Tokens and U.S. Securities Law: The State of the Union*

On July 25, the Securities and Exchange Commission (SEC) published a report opining on the practice of initial coin offerings (ICOs). Insight into regulators’ views on ICOs has been long awaited, but this report is likely of limited help to U.S. entrepreneurs and investors seeking clarity on how to launch or participate in token sales in a legally compliant manner (if blockchain technology is still new to you, you can read our primer here).

Misconceptions of the SEC’s Report

The impact of the new report has often been depicted inaccurately by the media, which states that the report brings forth a crackdown on ICOs. In actuality, the scope of the report is remarkably narrow, stating that the (now defunct) DAO tokens from the infamous DAO coin offering in 2016 constitute “securities” under U.S. law. The report does not discuss any tokens other than DAO tokens. For securities lawyers familiar with blockchain technology and the DAO, this result was expected. DAO tokens certainly fit within the definition of “investment contracts” as per the Howey Test (and are therefore securities under U.S. law), but the application of the Howey Test to other protocol tokens and app coins is not quite as “cut-and-dried”.

Not all ICOs/Tokens are Built Equal

Assessing whether a token is a security or an asset/commodity is an ad hoc exercise. The assessment relies on a number of factors unique to each token and the circumstances in which the token was sold to investors. For instance, one consideration is the phase of development that a blockchain project is in at the time of its ICO. Companies that defer launching a token sale until completing a functional testnet (or MVP of a dApp) will have a stronger argument that — because their token has utility at the time of sale (i.e., allowing the tokenholder to use and interact with the testnet/dApp) — it is an asset/commodity. By contrast, companies that launch an ICO with little more than a white paper and a promise to build the next big platform may be signalling the opposite conclusion to regulators. Can purposeless digital tokens realistically be viewed as anything but a speculative investment instrument?

Another consideration is the technical features of the tokens and the rights that they afford tokenholders. In the case of the DAO, tokenholders received the right to vote on investment projects and the right to receive dividends (paid in Ether) on the ROI of those projects. DAO tokens are resemblant of “digital stock” in an investment fund, which causes concern from a securities law perspective. Instead, other protocol tokens grant tokenholders the right to contribute “rewarded” labour into the underlying network (e.g., Proof-of-Stake forging), the right to vote on governance issues affecting the network and the right to use the network and its outputs. Tokens with these characteristics may not be the same type of asset as DAO tokens.

There is a useful securities law framework publicly available which serves as starting point in navigating this analysis (thanks to the combined efforts of CoinBase, Coin Center, Union Square Ventures and Consensys).

Compliance on a Spectrum

Tokens are a novel asset class. Regulators need time to fully grasp the technology before developing a regulatory framework around these assets. Until then, the goal of transacting in tokens in compliance with future regulation can only be assessed on a spectrum of best practices.

Over the past several months, blockchain developers have generally made great strides towards more compliant practices. During the era of “ICOs 1.0,” the extent of compliance was to incorporate an entity overseas (often as Swiss non-profit organizations) and label ICOs as “fundraisers” and investments as “donations.” Some companies took an added step by excluding U.S. investors from participating in their ICOs via disclosure language to that effect (although few, if any, companies took measures in actually blocking U.S. participants from anonymously investing in their fundraisers). Presumably these ICOs attempted to avoid the jurisdiction of the SEC.

As the market for ICOs has sophisticated, we have entered the era of “ICOs 2.0.” More developers are now opting to incorporate within the U.S. and raise capital via the SAFT (the “Simple Agreement for Future Tokens”, a re-purposed variation of Y-Combinator’s SAFE). SAFTs are executed privately between the entities launching token offerings and U.S. “accredited investors” (i.e., individuals with a net worth of at least USD $1 million or annual income of at least USD $200,000). This allows companies to raise capital for their projects while still circumventing many of the costly requirements of a securities offering.

More recently (thanks to the work of Protocol Labs, AngelList and Polychain Capital) accredited investors may use a KYC-enabled platform called to vet and invest in a variety of ICOs. is a funding portal for token offerings that combines the accessibility of public ICOs (provided participants meet the definition of an “accredited investor”) with built-in KYC and securities law compliant features. This platform represents another positive step forward in bringing transparency and accountability into the ICO market.

What’s Next?

It’s possible that a legislative regime of basic legal rights for tokenholders is the next step—of course, time will tell. In the meantime, we’re just going to have to wait and see if the robots take us over or not.

* This article is a republication with edits made to the original, which is available here.

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