How Certain Are You That Your Utility Token Isn’t a Security?
The SEC implied most utility tokens may be securities — what are the implications of such a stance?
I have argued that security tokens offerings (STOs) will be the new standard adopted by blockchain companies for raising capital. In essence, the invisible hand will push buyers of digital assets to invest in security tokens over utility tokens. Would Adam Smith cringe at the fact that a term he coined (pun intended; not going to point them out but more puns to come) back in the 1700s is being applied to crypto, or would he crack a smile at the fact that his brainchild is still very much lending a helping hand to those of us thinking through novel concepts such as the incentive mechanisms of blockchain ecosystems? He did, after all, demonstrate a propensity to adjust his world views. In his old age, he stopped believing that the invisible hand, free of government interference, would bring the most value to society.
Before I digress further, let me get back to the point of this post. Although the invisible hand is a powerful, autonomous force, it moves fast or slow in a direction depending on its not so translucent counterpart: regulation.
On June 14, 2018, the SEC Director of the Division of Corporate Finance William Hinman described under what circumstances a digital asset will be considered a security. I recommend reading the entire transcript of the speech — Digital Asset Transactions: When Howey Met Gary (Plastic). It is well worth the time.
“Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers. When someone buys a housing unit to live in, it is probably not a security…. But under certain circumstances, the same asset can be offered and sold in a way that causes investors to have a reasonable expectation of profits based on the efforts of others”
“Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers. When someone buys a housing unit to live in, it is probably not a security…. But under certain circumstances, the same asset can be offered and sold in a way that causes investors to have a reasonable expectation of profits based on the efforts of others”
In other words, any asset can be a security depending on the way it is sold, and on the reasons why someone is purchasing the asset. For example, an apartment building isn’t a security, but a small ownership stake in a REIT that owns apartment buildings is a security. Why? The individual purchasing the REIT share expects to generate a return from such a purchase and has no other use for it other than that.
Bringing this back to crypto,
“The same reasoning applies to digital assets. The digital asset itself is simply code. But the way it is sold — as part of an investment; to non-users; by promoters to develop the enterprise — can be, and, in that context, most often is, a security — because it evidences an investment contract”
The way William Hinman describes a security implies that most utility tokens, as they function now, are securities. Utility tokens are definitely considered securities at the time of the ICO. Why? Blockchain companies were issuing tokens and selling them to individuals that were buying them with the expectation of generating a return. A lot of blockchain companies have utility tokens trading on exchanges, but have yet to develop a functional product. Therefore, their tokens are nothing more than vehicles for speculation. The SEC will consider a utility token a security as long as individuals continue to speculate on it AND these individuals continue to rely on a centralized 3rd party to increase the value of the token through their actions.
Concluding Thoughts
How big of an impact will such an implication have on the crypto market?
- Think about the level of disclosure that will be expected of certain blockchain companies moving forward and their ability to comply
- Think about all the token delistings that may occur if exchanges do not have the proper security licenses
- Think about the ramifications on all the investment advisory firms that do not have the proper licenses to trade securities
The invisible hand has been moving security tokens to the forefront of the conversation. Its visible counterpart has accelerate the timeline.
What do you think about William Hinman’s speech?
Thank you to Phil Glazer for writing about the speech and bringing it to my attention.
Thank you Vinny Lingham for the photo that perfectly encapsulates the topic at hand (yes, pun intended).
Disclaimer. This post is intended for informational purposes only. The views expressed in this post are not, and should not be construed as, investment advice or recommendations. This document is not an offer, nor the solicitation of an offer, to buy or sell any of the assets mentioned herein. All opinions in this post are my own and do not represent, in any manner, the views of CMX Capital or affiliated companies.
