What is SEC Commissioner Hester Peirce’s safe harbor proposal and the implications surrounding it.
By Vanessa Malone
In a speech last week, SEC Commissioner Hester Peirce announced a proposal for a three-year “safe harbor” for tokens offerings which would exempt the sale of tokens or cryptocurrencies from certain federal securities law requirements. Token project issuers would need to meet certain conditions and follow strict personal and public disclosure rules to qualify, but it would give issuers time to develop their networks and products without being instantly classified as an offering of securities.
Having a formal proposal in place is a big step as it forces the rest of the SEC commission to consider and discuss a critical issue prevalent in the blockchain community.
To understand the root of the problem, it’s important to understand the relationship between utility tokens and security tokens.
In 2016 and 2017, aside from a select few digital currencies which to date have been deemed commodities (i.e BTC and Ether) most of the Initial Coin Offerings (ICOs) that came out were to raise money for decentralized networks being built on a new or existing blockchain. The funds were raised by selling tokens, which in turn would be utilized to interact with functions of the network. They we’re called utility tokens because they worked to provide access to functions within the ecosystems being built.
A major frenzy took place and investors were throwing billions of dollars into projects that only disclosed a white paper and a promise to build the next greatest thing. Unfortunately, this led to turmoil and today, the majority of those ICOs are now below their listing price or have become completely obsolete.
This is where security tokens, or what we like to call digital securities, come in.
In July 2017, regulators came out with the blanket statement that such tokens offered in an ICO are securities, and thus fall under the SEC’s jurisdiction.
While some issuers attempted to refute this logic, those who wanted to move forward with their projects were then forced to mold the equivalent of frequent flyer miles into a securities framework.
In Peirce’s speech, she echoes this dilemma saying a “contract, transaction or scheme” by which the token is sold may constitute an investment contract; but, the object of the investment contract — the token — may not bear the hallmarks of a security.”
Two examples of this were the Blockstack and YouNow token offerings which were qualified under Reg A+, allowing the general public to invest alongside high net worth individuals. As we’ve discussed before, the Regulation A+ investment vehicle promotes accessibility which is something investors flocked to during the ICO-craze.
While successful in their raises, the legal road was extremely expensive and unclear, and another roadblock was then hit when it came to secondary trading. Unlike the platforms built to trade cryptocurrencies, no liquid secondary trading platform exists for security tokens in the U.S.
Currently, Blockstack’s Stacks (STX) token can be traded on the Binance and HashKey Pro crypto exchanges. But this only applies to non-U.S. persons. So what happens to the 4,500 investors who participated in the U.S. round? They are forced to hold tight and wait until a U.S. trading venue is approved.
Again Peirce touches on the issue of forcing these types of tokens to go through the same securities framework as traditional digital securities, which are merely digital representations of ownership interests in an underlying asset or company.
“Conflating the two concepts has limited secondary trading and has had disastrous consequences for the ability of token networks to become functional.”
What’s interesting is that two very different worlds are colliding when it comes to tech and regulation. The tech world is fast-paced, the regulatory world is slow and careful.
At our last Dialogue with the Regulators forum, one panelist reiterated this very point. Fast-paced tech-companies have a hard time adjusting to regulation as you can’t “launch an MVP” of an exchange or other products that involve securities. It has to be right the first time which calls for a different development process.
On the other side, attempting to fit new technological innovation into current laws is tough, and it’s proposals and conversations like these that will hopefully get the ball rolling on real and productive change.
Join the Dialogue
On that topic, regulatory issues are not unique to the U.S. And more open dialogues need to be had in order to move forward. If you’d like to be part of these important conversations, please be sure to check out our Dialogue with the Regulators speaker series. The next event takes place Thursday, March 19, in London and brings regulators and industry leaders from around Europe to discuss blockchain, fintech, and compliance. Learn more at https://www.horizon-globex.com/events/DWRLondon.