Explaining The “Simple Agreement For Future Tokens” Framework
Written by: Lukas Schor of The Argon Group
Reasoning behind the SAFT framework
“ICOs, these things can transform. They may start their life as a security from a capital-raising perspective but then at some point (…) turn into a commodity.” CFTC Commissioner Brian Quintenz
This statement was probably the most specific comment by the Commodity Futures Trading Commission regarding the classification of ICO’s and shows quite well the bipolar nature of many tokens. The reasoning behind the Simple Agreement for Future Tokens (SAFT) framework is the fact that there is no bright line determining which types of tokens are securities and which are not. Therefore, tokens sold as utility tokens to the public might end up being considered securities at the time of issuance by the U.S. Securities and Exchange Commission (SEC), which is often followed by many unwanted legal consequences.
Issuing unregistered securities is a violation of Section 5 of the Securities Act of 1933, and, beyond significant monetary penalties, issuers could face a maximum of five years of federal prison. Secondary trading markets that facilitate transactions in the tokens could themselves be liable for penalties for failing to register as a broker-dealer, exchange or alternative trading system (ATS). An organization that claims that its tokens are non-security utility tokens, and does not register or use a registration exemption, also must evaluate the “Blue Sky” securities laws of all states in which token buyers reside.
How the SAFT works
The SAFT framework seeks to solve this uncertainty for both investors and issuer. If tokens are sold with the believe that they will be a utility / commodity in the future, a SAFT contract can be created as a security sold to accredited investors. This agreement is ensuring investors the delivery of tokens once a functioning network or application has been developed and tokens can be used on it. The bet that issuers and investors of a SAFT are making is that the SEC or the courts will determine that the tokens are not securities at this later point, while they might have been classified as such during the ICO because there was no fully functional network (= no use value) yet.
At a high level, the SAFT looks like this:
- The developer of a token-based decentralized network enters into a written agreement, called a SAFT, with accredited investors. The SAFT calls for investors to pay money to the developer in exchange for a right to tokens once the network is completed. The investors typically get a discount. The developers don’t issue any pre-functional tokens at this stage, but they do file the required forms with the SEC.
- The developer uses the money to develop the network. This could take months or years. Still no pre-functional tokens are issued.
- Once the network’s basic functionality exists, the developer creates the tokens and delivers them to the investors, who can sell tokens to the public on the open market to realize their profit.
- The developers themselves can also sell tokens to the public at this point as it is now a consumptive use-token.
Benefits of using SAFT
Through the two-step process, the SAFT framework is bringing a financing structure and standard for token financing that fits with the stage and intent of the companies. If executed as set forth in the SAFT white paper, a token sale can permit users to participate financially in that creation and growth without taking on significant risk. Additionally, this structure allows for more institutional investors to feel confident participating in those kinds of token sales.
The initiator of the SAFT whitepaper, Marco Santori, sees the framework as a way to work within existing laws, one that doesn’t assume legislative change to accommodate the technology could be possible. Resulting, SAFTs can reduce risks for institutional investors, while democratizing access through a vibrant secondary market.
In this way, only wealthy individuals and institutional buyers, not the proverbial mom-and-pop investors, would bear the risk of the project failing, while consumer protection regulations would still apply if the final product — the network — turns out to be defective.
Also, many blockchain projects, originally based in the U.S., have made the difficult decision to relocate the project to non-U.S. jurisdictions like Switzerland. This seems to be due primarily to questions around the applicability of the U.S. securities, money services or tax laws. The SAFT framework enables projects to have more clarity regarding these three bodies of law. This might lead to more companies (and thus jobs) remaining within the US jurisdiction.
Shortcomings of the SAFT Framework
Even though tokens issued using a SAFT are more likely to escape the SEC’s security classification, it is yet to be officially confirmed by the SEC that this two-step framework actually works as intended.
“Artificially dividing the overall investment scheme into multiple events does not change the fact that accredited investors purchase tokens (albeit through SAFTs) for investment purposes, and likely will not prevent a court from considering these realities when assessing whether these tokens are securities.” Cardozo Blockchain Project
Other limitations include:
- The SAFT doesn’t achieve much for tokens that are themselves securities (e.g. limited partnership interests like the DAO token). Using a SAFT won’t make a securities token any less of a security. The SAFT only works for “utility tokens.”
- It won’t aid even utility tokens where purchasers remain reliant on the efforts of the token sellers (or others) for their expectation of profit after the token is circulating (read more about this). Examples include situations where the seller relies on the issuer’s promises to buy back the tokens to increase the price, or where the seller promises to develop the truly valuable functionality at some point after the sale.
- The SAFT framework is focused on bodies of US federal law and not generally applicable worldwide, although it can be beneficial in regards to US regulation it can very well be deemed as an illegal practice in other jurisdictions, potentially excluding many international contributions.
- Finally, a SAFT approach also has the unfortunate effect of excluding the general public from participation, as only accredited investors could part-take in the first part of token sale.
Trading SAFT securities
The online retailer Overstock recently announced that tZERO, a joint venture with The Argon Group, will hold an ICO to fund the development of the first licensed security token trading platform. The tZERO tokens will be issued in accordance with SEC regulations, and Overstock CEO Patrick Byrne has stated that token holders will be entitled to quarterly dividends derived from the profits of the tZERO platform. (Follow us on Twitter to get updates on the tZero ICO)
There’s several issues that need to be fine-tuned in order for the SAFT framework to exist as a best-practice for token sales. But as the creator Marco Santori mentioned, the initial Whitepaper was a first step towards a compliant token sale framework but this doesn’t mean it’s ready for prime-time just yet.
Whichever approach is taken in terms of a token sale, it is critical to work closely with well-informed legal counsel to navigate through the complex facts and circumstance analysis underpinning the U.S. federal securities laws.
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