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‘The Gensler era has not been easy’: Security tokens push crypto firms into long and costly SEC maze

The Securities and Exchange Commission, the key US financial-market cop, wants to see the crypto markets regulated and monitored like any other market. It has encouraged the crypto industry to talk to the commission and regulate their securities and services through the commission.

There is a lot of momentum for US regulators to apply existing laws to the crypto industry. In a September speech, Chairman Gary Gensler said the existing securities laws do cover digital assets, and that he had directed his staff to work with companies to get tokens registered. In a talk last month, Senator Elizabeth Warren of Massachusetts encouraged him to do more, and said Congress needs to do more as well.

There are a handful of crypto companies that have set out to register digital securities with the commission. Such so-called security tokens trade like cryptocurrencies – they’re blockchain-based – but are registered with an enforcement agency like the SEC and trade on regulated trading platforms. Imagine a share of equity that trades on a blockchain-based network.

There is the potential for these tokens to be used across a range of asset classes. But right now, there are very few of them trading and part of that problem appears to be the SEC itself. The SEC’s process for crypto companies to become compliant is time-consuming, expensive, and not exactly user-friendly.

“The Gensler era has not been easy on the space,” said Alan Silbert, the chief executive of crypto exchange INX, which operates a platform for trading security tokens.

DL News asked the SEC for a list of the security tokens that have been registered with it, and the list they gave us had nine names on it: INX, Blockstack, YouNow, Ceres Coin, CarrierEQ, Paragon Coin, Blockchain of Things, Enigma MPC, and Salt Blockchain.

‘I’d rather spend the resources on building than legal fees’

“For us, it was definitely hard,” said Blockstack co-founder Muneeb Ali. The company, which was developing its own blockchain-based network, wanted to register a security token in 2018 with the SEC to help raise capital. It spent 10 months and $2 million on lawyer fees alone to get its token registered under a so-called “Reg A” filing, which allows for certain exemptions from the rules for a full-blown public offering.

The price tag alone puts the entire process outside the reach of any small startup. And right now at least there is no automated process for filing; each company has to start from scratch.

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The experience was ultimately good, Ali said, but the legal overhead and the time to get it approved was onerous. “I’d rather spend the resources on building (product) than legal fees,” he said.

The only company that has so far gone through the entire process of registering its security and getting it approved in the same manner as an IPO is a crypto-exchange called INX.

INX spent exactly 953 days to get its security token approved, Silbert said. He estimated the company went through about 15 “rounds” of back and forth with the SEC. It would submit paperwork, the SEC would respond with questions. The company would answer them, resubmit, and wait for the next batch of questions.

Security tokens are worth focusing on because they appear to be exactly what Gensler, Warren and the commission want: Securities that would offer investors the same kinds of transparency that stock investors have.

About three-quarters of all the SEC’s questions concerned risk and risk disclosures, he said. “They’re very concerned with you throwing out there every possible risk under the sun,” he said.

The company hired lawyers and accountants and structured its board so that it is composed mostly of outside directors. The goal was to replicate everything a typical company going public would do. To an extent, he said, the company’s experience, and especially its prospectus, can be a template for others to follow, which should make the process easier. But easier is not easy.

Ultimately the process was worthwhile: the company raised about $85 million in its offering. But getting there was daunting. “You really need resources, patience, and lawyers,” Silbert said.

Circle Internet Financial had plans to go public via a Special Purpose Acquisition Company merger, but had to scuttle the plans in February because the company couldn’t get SEC approval. Co-founder Jeremy Allaire did not blame the SEC – and reiterated that opinion last month. But the main reason it did end the deal was because it did not have the commission’s approval. And the commission has shot down myriad applications for a bitcoin-based exchange traded fund.

Security tokens are worth focusing on because they appear to be exactly what Gensler, Warren and the commission want: Securities that would offer investors the same kinds of transparency that stock investors have.

But right now the security-token market is tiny. A website called Security Token Market tracks 227 of them. Some are registered overseas. Most have little or not actual trading volume. Only two of the tokens tracked by STM had a 24-hour trading volume of more than $25,000. More than half had a one-day trading volume of less than $10.

Part of that is because most of the big crypto exchanges do not have the proper licences to sell registered securities. Blockstack, which has since been renamed Hiro, actually went through an entire process of tearing the company up – decentralising it – and de-registering the security token in order to get it traded on exchanges.

In September, INX launched a trading platform called INX One built expressly for security tokens. For issuers, it gives them the ability to list their initial token offerings – similar to an initial public offering of stock but one that is open to registered users of the platform; traditionally, IPOs have been inaccessible to retail investors. The platform also allows for secondary trading of the asset.

But it currently trades just two security tokens, as well about about two dozen cryptocurrencies: its own and one offered by a company that owns the Millennium Sapphire, the largest — 28 pounds — carved sapphire gemstone in the world.

The company said it planned to list new tokens last week from Blockchain Capital, Spice VC, Protos, and Science Blockchain and had more that would be getting listed in the coming months. Still, that’s nothing compared to the thousands of cryptocurrencies available, and the tens of thousands of publicly traded stocks available on exchanges around the world.

Presumably, Silbert said, companies could take INX’s prospectus as a template, which should make the process quicker. And he expects that as more companies go through this process, the SEC’s knowledge and ability to sift through the applications will increase.

Paul Vigna is the co-author of “The Age of Cryptocurrency: How Bitcoin and the Blockchain Are Challenging the Global Economic Order”