SEC Clarifies: “Tokens Sold in a Functioning Network Are Not Securities” – What Does This Mean For The Crypto Regulations?

TL; DR

  • The SEC commission states that tokens sold in a functioning network are not securities
  • The statement clarifies the commonly held view that functional utility tokens are less likely to be deemed securities
  • ICO founders should be aware of how their tokens are structured, regardless of whether fears of SEC extradition are overblown or not

Commissioner Hester Peirce, a member of the SEC who famously defended the right for there to be an approved Bitcoin ETF last year, recently published the transcript of a speech she gave regarding regulations around tokens and their classification as securities/insecurities.

In this speech, she stated, “When the tokens are not being sold as investment contracts, however, they are not securities at all. Tokens sold for use in a functioning network, rather than as investment contracts, fall outside the definition of securities.”

What this implies is a token that functions purely as a utility should not be classified as a security. Hester also references the Howey Test as a tool to measure how tokens should be classified.

The Howey test evaluates whether an asset is a security based on the following criteria:

  1. It is an investment of money
  2. There is an expectation of profits from the investment
  3. The money invested is in a common enterprise
  4. Any profit comes from the efforts of a promoter of a third party

To be classified as a security, the asset has to pass all four criteria.

While the information shared isn’t new, it reiterates how the SEC is trying to make sense of the highly complex and unpredictable world of cryptocurrencies. For many crypto projects, the act of being labeled a security is essentially a death sentence for their business because of the costs and time it would take to achieve legal compliance.
For this reason, most projects did their best in 2018 to avoid being labeled as a ‘securities’, registering their companies abroad and restricting US users from investing in their ICOs (although many were still able to spend by using a VPN).

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Despite the fears that crypto projects have of being labeled securities, some have interpreted these fears as being overblown. Due to the massive amount of ICOs that have launched in the space (and continue to launch each month), there are arguments that the SEC is merely trying to stoke fear of consequences that they ultimately would never have the budget to act out on through means of extradition.

Trying to be aligned with the US

The debate about the limits of the SEC to extradite foreign companies has been an ongoing one for years. While many believe the US is just another country, and that foreign nations don’t particularly care about their efforts to impose regulations outside of their borders, others see the US as an economic empire with enough leverage and negotiating power to get most countries to bend to their will and surrender their own companies to the American legal system.

Ultimately, whether the fears of extradition are warranted or not, any ICO founder worth his or her salt should take extra precautions in how they develop their tokens to avoid the dreaded label of ‘security.’

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