The security tokens security tokens are, as their name suggests,securities represented by electronic book entries(tokens) in distributed registries. As such, they are subject to general securities legislation, both in the United States and in the European Union.
The emergence of Ethereum and other blockchains structured in user accounts and capable of executing smart contracts, opened up the technical possibility of documenting assets using distributed protocol technology (and particularly, one of its varieties, blockchain). Soon, the expression token was generalized to refer to the mode of representation of subjective rights within a blockchain.
During its first three years of existence, the US federal authorities barely paid any attention to the token market that was beginning to emerge in the Ethereum arena. However, the attack on The Dao in August 2017, which caused extremely heavy losses to its investors (and the disruption of the Ethereum network itself), prompted the SEC(Securities and Exchange Commission, the federal office in charge of regulating the markets and stock exchanges) to intervene. After several months of investigation, the SEC considered that the shares (tokens) in The Dao had the character ofsecurities, and it is from then on that the expression security tokens began to be generalized in the crypto economy.
In the United States, investments that meet the Howey test, established by the Supreme Court in a famous 1946 ruling, are considered to be securities. According to it, security is defined as any "investment of money in a common enterprise, involving the expectation of earning money from the efforts of another". Any investment that meets these conditions, including those that take place in the crypto world, falls within the definition of security, and is therefore subject to the provisions of the Security Act of 1933, which imposes the obligation to register public issues of securities with the SEC and prepare a prospectus, and the Security Exchanges Act of 1934, which regulates secondary markets. If a token meets the Howey test, it becomes a security token: its first mass issuance, known as STO(Security Token Offering), must be registered with the SEC on Form S-1.
In Europe, security tokens or tokens-value are also considered as transferable securities and are fully subject to the provisions of the sectoral legislation. Particularly in Spain their first issues (primary market) are regulated by Regulation (EU) 2017/1129 and Articles 33 et seq. of the Securities Market Law, among other provisions. The regulation of secondary securities markets, largely contained in the MiFID II Directive, has recently been amended by the famous Regulation (EU) 2022/858 ("DLT Regulation"), which, however, has hardly introduced any alterations to the concept of transferable security. It has only explicitly recognized that securities can be documented, traded and transmitted in DLT systems, setting quantitative limits for the volume of securities that can be traded in each of these systems. Unlike what happens in the United States, whose legislation allows security tokens to be stored in public and open networks such as Ethereum's blockchain or IOTA's Tangle, in Europe, the DLT Regulation seems to implicitly impose the use of closed systems, under absolute control of entities registered as market governing bodies or central securities depositories.
Due to its regulatory parsimony, the DLT Regulation leaves certain issues unresolved:
- Is it possible that throughcross-chain bridging mechanisms some of these security tokens could be traded on open networks?
- How would KYC regulations then be implemented?
- Would the new tokens be considered derivatives?
