Note: This blog post was originally published by our Co-Founder Chris Housser on Medium on March 28, 2018.
Last month the SEC subpoenaed 80 firms involved with initial coin offerings. It is likely many token sales will be considered in violation of federal securities law. Enforcement actions are likely impending, and blockchain’s next buzzword in 2018–2019 will be “securities tokens”.
Securities tokens will need to comply with global securities laws. To be compliant, securities token offerings will require legal guidance, seasoned blockchain developers and auditors, dependable Know Your Customer / Know Your Client (KYC) providers, and a pool of investors that have gone through and Anti-Money Laundering (AML) processes to demonstrate they meet the required investment criteria.
KYC and AML are two key processes in the world of finance. Securities cannot be sold to someone without knowing who they are, their appetite for financial risk, and their source of funds. This helps to minimize the risk of serious financial harm and to ensure funds are not transacted with terrorist organizations or other organizations and individuals that appear on sanctioned lists.
A functional securities token platform integrates with a number of KYC/AML providers that will check the identity, residency, and accreditation status of every individual who wants to potentially invest in such a token. The investors' tolerance for financial loss should also be examined. By performing these checks, issuers are assured that only authorized investors are able to transact with their security tokens.
The Polymath protocol allows issuers to enforce these checks and restrictions for both the primary issuance and secondary trading. For example, if an entity determines to issue to only accredited US investors, a securities token architecture goes through a verified checklist to ensure that any transaction of that security can only be done by those accredited US investors on an authorized list.
A securities token platform would be comprised of a set of tools that helps people put all necessary aspects of regulations and blockchain technology together efficiently. It would create the infrastructure for companies to create their securities on the blockchain in an easy-to-use, streamlined manner.
The platform would not be a broker-dealer, nor a law firm. It would be a decentralized platform that has the potential to bring together these necessary parties to more efficiently launch securities in terms of time, coordination, and costs.
While the SEC learns about the technological and economic landscape of initial coin offerings, its concerns may parallel those of the IPO frenzy of the early 1990s.
The recent subpoenas demonstrate to individuals and entities that the government is actively looking to regulate and enforce in this space. A securities token platform with widely adopted standards and best practices could go a long way towards developing best practices for this new phenomenon. All participants, including issuers, investors, developers, KYC providers, lawyers, need clarity and guidance to help safely grow this space. By working with regulators to help create an acceptable standard, users will be able to more comfortably act and enforcement actions will be more clear.