While the Security Token Offering (STO) ecosystem in the US is currently the global leader in this still-nascent industry, regulatory advantages in the EU mean that – particularly for retail investors – Europe offers more near-term potential to invest and trade in digital securities and by extension a favorable climate for promising startups to raise capital. Recent precedent in a handful of EU nations, combined with a healthy pipeline of security token platforms, exchanges, and offerings means that Europe may soon replace the US as the leading force in the emerging STO landscape.
STO environment in the US
Most of the hype around security tokens – which promise to offer democratized access to hitherto private equity offerings and increased liquidity for their secondary trading – so far has come from the progress made by US-based platforms and exchanges. For example, security token issuing platform and secondary exchange tZERO, a subsidiary of e-commerce giant Overstock.com, raised 134 million USD in a private sale that lasted for most of 2018. Promising to provide securities issuers with a “new solution for accessing capital and enabling secondary liquidity for traditionally illiquid investments” tZERO announced on January 24 that secondary trading of its tokens is now live.
A number of well-publicized security token offerings were also conducted in the US in 2018 by US-based issuing platforms. The St. Regis Aspen Resort in Colorado, for example, raised 18 million USD in the first equity offering hosted on the Indiegogo crowdfunding platform. Security token issuing platform Harbor announced in November a real estate investment trust (REIT) representing 20 million USD of private equity in a student housing high-rise serving the University of South Carolina.
Obstacles for US STOs
Every major offering in the US so far has been made available only to accredited investors (accredited investors are defined as those with a net worth of at least 1 million USD, excluding the value of one’s primary residence, or with income of at least 200,000 USD each year for the last two years). The vast majority of security token offerings in the US are carried out under the auspices of Regulation D, an exemption to the full burden of reporting normally required for securities such as public offerings listed on exchanges like the NYSE. The offerings conducted under the Reg D exemption have no limit to the amount of money that can be raised, but they must come from a maximum of 1,999 individuals, all of whom must be accredited investors. Additionally, despite the hype, there is still effectively zero trading of security tokens in the US.
One criticism of security token offerings, which have been hyped as a replacement for traditional security offerings, is that they don’t solve a critical problem and therefore will not find a significant market. If the offerings are directed to accredited investors only, as is the case so far in the US, this is a fair criticism. Accredited investors, after all, are already well serviced by traditional channels for buying securities. Switching to security token offerings, which bring increased technical barriers, if anything represents an impediment to such investors, who tend to already have professional brokers to manage the details of their finances. The critics rightly ask, “who will be the buyers of all these security tokens?”
In the US there is also an exemption from the full burden of securities reporting that’s directed towards retail investors. Known as Regulation CF – crowdfunding under the Jumpstart Our Business Startups (JOBS) Act – this exemption enables retail investors to participate in securities offerings so long as the total offering doesn’t exceed USD 1 million. The contribution of each retail investor under this exemption is also limited, in most cases, to just USD 2000. Due to its limitations, regulation CF has only been successfully used for small projects such as those funded through websites like Kickstarter.
The regulatory environment in the US has so far meant that STOs are only being offered to accredited investors. In Europe, however, we see a different pattern evolving.
STO with more chances in Europe
Under the EU’s New Prospectus Regulation, the burdensome prospectus – with its long, difficult, and expensive approval process – is not required for any securities raise with a total value of less than 1 million EUR, an increase over the previous limit which was just 100,000 EUR. At first, this regulation would seem almost identical to Regulation CF in the US. However, under the new rules, which only came into effect in July of 2018 and are only now being tested, individual EU Member States may exempt offers where the total consideration does not exceed 8 million EUR. It is this provision of the regulation, according to GateToBaltics, a group of corporate lawyers with almost 20 years’ experience specializing in company formation, which now sets European regulation apart from regulation in the US: “If a company is planning to launch an STO and their hard cap is up to 8M, we would recommend looking in to specific EU jurisdiction” write the group in a November 29th post.
It is already well-known that certain EU jurisdictions are positioning themselves as “crypto-friendly” zones. In Estonia, for example, a financial supervisor has stated on the official website: “Cryptocurrency offerings can provide new opportunities for businesses to raise capital and for investors to access a broader range of investments,” according to a translation from GateToBaltics.
The first STO in Europe was launched by Neon Exchange (NASH) on 3rd September 2018 with the approval of Liechtenstein’s Financial Market Authority (FMA). This approval, which according to a NASH blogpost, was the result of “a year-long effort, requiring the combined efforts of several legal firms and dozens of lawyers,” allowed the decentralized crypto exchange to raise money from retail investors. Crucially, this approval set a precedent for the issuance of tokenized securities in European markets. NASH’s approval means it can be listed on any conventional European securities exchange.
In November 2018, France and Lithuania based security token issuing platform Desico launched an STO under the Lithuanian Crowdfunding Law. The DESI token is classified as a Revenue Participation Note (RPN), which means the tokens don’t constitute ownership of Desico but do entitle the holders to a percentage of the revenue earned by Desico (in this case 12.5% of such revenue). The Desico precedent proves that Lithuania now has a legal framework for retail investment into STOs.
Precedents are also being set in Germany where STO issuing platform Neufund successfully concluded its tokenized security offering in December, raising €3.4 Million in what it claims is the first successful offering of tokenized equity to the general public in Germany. Neufund’s offering was only available to high net worth individuals, but their STO issuing platform aims to be accessible to global retail investors. To achieve this, Neufund has been working closely with the German financial supervisory authority, Bafin.
The fintech startup’s CEO, Zoe Adamovicz, wrote in October an open letter to the Bundestag asking the members of the German legislature to put Distributed Ledger Technology specific guidance into place.
“We were more than astonished about the positive reaction from the regulator’s side. Only several weeks after sending the letter we were invited to a meeting at the Bundestag chaired by Senator Heilmann. During the meeting, he proposed an amendment of an already existing law to incorporate security tokens. I think that this is an important first step and I am looking forward to further talks in 2019,” she wrote in a December post.
According to their homepage, Neufund currently has 11 companies committed to conducting STOs on their platform and hopes to legally offer them in 2019 to retail investors who have passed KYC procedures. The CEO is quoted in a Forbes article: “Offerings conducted through Neufund can address a global pool of investors – you do not have to be an accredited investor to participate in the upcoming equity token offerings. We already have more than 3000 investors from more than 90 countries registered on our Platform”.
European infrastructure for STOs growing
The infrastructure needed for the secondary trading of these security tokens is also well underway in Europe. A subsidiary of the Gibraltar Stock Exchange (GSX) the “Gibraltar Blockchain Exchange” (GBX), which raised $24 million a token sale that sold out in 9 seconds in early 2018, is expected to launch security token trading in the first quarter of 2019. When that happens, security tokens will be officially recognized by a stock exchange authorized by the EU. The Malta Stock Exchange also has plans to launch a trading platform for tokenized securities in partnership with Binance, which in 2018 made the regulatory-arbitrage-inspired move to the EU Special Member Status nation that has taken on the moniker “blockchain island” due to its crypto friendly stance. Then there’s SIX Swiss Exchange, which is developing a digital exchange that will include the issuance, listing, and trading of security tokens and be in compliance with the Swiss financial regulator FINMA and approved by the Swiss National Bank.
A friendly regulatory environment combined with accumulating legal precedent and growing secondary trading infrastructure means the issuance and trading of security tokens in Europe with the participation of retail investors may soon be routine. This has the potential to democratize access to early-stage investment in promising startups while offering such startups more options to get off the ground.