Wait a SEC, what's happening?
Speculation surrounding the legality of permission-based token distribution has been rampant from the earliest days of the ICO boom. North Americans wishing to launch their own coin offerings have often been hesitant, fearing retribution for breaking laws that had yet to be written. Given the diversity of potential use-cases associated with token launches, many have feared what would happen to the burgeoning ICO space if a government entity were to conclude that all tokens should be classified identically, regardless of functionality. The days of uncertainty are ending however, as at long last the SEC has issued a statement in regards to the legal status of tokens and the platforms they empower.
The heart of the SEC’s statement centered upon ‘the DAO’; a decentralized venture capital organization whose contributors were awarded proportional voting rights in return for their investment, as well as the promise of any profits associated with successful projects. To determine the legality of ‘the DAO’, the SEC subjected the project to the Howey test. The Howey test is common scrutiny for determining whether or not an item is being sold as a formal security. Under such inspection, an item is deemed to be a security wherein it meets the following criteria:
- There is an investment of money
- There is an expectation of profit
- The investment is in a common enterprise
- The majority of incoming profit is made through the efforts of a promoter, or third party
In the case of ‘the DAO’, all four precedents were deemed to have been met. The SEC therefore determined that tokens issued by ‘the DAO’ had been illegally issued securities. Money, as outlined by the SEC, is not considered limited to fiat currency, but rather extends to items of tangible monetary value. Additionally, ‘the DAO’ was founded and promoted by smart lock company, Slock.it. In addition to maintaining positions of trust in the DAO itself, Slock.it was widely anticipated to be the first company funded by ‘the DAO’. This would have made ‘the DAO’ a directly profitable venture for their private enterprise.
Global consequence & response
Though the SEC is a U.S. based entity, their report is certain to have global consequences. The law applies not only to ICO promoters within the U.S.A., but also to international ICO’s whose intent is to target American investors. It has long been the expectation that U.S. law would side against ICO’s, DAO’s, and other coin distribution schemes. As a result of this speculation, blockchain companies have done their best to limit exposure to the U.S. market.
Community response has varied, with some viewing the SEC’s definition as a setback for the digital currency community as a whole. Creation of securities must be sanctioned by the SEC, and involve an expensive and time consuming approval process. Once authorized, securities may then only be distributed through licensed platforms. These roadblocks largely eliminate the ability of unfunded individuals to legally launch and distribute many types of tokens on their own. Others are less concerned, citing the SEC’s decision as inevitable, and ultimately good for adoption of the technology. By classifying certain tokens as securities, the SEC has made it more difficult for unscrupulous parties to launch well marketed, but poorly intentioned ICO’s. Increased documentation concerning the expectation of a given project is likely to be a side effect of this decision as well.
What remains unclear is how tokens falling outside the specified guidelines will be perceived. The SEC goes to great lengths to state that their determination is based on a singular case (the DAO), and is not a finite ruling upon the technology at large. This suggests a dedication to nuance in determining whether future projects intend to distribute a tokenized security. For instance, a token whose utility is tied to accessibility within a piece of technology or app may be considered exempt if it is apportioned without the promise of profit or future monetary value.
Though the SEC has introduced some pain points that the community will have to work around, it is refreshing to finally know where the U.S. stands on both DAO’s and the distribution of certain coin-centric offerings. As laws become clearer, best practices are likely to take hold over time. Ultimately, blockchain crowdfunding initiatives remain a promising alternative to their centralized equivalents. Regardless of any early legal limitations, ICO’s are likely to continue to create a frictionless crowdfunding experience for savvy blockchain investors around the world.