Size Does Matter — Part 1

A Philosophy of Securities Laws for Tokenized Networks

Dec 26, 2019 · 20 min read
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I am a U.S. corporate/securities lawyer who has spent (wasted?) much of the last three years contemplating how securities laws apply to tokenized blockchain networks. And my question is this:

Where is all the dankness!!???

That’s what I want to know.

Crypto culture is broken, and I blame securities laws:

And, yes, I blame securities laws for pretty much all of this. Well, not just the laws — but the people who try to enforce them, try to advise about them, try to comply with them and/or try to avoid them or don’t mind breaking them. Because I think there has been a shocking lack of understanding and imagination by all those players— I, too, am guilty and have played my part in this. But now I am trying to blaze a new path.

Securities attorneys, securities regulators and blockchain enthusiasts all disagree with each other and one another about securities laws. I am not going to be able to resolve all those debates today, and I am not even going to try.

What I can do (at least I think) is provide a framework of sorts — if you’ll indulge me, a philosophy — of how I think securities laws should (and possibly already do) apply to tokenized open networks and how this might help fix the problems I mentioned above and bring back the dankness to crypto.

I do not expect everyone to agree with me. You probably won’t agree with me. If you’re a lawyer, you’ll definitely disagree with me because, as a very legally savvy Ethereum dev once aptly said to me, “You lawyers all secretly hate each other.” (And it’s true!)

But I think even those who disagree can appreciate having a coherent set of interlinked concepts and arguments at which to aim their rebuttals. Maybe they will even appreciate how securities laws could end up being a positive force for enhancing the most deeply rooted cypherpunk values of the industry.

In explaining this philosophy, I do not plan to cite much to securities case law or scholarship. Filling in that detail would certainly be useful — and perhaps I or others will do it in future work — but it would also be boring. And there are only so many hours in a day. My arguments will also range from syllogisms to Socratic dialogues to intuition pumps and reductio ad absurdums. They won’t be very technical.

But if this were scholarship, I’d publish it in a journal, get it peer-reviewed and probably be invited to talk on more panels. This is not scholarship; it’s more like my personal cryptolaw manifesto. I’m a lawyer, but I’m also an outsider — this article may best be appreciated by other outsiders and less so by people who already have achieved a lot of wealth and power in the industry. So be it.

Open Network Tokens Are Shares of Network Equity

Gilles Deleuze and Felix Guattari once defined philosophy as “the art of forming, inventing, and fabricating concepts.” So, too, my philosophy of the securities laws for tokenized networks begins with one special concept: the concept of network equity.

Network equity should be familiar — it is already how you think about the value of most of your tokens. It is essentially the notion of network value Joel Monegro meant to describe with his “fat protocol” flywheel:

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Joel Monegro’s Fat Protocol Flywheel

I define a “network equity token” as a token that (in theory or practice) tends to capture all or a portion of the value of an open network. This should not be too controversial, but, sadly, it is.

You see, I believe that when we use terminology like “ICO,” “dilution,” “stakeholders,” “market cap” and “fork” (which are reminiscent of IPOs, equity dilution, stockholders, market capitalization and stock splits for corporate capital stock), it is not accidental. Contrary to the commentary by some mavens (including myself in a past life), the use of such terms is not just the result of some colossally unfortunate misunderstanding of network tokens, traditional securities, or both. Rather, we are using these words deliberately, and in a way that makes sense, because they are the words that come closest to capturing our intuitions about what network value is (a kind of quasi-equity) and how open network tokens capture it (like shares).

The ICO mania of 2016–2017 was fueled by people who believed that by buying a protocol token they were buying a “stake” in an open network which would increase in value as the network became more popular. The nature of the captured value is not exactly the same as the nature of corporate shareholders’ equity (it is not a claim on the positive difference between assets and liabilities belonging to an entity), and how a token captures that value is not the same as how a share of stock captures the value of shareholder’s equity (the former being functionalistic and the latter rights-based). Nevertheless, a network token is the closest one can come to acquiring equity in a network that is not owned by anyone, and being a tokenholder in that network is as close as one can come to being a stockholder in an owner-less enterprise for the management of that network. “Equity” also has a broader meaning than “shareholders’ equity,” as reflected in concepts like “home equity” and “brand equity”. Hence, I consider “network equity” to be appropriate both in name and concept to cover the value represented by open network tokens.

The motive for this article is basically as follows: I believe the regulatory questions around open network tokens become far clearer when such tokens are openly viewed as shares of network equity and when their nature as securities is embraced (until the point of “sufficient decentralization”). This is better than viewing such tokens merely as “digital money” or “utility tokens”; those concepts are a very poor fit for how tokens are actually used, valued and thought of, and have mainly been adopted in a half-baked attempt to dodge securities laws.

