RavenProtocol
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RavenProtocol

Why the SAFT is Important for Blockchain Projects

Simple Agreement for Future Token

Photo Credit: Unsplash

Introduction

As we all know, the public token sale, colloquially known as an “Initial Coin Offering,” is a powerful new tool for creating decentralized communities, kickstarting network effects, incentivizing participants, providing faster liquidity to investors, and forming capital for creators. In these sales, network creators sell an amount of the network’s tokens at a discount to users, investors, or both.

However, for all the purchasers involved in “Direct Token Pre-sales” process, they tend to expect profit predominantly from the sellers’ efforts to create functionality in the token. As such, these sellers may unintentionally be selling securities, and may have failed to comply with several U.S. laws.

To conquer the outstanding obstacle, Protocol Labs, Cooley, AngelList, and CoinList kicked off The SAFT Project to provide a standard, compliant transactional framework to finance token networks.

What is SAFT?

The SAFT is an investment contract. A SAFT transaction contemplates an initial sale of a SAFT by developers to accredited investors. The SAFT obligates investors to immediately fund the developers. In exchange, the developers use the funds to develop genuinely functional network, with genuinely functional utility tokens, and then deliver those tokens to the investors once functional. The investors may then resell the tokens to the public, presumably for a profit, and so may the developers.

In addition, The SAFT is a security. It demands compliance with the securities laws. The resulting tokens, however, are already functional, and need not be securities under the Howey test. They are consumptive products and, as such, demand compliance with state and federal consumer protection laws.

How does SAFT comply with the current legal framework in U.S.?

In order to understand how SAFT fits into U.S. legal system, we will talk about how SAFT comply with three most relevant federal laws 1) The Federal Securities Laws 2)The Federal Money Services Laws 3)The Federal Tax Laws.

Compliance with The Federal Securities Laws

Under the Federal Securities Law, it is illegal to offer or sell securities in the United States unless the offer and sale are exempt under the federal securities laws or made pursuant to an effective registration statement filed with the SEC. One kind of a security under federal law is an “investment contract.”

The Howey test is analysis of what is meant by the term of “investment contract.” Courts often break Howey test into four prongs to determine:

(1) Investment of Money

(2) Common Enterprise

(3) Expectation of Profits

(4) From the efforts of Others

If all prongs are satisfied, then a contract, scheme, or arrangement passes the Howey test and constitutes a security.

Under the legal framework provided by SAFT, sellers of already-functional utility tokens have very strong arguments against characterization as a security: Such tokens rarely satisfy both the “expectation of profits” and “from the efforts of others” prongs of the Howey test.

Compliance with The Federal Money Services Laws

Federal law makes it a crime for anyone to knowingly conduct, control, manage, supervise, direct, or own all or part of a money transmitting business which is not licensed under state and federal law, referred to as an “unlicensed money transmitting business.” It is clear that some direct token pre-sales may be characterised as unlicensed money transmitting businesses.

Based on the analysis on federal regulation promulgated by Financial Crimes Enforcement Network(“FinCEN”) which oversees registration of money transmitting businesses, FinCEN has stated that users of CVC are not money transmitters, but those who both issue and redeem CVC (administrators) and those who exchange CVC for either fiat or other CVC (exchangers) who accept and transmit funds as a business would be deemed money transmitters.

While FinCEN has consistently maintained that “[a]n administrator or exchanger that (1) accepts and transmits a convertible virtual currency, or (2) buys or sells convertible virtual currency for any reason is a money transmitter, there is a risk that direct token pre-sales violate the money transmission laws

Compliance with The Federal Tax Laws

Tokens, whether CVC or other kinds of blockchain tokens, are generally treated as “property” for U.S. federal income tax purposes. Consequently, proceeds from a token sale (whether pursuant to a SAFT or a direct pre-sale) are taxable to the entity selling the tokens. As a result, entities that are organised as corporations formed in the United States selling tokens will generally bear a heavy tax burden on the proceeds from the token sale. Typically such sellers should expect a combined federal and state tax rate between 35% and 50%.

Many prospective sellers of tokens, when confronted with the probability of a heavy U.S. tax burden resulting from a token sale, have considered incorporating “offshore” in order to avoid U.S. taxes on the token sale. The rules regarding offshore sales of tokens are beyond the scope of this paper; however, simply offering tokens through an offshore affiliate will, in most cases, not reduce (and may increase) the U.S. tax incurred in connection with a token sale.

Direct token pre-sales, from a tax perspective, generally do not allow the seller to effectively manage its tax liability. The SAFT, on the other hand, offers greater opportunities for tax management under the current tax regime as we understand it.

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