Morocoin's Investigation into the Global Landscape

STO, standing for Security Token Offering, is currently the hottest topic in both the capital market and blockchain industry. Amid the prolonged slump in the digital asset market and global economic challenges, STO has emerged as a breakthrough in tech finance, drawing significant attention. The question that everyone is interested in is: What exactly is an STO, how does it work, and what are its prospects? The blockchain team at Morocoin Exchange has conducted research on this topic and held in-depth discussions with executives of U.S. STO platforms on related legal issues. Based on this, they have summarized six critical points about STO for reference.

1. What Exactly is STO?

STO refers to the process of legally and compliantly issuing tokenized securities under one or more jurisdictional regulatory frameworks to raise funds. Essentially, STO is the process of issuing securities using blockchain technology.

To date, preliminary research has not revealed any mainstream commercial country that has enacted specific laws and regulations for STO. Therefore, it is understood that conducting STO still requires operating within existing traditional securities and financial regulatory frameworks.

Theoretically, there are two possible ways for STO:

(1) Register with the securities regulatory authority under the public offering (IPO) standards of each jurisdiction, tokenizing and issuing the underlying assets.

(2) Appropriately utilize exemptions listed in each jurisdiction’s regulatory acts for legal compliance.

However, the first method, due to its high financial data requirements and complex procedures, is less economical and practical for STO at present. The second method is more feasible.

2. How to Comply with U.S. Laws for STO?

As the world's most economically powerful country with the most comprehensive financial securities system, the U.S. provides detailed descriptions of securities registration exemptions, which essentially meet the diverse needs of STO for a considerable time.

The private offering regulation, Regulation D506(c), has stricter requirements in "selling to no more than 2000 qualified investors" and "investor identity verification" than other exemptions. It is nearly a green light in other aspects: fast processing, no disclosure requirements, and low costs.

Regulation A, often called mini IPO, has lower investor thresholds. To protect investors, the SEC imposes certain requirements on its offering documents, financial data, and information disclosure, leading to higher costs. However, it offers higher liquidity compared to securities issued under Regulation D.

Regulation CF crowdfunding regulation has a lower fundraising cap and not-so-easy issuance requirements, making it a less popular choice for STO.

Another type, Regulation S, is often used in combination with other exemptions (REG A/D). Regulation S allows fundraising from investors outside the U.S., with no limit on the amount raised and no nationality restrictions for fundraising companies. Securities cannot be traded in the U.S. for one year post-issuance. Tzero, for example, used a combination of Regulation S and Regulation D506(c).

3. Has STO Been Approved by the SEC?

Recently, there have been claims of "U.S. approval of STO" or issuers stating their security tokens have been "approved by the SEC." At least as of now, such statements are not accurate.

Based on public online searches, securities tokens issued in compliance in the U.S. are primarily based on Regulation D and Regulation S. Securities tokens issued under Regulation D have not been approved or reviewed by the SEC; issuers only need to comply with Regulation D's requirements and file Form D on the SEC website within 15 days of the first sale. Regulation S also only requires filing without approval. All filed forms can be publicly accessed in the SEC's EDGAR database. These exemption regulations, with lenient pre-issuance reviews, rely on the issuers' strict adherence to the qualified investor restrictions. Violations can result in severe penalties by the SEC.

Therefore, it is believed that if security tokens issued through Regulation A successfully emerge, then it can be considered that "the SEC truly approves STO." According to public reports, several issuers have applied for Regulation A issuance.

4. How is STO Regulated in Europe?

European STO regulatory policies are divided into two levels: the European Union level and the member states' level.

At the EU level, the main regulatory bodies are the European Securities and Markets Authority (ESMA) and the European Central Bank (ECB).

In Europe, if an STO's hard cap does not exceed 5 million euros; or if it sells security tokens to no more than 150 residents of a member state (regardless of whether they are qualified investors); or if each token sold is not less than 100,000 euros in value; or if each investor purchases at least 100,000 euros in tokens, these situations can enjoy exemption without the need for a registration prospectus.

Compared to the U.S., the regulatory policies of EU member states are not as detailed but are relatively more lenient and open, especially in smaller countries like Malta and Estonia.

HydroMiner, a cryptocurrency mining project from Austria, launched H2O token last year and is now offering H3O token. Unlike H20, H30 is a security token that will distribute profits from HydroMiner's mining operations. HydroMiner plans to IPO on London Stock Exchange’s AIM (Alternative Investment Market) in the third quarter of 2019, converting H3O tokens into equity tokens compliant with EU regulations.

The presale phase of H3O has ended, and its prospectus is currently under review by the Austrian Financial Market Authority (FMA). If approved, H3O tokens will become one of the first tokens in Europe to rely on a complete capital market prospectus.

5. How Do STO Platforms Operate?

As they mainly use issuance exemptions, the significant upfront costs of issuance exemptions are mainly in the qualified investor review phase.

However, machines can perform better than humans in this phase, so the selling point of various STO trading platforms on the market is how to accurately and efficiently complete the qualified investor review and continue to perform identity verification for token holders in the circulation phase.

Platforms like Polymath and SWARM embed necessary legal regulatory requirements into the token's smart contract, adding a regulatory layer protocol on top of ERC20. The equity-mapped tokens issued through their platform can self-verify whether the buyers and sellers are qualified for trading. Openfinance Network has launched Investor Passport, which collects and analyzes user information and documents to ensure only qualified users are selected for trading.

Users with Investor Passport can invest in security tokens that match their investment scope on the platform. This not only speeds up the compliance process but also significantly reduces the issuer's labor and time costs.

6. Is STO as Good as It Seems?

Some believe that STO, with government endorsement for token issuance, is more credible than ICO, IDO, IEO. Compared to traditional securities, it has stronger liquidity, does not depend on centralized intermediaries, has a broader range of tradable assets, T+0/24-hour trading, and significantly faster transaction speed.

Indeed, theoretically, any asset (tangible + intangible) can be securitized. Valuable assets like art or indivisible intangible assets like copyrights can be fragmented into small pieces.

But is STO's liquidity really that strong? The biggest issue with STO at present is the nascent secondary market.

Due to policy restrictions, security tokens can only be traded on specific platforms or through brokers. It is understood that STO can be commercially viable only if all the following conditions are met:

(1) The issuance and circulation processes of such trading platforms comply with the legal regulations of the relevant jurisdiction.

(2) The trading platform shares regulatory standards with other platforms, allowing relatively free circulation of ST on those platforms.

(3) Trading platforms with the same regulatory standards have sufficient market depth.

(4) These regulatory standards are recognized by the securities regulatory authorities of the relevant jurisdiction.