A great deal of confusion exists as to the gauntlet of US securities laws with respect to alt-coins or crypto tokens issued through initial coin or token offerings. At its most basic a utility token may be described as a license, a ticket, or a franchise where the holder of the token has not purchased the token in order to obtain a profit in the form of capital gains or dividend-type passive payments but the token is intended to be used in commerce within a particular platform to obtain some product or service. To further elaborate, in order to avoid a token being deemed a security, even if it is purchased with an eye to receiving some form of financial benefit, the issuer of the token may avoid the token being deemed a security if a given holder of the token is required to actively participate in the business operations of the issuer in order to receive any financial reward.
In contrast a security token is a virtual currency that is purchased with the main purpose of investment, with the expectation of capital gains or regular periodic passive payments from the issuer or the issuer’s automated ecosystem. Further, as a security token, such issuer is required to comply with federal securities laws such as registration with the SEC or issuance under an exemption from registration such as Regulation D rule 506. In such a case the holders of such tokens must be verified “accredited investors” and are not required to participate in the business operations of the issuer. Security tokens may be issued similarly to interests or units in an LLC or shares in a corporation; only a two-entity structure is not required to issue such tokens because the tokens themselves emanate from the sole issuing entity and their ownership is evidence per se of the interests held by any purchasers of the tokens.
What kind of purchaser involvement in the business operations of the issuer would be sufficient to clearly move the utility v security scale clearly into the utility side? There is no definitive answer to this question and each token would stand on its own with respect to the Howey test; however, some general guidance may include requiring all holders of tokens to regularly vote on the direction and actions of the enterprise. And such a vote must not be a formality or inconsequential; such a vote should really count, be counted by the issuer and if in the majority then the vote should actually direct the mandatory course of action of the issuer. Additional actions may be performing some form of transaction review, such as filing periodic reports regarding the status of the holder’s node or reviewing the blockchain ledger transactions and providing a summary of the activity that has transpired over a given reporting period. Reaching out to participants, customers, users, or businesses of a given ecosystem and obtaining information from them regarding the status of their experience or other relevant information, is another option.
The point of consciously creating a utility token is implementing the active participation of the holders of such tokens. To be sure, such participation is not necessary when the token is being used to purchase goods or services because in such as case the token is not being held for speculative purposes. Spending the token in exchange for a valuable consideration would in and of itself generally be sufficient to deem a token a utility token. Goods or services may include physical or virtual products such as hosting services, intellectual property such as books or reports, or electronics. The additional step of requiring purchasers of tokens to purchase additional tokens from other holders, exchanges or the issuer make this factor rather difficult to implement, as it adds an additional step over simply exchanging fiat currency for the good or service, hence there should be a tangible benefit to purchasers for making the effort to buy the issuer’s token before using it.
There is no need to fear US securities laws if a coin issuer is well versed in the relevant regulations before the platform is designed, and such platform design occurs alongside competent counsel with experience in this space, experience in dealing with the SEC and US securities regulations. In general, the SEC takes a very broad view of what a security is, and there can be no guarantees that what clearly appears to be a utility token will not be deemed a security in the future. Additionally, other agencies such as the Commodities Futures Trading Commission, IRS, and FINRA are all vying for control over crypto-currencies, hence the current regulatory scheme is full of uncertainties and future regulation may see virtual currencies deemed as securities, commodities, personal property, currency, or something in between.
If you have any questions about the status of your already designed and issued token, or a planned virtual currency platform, please don’t hesitate to reach out to the Belenky Law Firm PLLC., to discuss your options. Unfortunately, this Firm does not accept alt-coins as payment at this time.