Can Security Tokens Convert into Utility Tokens?

Blockchain Beach attended UCLA Cyber Days in February and I had the chance to speak with Greg Gilman, Co-Founder of Science, a venture capital firm based in Santa Monica, CA. What’s notable about this firm is that after being early investors in companies like Dollar Shave Club, they recently raised a venture round using an ICO for a Security Token. Owning the Science Token gives investors the value of underlying investments that the fund makes into other Blockchain companies and ICOs.

With Greg having gone through a Security Token sale, I asked him a few questions about what he learned and what he expects to happen with his tokens:

Blockchain Beach: Can Security Tokens convert into Utility Tokens?

Greg Gilman: The SEC is stepping up their rhetoric on regulations. All exchanges would have to immediately drop Utility Tokens that are regulated into Securities.

(A company) may have conducted a Security sale incorrectly, but once the Tokens are operational in a system, it has Utility. It should revert back to a Utility, but that’s unclear.

BB: Does you see Tzero as being the exchange for Security Tokens?

GG: Yes and I plan for Science to be listed. Science is currently an ERC-20 token.

BB: What’s the role of Polymath (POLY)?

GG: Polymath is a platform that allows companies to create a Security Token within their issuance platform and build safeguards in from sale to resale, etc.

For Science, US Token holders are locked in wallets for a year and Tokenhub was able to facilitate that. After the year is up, we need to be able to control resale and Polymath can help with that. For example, if a non-accredited US investor were to buy our Security Token on the open market, Science could get in trouble for that. Polymath can ensure that the Tokens are only able to be transferred to specified wallets, among other safeguards.

BB: Who can hold security tokens?

GG: Tokenhub told us how to structure our sale for US investors in compliance with Securities Act Rule 144. The challenge is how to know if Non-US holders sell to US Holders and Polymath may be that solution.

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This was interesting to hear because it points out a misconception that seems to be prevalent with people I speak to. The SEC is believed by many to be the governing regulator when it comes to Blockchain companies and there are some that think the SEC will rule that all Tokens to be Securities.

The SEC has been able to make the most noise and shut down ICOs (Centra being the latest) because they are the governing body when it comes to the issuance of investment products. Stopping an ICO in progress is a lot easier than backward regulating a company that is using a Token and showing utility — Ethereum was an ICO, but I don’t think they should be shut down now for selling an unregistered security.

As we’ve written before, the CFTC has governance over the Futures Markets and Chairman Giancarlo has stated that gives them insight into the underlying spot markets (brokers like Coinbase and exchanges like Bittrex or Binance). There’s also FINCEN, FINRA, and a number of others that are going to have their say before all is said and done.

It’s also important to note that all of these regulator agencies focus on enforcement, not law making. That is the main reason that they are trying to use exiting regulations on the Blockchain Industry, rather than creating new ones. New legislation would come from congress or legal precedent can be set via new case law, both which will take months, if not years.

Note: Again, this interview happened two months ago, so do not take this as legal or financial advice. The author and Blockchain Beach are not legal or investment professionals, but made an editorial decision to publish this information now, with the current state of regulation still unclear.