Indeed, the “network equity” frame aligns far more closely with the actual intuitions, motives and beliefs of network participants as they are found in the wild. Token network developers can be seen to allocate network tokens to early employees like they are “founders’ shares” in a hot startup, often even to the point of subjecting them to vesting. Large early token buyers conduct due diligence and seek to establish reputations just like Silicon Valley venture capital funds. Retail token buyers who buy in later and have less information tend to piggyback off of the credentials, prestige and prior valuations achieved by the founding team and early investors. All this feels a whole lot like what happens in the normie corporate equity market. Sure, there are some differences — and ultimately some of those differences should be reflected in amendments to the applicable laws — but there are far more similarities than differences.

At this point, I have made some bold assertions. I suspect that at this stage of the article many readers will still be skeptical about the merits of those assertions. You may still question whether “network equity shares” is a good way to view open network tokens. You may be thinking “aren’t tokens a lot more like products than shares? or aren’t they kind of like commodities or something?”

Therefore, I will devote the next section to addressing potential skepticism — by debunking every other common analogy for tokens to traditional instruments in the traditional commercial/corporate world.

Why Other Conceptions of Open Network Tokens Are Weak Sauce

Debt is an obligation of the borrower to pay, and the lender to receive, a principal amount plus interest, potentially as modified by some extrinsic factors like fluctuations in the currency in which principal and interest are denominated. Debt can be secured (the creditor has the right to foreclose on specific collateral to ensure repayment) or unsecured (no collateral).

Needless to say, open network tokens are nothing like debt:

First of all, they do not represent a right to reclaim funds. However, I consider this difference relatively unimportant. Network tokens also do not represent a right to claim the difference between assets and liabilities. Thus, if I were limited to this reasoning, network tokens would be nothing like debt and nothing like equity; my entire philosophy would be dead in the water.

The much more important reason why open network tokens are nothing like debt is, secondly, that the returns and risks one expects from such a token are totally unlike the returns and risks a creditor expects from a loan. One never expects a blowout return or catastrophic loss from debt: they are inherently conservative investments designed to yield modest returns with significant downside protections (particularly in the collateral-backed variety). However, the primary goal of equity investment is a blowout return, and the price one pays for the possibility of gaining that return is bearing the risk that very few such investments generate any material return at all; in fact, many can and will result in total or close to total loss. Thus, the profit and risk profile of open network tokens is far more like that of equity, and in any event is very, very little like that of debt.

2. Open Network Tokens Are Not Much Like Consumable “Products”

An oft-repeated concept for open network tokens paints them as “products,” or sometimes more specifically “software products”. This analogy is a little better than debt, but still highly inaccurate and misleading in the vast majority of circumstances.

First of all, the “products” covered by securities law precedents are about as little like open network tokens as imaginable. I have had many an occasion to hear securities lawyers whose opinions I otherwise respect to compare tokens like ETH to the oranges in the Howey case, the whiskey in the Glen Arden case or the rare coins in the Brigadoon Scotch Distributors case. One of two things is always true of these lawyers:

(1) they’re acting as persuasive advocates and thus not being completely candid; or

(2) they don’t really use crypto, are not in crypto communities and therefore have not yet made frenemies with the mingled sense of dread and taboo pleasure to be found in buying an unreasonably large quantity of a properly pumpamentalized open network token, brimming with fevered dreams of sick gainz at 3 o’clock in the morning.

An open network token, by itself, is useless. You can’t drink it like whiskey. You can’t eat it like an orange. You can’t hold it up to the light and admire the deft, antique craftsmanship of the embossed design or the nuanced sense of history imparted by its slightly worn and scored patina.

A network token is none of these things: Rather, it is a unit of account that belongs to you by virtue of the fact that it is recognized as being governed by a particular public/private key pairing on a database maintained by a network of nodes operated by numerous people, in accordance with rules established in a piece of software that was designed by numerous other people to recognize and govern changes of such units of account under such conditions and in accordance with such cryptographic rules.

If everyone stopped running those nodes, the token would be useless and valueless to the point of arguably being nonexistent. If the software client didn’t work right or stopped being updated or at least maintained, the token would be substantially or completely devalued. The token can never truly be used or even enjoyed in the absence of these network-based dependencies.

Let’s compare that to some other things that securities lawyers would have you believe are similar to tokens and should be regulated the same:

Whiskey, oranges and collectible metal coins are products because they have a life independent from the circumstances of their production. Open network tokens do not…they are only useful in the context of a particular network and the continued willingness of people to operate that.

3. Open Network Tokens Are Not Much Like “Software Products”

If you are smart, you are probably now thinking I am an idiot. You should want to say to me something like this:

“You say that tokens are nothing like whiskey, oranges and metal coins…and this I agree is true. But tokens were never meant to be such old-fashioned types of goods. Tokens are meant to be modern, maybe even postmodern. Tokens aren’t just products, they’re a special kind of products — software products — which play by different rules, but nevertheless are nothing like equity securities. You wouldn’t say a buyer of a license to Microsoft Word is buying equity in Microsoft Corporation, now would you?!”

