Crowdfunding and Security Tokenized Investments: Legal Frameworks and Recommendations

INTRODUCTION

India's financial infrastructure is transforming at a rapid pace with fintech innovation and the advent of blockchain technology but the country's securities law framework is nevertheless not adequately equipped to handle new forms of digital funding such as equity crowdfunding and Security Token Offerings (STOs). While the Securities Contracts (Regulation) Act, 1956 (SCRA), the Companies Act, 2013, and regulations issued by the Securities and Exchange Board of India (SEBI) collectively regulate classical securities, they are not effective in addressing tokenized or blockchain-based investment structures. The attendant regulatory lacuna has left issuers and investors uncertain, and legitimate capital formation within start-up ecosystems inhibited. This blog contends that India's current legal framework has to adapt to accommodate tokenized securities and legalize equity crowdfunding in a harmonized and technology-agnostic manner. In particular, it argues that the statutory definition of "security" in Section 2(h) of the SCRA has to be read broadly to include programmable, fractional, and blockchain-based securities. This would bring India's regulation of securities in line with the technological reality of contemporary investment platforms while preserving investor protection and market integrity. The study uses a doctrinal legal approach, considering statutory laws, SEBI consultation papers, and Judicial precedents like Sahara India Real Estate Corporation Ltd. v. SEBI and Anbronica Technologies Pvt. Ltd. The research also examines policy proposals released by SEBI and investigates their sufficiency in covering the distinctive risks related to digital securities and online fundraising. Part I sketches the regulatory framework of tokenized investments and crowdfunding in India. Part II discusses judicial interpretations which have defined the boundaries of acceptable fundraising. Part III suggests reforms to include blockchain-based instruments in India's securities law regime and establish a sandbox regime for regulated experimentation. The blog concludes by calling for an unequivocal, technology-neutral, and investor-friendly regulatory framework to promote responsible innovation in Indian capital markets.

II. LEGAL LANDSCAPE FOR EQUITY CROWDFUNDING AND SECURITY TOKEN OFFERINGS (STOs)

1.     Definition of ‘securities’: Although there is no specific legislation governing the regulations of Security token offerings and equity crowdfunding, it is read in context to Securities Contract (Regulation) Act and under the guidance of SEBI (Security and Exchange Board of India) along with rules of Companies Act,2013. Section 2 of SEBI defines the word ‘security’ which is further regulated in the Securities Contracts (Regulation) Act, 1956. Under this act, security is derived from a debt instrument, share, loan, risk instrument or any other form which may be secured or unsecured. Although these Acts govern the functioning of both the STOs but these laws were made in consideration of settling the disputes in securities in conventional market which has grown rapidly into varied form.

2.     SEBI Consultation Paper on Crowdfunding (2014): SEBI in consultation paper elucidated the meaning of Equity Crowdfunding as “soliciting small shares from multiple investors through web-based platform in consideration of issuance of equity shares.” Crowdfunding need not necessarily to be confined to only the equity, it can also be peer to peer, for reward (when an investor is given equity by company due to his performance, etc) or for donation where an investor donates the money to the company for without any consideration of any share. Out of this, reward and donation-based crowdfunding is regulated by the Income Tax Act and equity crowdfunding is regulated as per SEBI guidelines. SEBI expressed its concern over the online solicitation of funds which constitute a ‘public issue’ which could trigger compliance requirements. Consequently, SEBI stated that only registered stock exchanges could host electronic platforms for issuance of securities.

3.     Legal Recognition of Tokenised Securities: The regulatory silence around STOs becomes progressively more troublesome with the growing acceptability of blockchain-based instruments across the world. A working approach, one that addresses the economic substance and not the technological form would enable SEBI to deal with tokenized instruments as securities when they resemble conventional financial assets. This reading would maintain investor protection with a degree of freedom to innovate.

