ICO Tokens & the SEC: Are Tokens Considered Securities?
ICO Tokens & the SEC: I am not the first one to write about this topic and I won’t be the last. I just wanted to express my opinion on the matter. That being said, I am not a securities expert, nor a lawyer, just a blogger with a perspective. For the purposes of this post, we will look at the securities laws of the United States. As you may know, almost all Initial Coin Offerings and their tokens are not open to US citizens.
What is a Security According to the SEC?
To begin the analysis, we first need the definition of what is defined as a security. The ramifications are serious, as any investment or purchase of an asset that is considered a security is subject to the the Securities Act of 1933 and the Securities Exchange Act of 1934 and are subject to regulation and registration with the SEC.
The guidelines of what is considered securities were pretty much defined in a case in 1946, SEC v. Howey. I will not get into the specifics of the case itself but rather what the results were in determining whether an asset is considered a security.
Under the Howey Test, a transaction is an investment contract if:
It is an investment of money
There is an expectation of profits from the investment
The investment of money is in a common enterprise
Any profit comes from the efforts of a promoter or third party
The final factor of the Howey Test concerns whether any profit that comes from the investment is largely or wholly outside of the investor’s control. If so, then the investment might be a security. If, however, the investor’s own actions largely dictate whether an investment will be profitable, then that investment is probably not a security. (source for this text is here)
What are you Buying When You Purchase Tokens Through an ICO?
This is the important question when looking at tokens and the security acts. What is the actual result when you purchase tokens? What do you get? The original Initial Coin Offerings, and most that are still being presented offer you an opportunity to purchase coins that later can be used as the “fuel” of the project that is being developed. You are purchasing the right to use your tokens to access the platform being created. Many of these tokens are also listed on exchanges and increase or decrease in value over time. I believe that this is where the confusion comes from.
In my opinion, the way I described the purchase of tokens, is not for the ability to trade them. In actuality, you purchase no equity in the company and have no control. You are not a shareholder, but rather a potential future user of the platform. The fluctuation of the price on the exchange should represent the market’s perception of the future value of such access to the project. The fact that there are speculators in the marketplace trading for profit should not actually make a difference and make it into a security.
Where There Could be a Problem with ICO Tokens & the SEC
Where I do see a possible problem is in some of the new Initial Coin offerings and what the tokens represent. There have been some Token Sales that have been structured differently than what was described above. Some are even “off-chain” offerings. When I say “off-chain”, that means that the project has nothing to do actually with the blockchain and the projects are just trying to raise money for a venture. That would not fit in the category of a traditional ICO and they should be looking for traditional Venture Capital funds. They vary in structure but have similar issues.
We have seen some new ICOs that are not trying to sell future access to their platform but are offering a distribution of future profit or a buyback at a premium in the future. In my opinion, this would classify them as a security under the Howey Rule and they would be subject to the rules and regulations including registering with the SEC.
ICO Tokens & the SEC Conclusion
To summarise the issue of ICO Tokens & the SEC, I would say that initially there is no issue, the ICO Tokens offer future use of a platform with no guarantee of financial reward or profit. The trading of the tokens should be the market’s perceived value of actions token holders will have when accessing the platform. The waters begin to muddy with some of the other ICOs that are not offering this proposition. We will see what the SEC decides, but in the meantime all ICOs are careful to exclude US citizens and word their whitepapers and offerings carefully to avoid this is of their ICO Tokens & the SEC.
For more of my thoughts, see this section of my blog: https://urbancrypto.com/category/blockchain-my-thoughts/