China is targeting STOs

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China is beginning to target Security Token Offerings.

It shouldn’t surprise anyone that as the ICO markets have cooled, specifically due to regulatory crackdowns and/or uncertainties, entrepreneurs have continued to look for ways to finance their projects. Security Token Offerings (STOs) have become popular in recent months because they are seen as a regulatory compliant path for issuing a digital token (usually representing equity, debt, or a claim on cash flow) in exchange for capital from investors.

STOs require an issuer to conduct proper KYC and AML practices, while also adhering to additional requirements depending on which regulation or regulatory exemption is used (Reg D, Reg S, Reg A+, or Reg CF). The idea here is that entrepreneurs have access to similar capital markets as ICO issuers, but regulators are able to ensure a fair, safe, and compliant marketplace.

US-based regulators have encouraged the use of these regulatory compliant financings, but it appears that China is taking the first steps to crackdown on them. The South China Morning Post is reporting that a deputy governor of The People’s Bank of China (China’s central bank) stated “the STO business that has surfaced recently is still essentially an illegal financial activity in China.”

This is interesting because the gentleman who made these remarks, Pan Gongsheng, made sure to separate ICOs from STOs, before saying that both are still rampant and illegal in the country. His comments followed last week’s comments by Huo Xuewen, the chief of the Bureau of Financial Work, who said, “I want to warn those who are promoting STO fundraising in Beijing. Don’t do it in Beijing. You will be kicked out if you do it.”

Not exactly soft language.

It is unlikely that STOs actually violate any regulations in China today, but this is more of a scare tactic to deter founders from pursuing the new financing path. As we know, China isn’t too keen on losing control of capital markets or having citizens gain greater access to investment opportunities outside of mainland China.

If security token offerings were illegal, the penalty presented wouldn’t be “you will be kicked out,” but rather a fine or jail time. This doesn’t mean that regulators won’t change the rules quickly in an effort to ban STOs, but at least they haven’t done so yet.

China is obviously a unique case but this new development presents a broader question — what would happen if regulators started to target security token offerings in the same way that they have targeted ICOs?

In developed countries, with uncorrupted legal systems and true checks & balances, it would be difficult to see selective enforcement used (ex: you can use Regulation D to fundraise, but if you have a token involved, it is illegal even if you follow the Regulation D rules). The problem arises in less developed countries that have corrupt or overreaching governments and legal systems.

It isn’t a stretch to imagine Venezuela, Russia, China, and others outlawing any financings that involve a digital token. They have enough controls in place to actually enforce these types of bans, while also having the political clout to have the decisions upheld in court. In this scenario, founders would most likely seek friendlier jurisdictions.

This leads us back to the idea of regulation arbitrage. Governments are entering a new world — one where they are forced to create attractive regulatory environments or risk losing their top talent to other nations. Banning all access to token-based capital markets would be one way to accelerate talent flight.

History will be unkind to the governments who bet against this technology. As Victor Hugo said best, “Nothing is more powerful than an idea whose time has come.”


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