essentially just a marketing ploy to raise funds for a blockchain project.

First let’s take a look at how we got to this point and then we’ll go into what the issues are with STO offerings.

The Past: The Unregulated Wild West

Utility tokens were supposed to be the digital equivalent of a “Chuck E Cheese” token for the blockchain industry. You can buy the tokens and they only have value when being used in some specific system — the games at Chuck E Cheese. Many projects would label this kind of functionality as the “Medium of Exchange” functionality of their token and it’s where many early tokens derived their value from.

Over time utility tokens added additional systems such as forced staking, burning, company buy back, etc. All of these systems were meant to increase the fundamental value of the utility tokens over a long time horizon.

Then in February of this year the SEC Chairman, Jay Clayton, stated to congress that “Every ICO I’ve Seen Is a Security”.

His main logic to argue this idea is that all of the tokens were sold to allow for a management team to perform substancial effort in the creation of a business or product. In layman’s terms — you’re selling an investment into a token for the future, making it a security today.

During this time almost all ICO projects stopped taking in money from US retail (unaccredited) investors in fear of SEC retaliation, substantially slowing down capital into blockchain projects from the true end user.

While this has not been so widespread if utility tokens are to be considered securities in the US it means that they most likely won’t be able to operate in the US. The movement of securities is in itself a regulated act. Many companies have not acted on this idea yet but you will begin to see both unregulated exchanges and projects themselves attempting to block US users from their interfaces.

The Wrong Direction: Let’s Make Securities Intentionally

The backlash from community quickly became that if this was the way the market’s were headed why don’t we intentionally make all of our tokens compliant securities so that we can once again sell into the US and in addition we can add traditional securities features such as revenue rights, equity, debt financing, and many more to the token.

Somehow though no one told them that by creating a security token you were causing the opposite problem of utility tokens. Instead of being blocked by countries, you had to choose countries to operate/sell in because otherwise you will have to register your security in every country that you have residents potentially owning your security.

We went from an unregulated market that still worked in most countries in the world — and was evening having certain small nations create real definitions of a utility token (see Anguilla) — to try to create a heavily regulated product that could not travel around the world and costs large compliance fees to operate on a per country basis.

In addition to this many of the STO offering’s being created didn’t actually have a benefit over traditional equity financing. You were still forced to have users locked into a one year holding period and the tokens aren’t currently tradable on any exchange because none exist yet.

Many companies are also attempting to perform a Reg A+ offering in which they are allowed to publicly solicit funds from US investors up to $50 million. At this current time though the SEC has not approved any STO based Reg A+ offering. These types of offerings are also very costly and time consuming which can make it impossible for early stage startups to attempt to raise funds in this manner.

The Future: Valuation and User Growth

I’m not entirely sure what is next for the future of ICOs. Returns are slowing down and markets are being cut off.

Blockchain companies may have to return to traditional debt or equity based financing to try to raise their funds and instead use pure utility token air drops to try to create a community much like the Decentralized Exchange, The Ocean did recently.

If they are going to attempt to continue to create utility tokens offerings the first issue they need to solve is the valuation of their own tokens. Most are substantially overvalued when they are initially released and are without a product to be used in. All of the value of the tokens are therefore entirely speculative leading to extremely quick market crashes for tokens.

Projects need to release utility tokens for products that are functioning and they need to focus on gaining and keeping users to increase the true fundamental value of their tokens.

Right now the entire community needs to focus on building products instead of trying to raise funds for the ecosystem to grow. Ether is considered a commodity and therefore can be used by projects to facilitate transactions. On top of this stable coins right now don’t seem to be heading in the direction of being a security and could be used to make dApps more understandable for the average user by allowing them to use their standard currency. So start building.


Disclaimer: I am not a lawyer and the content of this article is not to be considered legal advice.

About the Author: Petros is a Blockchain Engineer at a crypto venture studio, Block 16. We are a full service blockchain agency that does crypto-economics, network syndication, marketing services and blockchain development. If you would like to reach out to me send an email to petros@block16.io.

2018-12-28T19:17:11+00:00