When Is An ICO Token A Security?
When is a token being offered via an ICO a currency? When is it a security? Can a coin change from one type to the other? The answers in Wilson Sosini Goodrich & Rosati's are detailed and nuanced, so we decided to have a go at summarizing them.
The U.S. Securities Exchange Commission was created as part of the Great Depression era New Deal and it exists to make and enforce federal regulations on securities. These include equity securities, or stocks, and debt securities, or bonds. Tokens in a “fully developed” system, where they can be readily exchanged for goods and services, are treated like a fiat currency created by the system operator, and not regulated by the SEC.
Securities represent the debt of or ownership in an entity which is actively managing to ensure their long term value. Tokens are just a medium of exchange.
Bitcoin is globally traded and liquid enough for business development. It is a currency. Tezos might be holding half a billion dollars in two liquid cryptocoins, but it's fate very much depends on the actions of a handful of individuals who control the foundation managing the funds and the software development team working on the coin itself. It is a security, despite their multi-national gyrations intended to avoid SEC regulation.
If a clever ICO operator decides they'll just move the business nexus offshore so they can offer tokens without SEC regulation, they are sadly mistaken. Any sale within the U.S., no matter what the origin, is under their jurisdiction.
A “fully developed” token used for commercial activities isn't a security. As an example KiK's KIN arrived five weeks ago on a network where half of their 300 million users are sharing content daily. Today's $27,000 volume seems pitiful, unless you're familiar with the system. There is an existing market on the platform that currently settles mostly via Paypal and the app system that goes with the coin hasn't even begun to produce innovation. KIN isn't going to be seen as a security and that daily volume is going to expand steadily.
What about a SAFT? If you're bought into a Simple Agreement for Future Tokens, even if that token is for a system that qualifies as “fully developed” when it goes live, the SAFT is a contract, and thusly a security.
The “known unknowns” in the article are numerous.
When, precisely, does a token that began life as a security graduate to “fully developed” status? How can tokens operate during the development period, when they are still securities, which limits how they are bought and sold? When do state money transmission laws apply?
The deeper issue is the egalitarian nature of ICOs. The SEC expects their rules to apply to accredited investors, those with a net worth of over $1 million, and in some cases those with a net worth of over $10 million. Massive crowd sales are just not something they've ever faced previously.
These are exciting times for ICOs, even with the hazards. There are going to be failures, this we're already seeing, but in the mix there is the next Oracle, a Fortune 500 that will rise due to blockchain innovation. The SEC is going to have to adjust its worldview to fit these new realities.