Understanding the difference between coins, utility tokens and tokenized securities
How the blockchain disruption is shaking status quo
The recent number of Initial Coin Offerings (ICOs), the enormous amount of money they’ve raised, and the speed with which they did it, has set off the alarms for funding industries from Venture Capital firms to government bodies.
The last 2 months have seen spectacular ICOs success, but also caused a lot of confusion for traditional funding institutions. People are scrambling to understand exactly what an ICO is & how they can use it to their own advantage. To name a few: Bancor (+$150 Million), Status (+$200 Million), Civic (+$33 Million), Tezos (+$200 Million), EOS (+$200 Million).
The recent SEC announcement to consider ICOs as securities could actually be a good thing since it highlights the importance of Initial Coin Offerings (ICOs) as a new viable way to raise funds. It highlights the need for a new regulation.
Balaji S. Srinivasan wrote a great piece on tokens back in May and Tim Draper recent post on Linkedin referring to his open letter to the SEC has opened up a large discussion on wether token sales should be considered as securities.
In planning an ICO for a project of my own, I’ve done a deep dive into ICOs. One of the most important conclusions I found: there are 3 main types of tokens.
Whether these 3 types of tokens are securities remains unclear as their technical differences are blurry. That’s why a new regulation might be needed to let new innovations flourish.
Tim Draper mentioned in his open letter: “If the purpose of a token is for societal transformation, and all proceeds go to the support and development of the token, it need not register.”
Conclusions
1. Coins or Cryptocurrencies
These are digital currencies like Bitcoin in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. They are operating independently of a central bank.
Soon every fiat currency may become a cryptocurrency, in that case operating with central banks. This is what Singapore has started with their Ubin project.
2. Utility tokens
The utility tokens are services or units of services that can be purchased. As describes in Balaji S. Srinivasan post, these tokens can be compared to API keys, used to access the service.
They are a way to fund projects of shared infrastructure that couldn’t be funded before. To enable such ecosystems to be built some tokens can be “pre-mined” in addition to be sold in “crowd-sales” during tokens launches.
3. Tokenised securities:
Tokens are representing shares of a business. In addition, considering the SEC announcement any token that can’t pass the Howey test should be considered as a security and fall under the 1934 Security Exchange Act.
The Howey test consists of the following:
- Is it an investment of money or assets?
- Is the investment of money or assets in a common enterprise?
- Is there an expectation of profits from the investment?
- Does any profit come from the efforts of a promoter or third party?
The final factor of the Howey Test concerns whether any profit that comes from the investment is largely or wholly outside of the investor’s control. If so, then the investment might be a security.
This is what brings confusion and in a way makes any utility token potentially a security since they can be traded on third party platforms. Utility tokens that a startup would issue to finance future customer’s purchases should not be securities, since their purpose is to facilitate the purchase.
Coinbase published a useful tool that can help developers to figure out if their tokens are securities or not: A securities Law Framework for Blockchain Tokens Getting a score of over a 100 which qualifies your tokens as securities happens pretty fast…
To learn more about ICOs as a new way to fund your business read my previous post: Hack your funding with an Initial Coin Offering
You should not rely on this Medium post as legal advice. It is written for general informational purposes only, as a guide to certain of the conceptual considerations associated with the narrow issues it addresses. You should seek advice from your own counsel, who is familiar with the particular facts and circumstances of what you intend and can give you tailored advice.
This Medium post is provided “as is” with no representations, warranties or obligations to update, although I reserve the right to modify or change this Medium post from time to time. No attorney-client relationship or privilege is created, nor is this intended to be attorney advertising in any jurisdiction.