No, I would not say a buyer of Microsoft Word is buying equity in Microsoft Corporation. That would be absurd. However, there is a circumstance in which I would say a buyer of Microsoft Word is buying equity….in Microsoft Word!

Consider the following alternate-timeline / Mandela effect version of history:

Under these circumstances, I believe there is a kind of equity in Microsoft Word that is being sold. At the start, there are two ways for me to buy equity in Microsoft Word: directly, by buying a license for Microsoft Word, or indirectly, by buying a share of equity in Microsoft Corporation. Eventually, however, as Microsoft Corporation sells more and more of its initial 50% allocation of the licenses, less and less of the equity of Microsoft Word will be available through the equity of Microsoft Corporation; eventually, the sole method of acquiring equity in Microsoft Word may be to buy one of the 100M Microsoft Word licenses that are circulating freely in the wild.

Now, there may be situations in which this Microsoft Word quasi-equity should be regulated as a security, and there may be situations in which it should not. Some people may be acquiring the license to use it; others may be acquiring 1,000 licenses with the hope of flipping them for 100x returns after multiple Microsoft Word upgrades over a period of years. It also might matter what the reasonably expected customer base for Microsoft Word is. Currently there are about 1 billion users. If we assume that’s about the right audience size, and there are 1 billion Microsoft Word licenses, then we have enough for everyone and should not expect the licenses to have much value as investment instruments. We will talk about all of that later.

For now, I just wish to point out how, in a very utility-token-like scenario, one can drive equity-like value into an actual software product. The fact that, in my hypothetical, there are only a limited number of Microsoft Word licenses that are supposed to ever be produced is very similar to the fact that there are only a limited number of BTC that are ever supposed to be produced, or there are only a limited number of ETH available at a given time (with slow additional issuance) to pay for gas on the network.

But, my destruction of this analogy of network tokens to software is not yet done. One can go further, and argue that it would be much more accurate to simply say that network tokens are nothing like software licenses at all. One ETH is not a license to use the Ethereum protocol. The Ethereum protocol and all instantiations thereof in the form of software clients like Geth are actually completely open-source to begin with. So you can’t tell me buying ETH is like buying a software license. The software is free; you don’t need ETH to use it. You could spin up your own version and premine yourself as many ETH as you would like on your own private ETH network.

On the contrary, buying ETH is buying the right or ability to transact on a particular network. This is less like buying a license to some particular piece of software than it is like trading one currency for another. They don’t take U.S. dollars in Japan; they only take yen. They don’t take U.S. dollars on Ethereum either — they only take ETH. ETH is the currency in which you pay (or the community pays) node operators on the Ethereum mainnet to do stuff for you (or them) — like run computations (or propose blocks). It also can be the currency in which you pay DAPPs/smart contracts — which are basically like virtual agents on the network — to perform certain functions, or give you certain other tokens, etc.

Thus, an open network token is basically nothing like an orange, whiskey, a collectible coin or a software product. These analogies/metaphors for network tokens are just not very useful or accurate and need to die. And even if these analogies somehow deserve more credit than I am giving them, then people need consider my hypothetical limited Microsoft Word licenses, which can still embody network equity, and essentially be an interesting type of security, despite being software licenses as well.

4. Open Network Tokens Are Not Much Like “Commodities”

This one is surprisingly obvious but also, I guess, not so obvious, since many people compare cryptocurrencies like Bitcoin to commodities like oil. I have to say I completely disagree with this, and it just makes close to no sense.

At the outset I’m going to be super cheap and lazy about this. Here is how the essence of commodities is captured by You may think that’s incredibly naive and un-scholarly, but actually I think there is more truth and profundity to the Investopedia definition than many people would like to admit:

A commodity is a basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. The basic idea is that there is little differentiation between a commodity coming from one producer and the same commodity from another producer. A barrel of oil is basically the same product, regardless of the producer. By contrast, for electronics merchandise, the quality and features of a given product may be completely different depending on the producer. Some traditional examples of commodities include grains, gold, beef, oil, and natural gas.

This basic idea is also captured in one of the all-time most savage Tweets from Nic Carter, about the relationship between XRP the token and Ripple the company:

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This is funny because we intuitively know it is ridiculous.

XRP tokens did not develop in the ground through the gooification of fossils and other organic matter over millions of years and then get struck upon by the Ripple founders like oil. XRP tokens are not mined out of some mountain where they’ve been sitting for millions of years like gold nuggets and could’ve been discovered by anyone. XRP tokens are not popular or valuable because there is something intrinsically useful and rare about them the way there is something intrinsically useful and rare about oil or gold or diamonds.

