This article is about liquidity in security token offerings. There’s an idea that security token offerings or STOs are more liquid than traditional securities offerings. While blockchain technology may enable a security token to be more liquid in the long run, raising money with an STO does not automatically provide liquidity to investors.
What is a STO?
An STO is a way that companies raise money by selling blockchain tokens that are considered securities. This is a response to initial coin offerings or ICOs that were popular last year.
Last year, companies raised millions of dollars with ICOs, sometimes in a matter of seconds. In an ICO, companies sold “utility tokens” that were meant to be used to purchase a company’s goods and services. However, many companies marketed these tokens to potential buyers as an investment and placed these tokens on exchanges so that the tokens could immediately be resold.
The SEC began cracking down on ICOs and the ICO industry as a whole, even when companies attempted to comply with the law in good faith. Jay Clayton, chairman of the SEC, stated that every ICO he’s seen is and offer and sale of a security and as such, any offer or sale of a security to a U.S. investor is subject to the U.S. securities laws.
In the United States, offers and sales of securities must be registered or exempt from registration. In a STO, the company raising money is conceding that the tokens that they are selling are securities. As such, the company must register with the SEC or qualify for an exemption.
Why Can’t an Investor Immediately Resell STO Tokens?
Under many of the available exemptions the securities that are sold are called, “restricted securities.” This means, unlike in an ICO, an investor cannot buy tokens in your STO and immediately sell them to someone else. The securities have to be registered or exempt from registration. For example, one of the most popular exemptions, Rule 144, allows restricted securities to be resold after 6-12 months, depending on whether the issuer is a reporting company.
How Does a Company Get Around the Liquidity Issue?
A company hoping to comply with the law and provide its STO investors with liquidity has a few options. This includes, registering the STO or using the Regulation A+ exemption. Under these offerings, the securities are not restricted securities.
A company can also build liquidity into the tokens, such as providing investors with rights to dividends or a share of the company’s revenue.
Finally, a company selling restricted securities should ensure that investors cannot resell the tokens until the holding period is over by locking up the tokens for one-year and only remove such restrictions upon the advice and opinion of legal counsel.
If you have questions, we are here to help. You can schedule a free strategy session with us by clicking here.
This article is provided for informational purposes only and should not be construed as legal advice. Read our disclaimer here.