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Also, pursuant to Section 11(2)(k) of the SEBI Act, 1992, SEBI can lay down conditions for intermediaries and give directions for regulation of the market in the interest of investors. This power may serve as the legal foundation for SEBI to establish a regulatory sandbox or pilot regime for STOs, subject to full legislative reform. Ultimately, India's present regulatory position leaves equity crowdfunding and STOs practically unregulated, if not illegal. Section 2(h) SCRA's definition of "security" offers a potential avenue of regulatory evolution, but in the absence of clear SEBI regulations or statutory changes, both issuers and investors continue to be left vulnerable. The following section details how judicial rulings have construed these statutory provisions and defined the boundaries of allowable fundraising.

DECIPHERING THE PRESENT LEGAL LANDSCAPE

Sahara India Real Estate Corporation Limited and Others vs. SEBI (Civil Appeal No. 8643 of 2012) is the landmark case of Supreme Court which deals with the rapidly evolving method of raising the funds highlighting the risks and fraud involved in Equity Crowdfunding. Sahara India Real Estate Corporation Limited marketed their debentures under Private Placement and raised around 24000 Crore from multiple number of investors against the regulatory framework of raising the funds by Private Placement established by SEBI, where the Supreme Court ruled that it is a clear violation of terms and subsequently, the SC ordered it to return the amount collected to the investors back whereby it was also made to send a clear message of respecting the boundaries between the private placements and public fundraising methods.

Anbronica technologies Private Limited  has also engaged in selling their securities under Private Placements by using Public Platforms as it had used Tyke Platform to raise the funds through crowdfunding by issuing the Compulsory Convertible Debentures where Registrar of Companies contended the act of company as it was involved in using the public website for issuing private placements which had led to non-compliance with the rules established by the SEBI as private placement must  be limited to the sophisticated investors with a limit of 50 whereas inviting the securities publicly by offering the same to anyone contradict the main essence of the Private Placement.

The path from Sahara to Anbronica demonstrates a changing tension between innovation and regulation. While Sahara was a cautionary warning against evading regulation, Anbronica lays bare the obsolescence of conventional frameworks in regulating digital financial instruments. The lack of STO-specific laws threatens both overregulation of legitimate innovation and under-protection of investors. India therefore, desperately requires an integrated legislative architecture that identifies Security Token Offerings as a separate, digitally native class of securities within the jurisdiction of SEBI.

RECOMMENDATIONS

India needs a synergized approach combining SEBI's digital assets and blockchain proposals and its crowdfunding regulation. The absence of specific legislation or regulation governing ‘tokenised instruments’ under security law has led to uncertainty in market. To address these issues, Parliament must amend Section 2(h) of Securities Contract (Regulation) Act, 1956 so as to expressly include electronic transactions within ambit of ‘securities.’ This would authorize SEBI to govern the entire blockchain-based instruments. Furthermore, SEBI may also exercise its power to introduce Digital Assets with legal backing. The requisite infrastructure would be created to enable rapid token platform licensing, enable conventional investor onboarding through blockchain-enabled KYC processes, and create legal recognition for smart contract-based compliance procedures. This would reduce hindrances and increase opportunities for startup funding, particularly in Tier-II and Tier-III cities. Blockchain-borne KYC, zero-knowledge proofs to enable privacy-friendly verification, and on-chain automation of disclosure through whitepapers must be made mandatory by SEBI. Taken together, these measures would enable India to walk the fine line between regulation and innovation. A structure based on the available statutory powers and phased reforms would allow SEBI to shield investors, promote market integrity, and make India a world leader in financial innovation based on blockchain.

CONCLUSION

India is at a crossroads of financial innovation. With the right regulatory environment, it can unlock the revolutionary potential of STOs and blockchain-enabled crowdfunding. SEBI can design a world-class ecosystem suited to Indian needs. Well-adopted, the new framework can propel a decentralized, inclusive, and globally competitive financial ecosystem for India. This is a sign of our country moving towards encouraging the investors to invest in safe environment adding to creditworthiness of investment in India, moreover it has also helped the small companies which are forming to grow and raise investment at larger level by prohibiting any unfair mean of raising investment. This evolution represents a progressive and sustainable step toward a future where both innovation and regulatory discipline coexist to support long-term economic growth.

Author: SALONI RANI, in case of any queries please contact/write back to us via email to chhavi@khuranaandkhurana.com or at  Khurana & Khurana, Advocates and IP Attorney.