No, XRP tokens are man-made, synthetic assets.They are popular or valuable not because they are a particular type of token or backed by a particular type of software, but primarily because some particular guys/a particular company gained investors’ confidence in their entrepreneurial efforts and tacitly or expressly assumed some responsibility for promoting, not the XRP software in general, but a particular instance of that software — a particular network on which that software is used.

Those XRP tokens — the ones on that particular network — and not some technologically identical private version of the same software (“pXRP,” as it were), are what have material value. The reason why is that particular humans stand behind them who have gained investors’ confidence. These are not like traditional commodities — the specific producer(s) backing or promoting them does(do) matter.

5. Open Network Tokens Are Not Much Like Currency— Until Suddenly They Are

Okay, here is the weakest part of my argument because, yeah, actually, open network tokens are a fuck of a lot like money. I’ll remind you here in case you were skimming the article: a couple of sections up I even analogized ETH to yen. So, what gives? What am I saying here?

This is actually the entire core of the issue and gets into what is sometimes referred to as William Hinman’s “mutability doctrine” as articulated in “Digital Asset Transactions: When Howey Met Gary (Plastic)”. We’re going to talk a lot about that. But for now let me be a bit lazy and revert back to an intuition pump.

Have you ever heard of company scrip or company town money? Again, I’m going to be super lazy and just quote Wikipedia, because it’s pretty good and, like I said before, I’ve already spent (wasted?) three years of my life on this stuff, so why not take the occasional shortcut? =)

Company scrip is scrip (a substitute for government-issued legal tender or currency) issued by a company to pay its employees. It can only be exchanged in company stores owned by the employers…

In the United States, mining and logging camps were typically created, owned and operated by a single company. These locations, some quite remote, were often cash poor; even in ones that were not, workers paid in scrip had little choice but to purchase goods at a company store, as exchange into currency, if even available, would exhaust some of the value via the exchange fee. With this economic monopoly, the employer could place large markups on goods, making workers dependent on the company, thus enforcing employee “loyalty”.

Now contrast that with Wikipedia’s definition of “currency” in the broader sense:

A currency (from Middle English: curraunt, “in circulation”, from Latin: currens, -entis), in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins.[1][2] A more general definition is that a currency is a system of money (monetary units) in common use, especially for people in a nation.[3] Under this definition, U.S. dollars (US$), euros (€), Japanese yen (¥), and pounds sterling (£) are examples of currencies. These various currencies are recognized as stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies.[4] Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.

Notice there is really no difference between these two things — company scrip on the one hand, currency on the other — except scale. Company scrip is only accepted in small, isolated towns under the (probably highly) centralized management of a company. Currency, on the other hand, is accepted by the peoples of an entire nation under the (probably less) centralized management of a government.

I contend something quite similar occurs with an open network token like ETH. At its worst, when the Ethereum network is sponsored and operated by centralized management and individuals or businesses with tight affiliations, ETH, as the medium of exchange of choice on the Ethereum network, is like company scrip. At its best, when the Ethereum network is managed and operated on a highly decentralized basis by lots of unaffiliated persons, ETH is like currency— the national currency of Ethereum-Land. ETH is way better money in the second situation than in the first situation. Scale, and the concomitant relative levels of centralization and decentralization that go along with scale, matter.

Despite this relatively strong analogy between a network token and money, there is still a confounding factor: Most people who buy ETH or any other network token in fact are not buying it to use it as a medium of exchange on the Ethereum network or other applicable network, even though it can be used that way. They are buying it with the hope of “number goes up.” Whether that expectation is reasonable and the particular form the expectation takes — e.g., whether it is focused on an entity or group exerting entrepreneurial efforts , or is focused on network evolutionary processes that essentially mirror the Darwinian processes of nature— matters (or should matter) a whole lot to how they are treated under the law.

Again, we’ll talk about that later, but my point here is very simple: the people buying ETH or another open network token only sometimes have the desire to use it as an in-network currency but almost always — particularly if they are buying a substantial amount of it all at once with the plan of HODLing for quite some time— have the desire to use it to capture the gains of growing network equity. This is true even of BTC, which is indisputably the crypto that put the “currency” in “cryptocurrency” and is one of the most money-like blockchain network tokens.

Open network tokens are not primarily commodities, products, software or currency — they are primarily shares of network equity.

— — —

In Part 2 of the article, we’ll talk more about the securities laws and how “network equity” might be treated under them — specifically, the Securities Exchange Act of 1934, which has not been adequately focused on in commentaries of how securities laws affect blockchain tokens.

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Written by

autonomous attorney



Coinmonks is a non-profit Crypto educational publication. Follow us on Twitter @coinmonks Our other project —


Written by

autonomous attorney



Coinmonks is a non-profit Crypto educational publication. Follow us on Twitter @coinmonks Our other project —

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