INSUBCONTINENT EXCLUSIVE:
&In cases where there is no… central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or
service available through the network on which it was created,& that digital asset is &out of the purview of U.S
securities laws&, according to William Hinman, the director of the division of corporation finance at the U.S
Securities and Exchange Commission.
This (edited) statement from Hinman at theYahoo Finance All Markets Summit: Cryptowill likely be seen as
the starting gun on a crypto free-for-all in the United States.
Hinman comments were certainly a positive signal to the market
They sent the price of Ether spiking from $469 to $516 over the course of the past hour.
While the markets may view this as an unadulterated
victory for cryptocurrencies of all stripes, the Securities and Exchange Commission simply looks to be expanding on the fairly nuanced
position it established with coin offerings and token sales.
Earlier this month SEC Chair Jay Clayton made a similar statement about Bitcoin
and its place in the regulatory firmament.
For the SEC, while cryptocurrencies like bitcoin and ether are not securities, token offerings
for stakes in companies that are built off of those blockchains can be, depending on the extent to which third parties are involved in the
creation or exchange of value around the assets.
The key for the SEC is whether the token in question is being used simply for the exchange
of a good or service through a distributed ledger platform, or whether the value of the cryptocurrency is dependent on the actions of a
third party for it to rise in value.
&Promoters, in order to raise money to develop networks on which digital assets will operate, often
sell the tokens or coins rather than sell shares, issue notes or obtain bank financing
But, in many cases, the economic substance is the same as a conventional securities offering
Funds are raised with the expectation that the promoters will build their system and investors can earn a return on the instrument —
usually by selling their tokens in the secondary market once the promoters create something of value with the proceeds and the value of the
digital enterprise increases,& Hinman said.
This was at the core of a 1946 case which was decided by the Supreme Court and set a standard
for the SEC authority to oversee certain types of securities issues
Howeyinvolved the sale of interests in orange groves to guests of a hotel
The guests could have cultivated their plots of land but instead relied on a service managed by the hotel to create value from the oranges
(this is a very rough paraphrase of the facts of the case).
&Just as in theHoweycase, tokens and coins are often touted as assets that have
a use in their own right, coupled with a promise that the assets will be cultivated in a way that will cause them to grow in value, to be
And, as inHowey— where interests in the groves were sold to hotel guests, not farmers — tokens and coins typically are sold to a wide
audience rather than to persons who are likely to use them on the network,& said Hinman.
Before a network is actually created and as the
tokens are marketed to investors rather than users of the token, they&re going to look an awful lot like securities to the SEC.
&The token
— or coin or whatever the digital information packet is called — all by itself is not a security, just as the orange groves inHoweywere
Central to determining whether a security is being sold is how it is being sold and the reasonable expectations of purchasers,& Hinman
continued.
&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
And regulating these transactions as securities transactions makes sense.&
Ultimately if the coin offering is successful, and the operations
of the network become wholly decentralized, then the SEC will cease to regulate the entity as a security, says Hinman.
&If the network on
which the token or coin is to function is sufficiently decentralized — where purchasers would no longer reasonably expect a person or
group to carry out essential managerial or entrepreneurial efforts — the assets may not represent an investment contract
Moreover, when the efforts of the third party are no longer a key factor for determining the enterprise success, material information
As a network becomes truly decentralized, the ability to identify an issuer or promoter to make the requisite disclosures becomes difficult,
and less meaningful.&
For Hinman, Bitcoin and Ethereum have both hit that tipping point
Other coin offerings haven&t.
&Promoters and other market participants need to understand whether transactions in a particular digital asset
involve the sale of a security
We are happy to help promoters and their counsel work through these issues
We stand prepared to provide more formal interpretive or no-action guidance about the proper characterization of a digital asset in a
proposed use,& said Hinman.
Below are a list of queries that the SEC regulator enumerated to help determine whether an offering is a
security or a utility token.
Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the
efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value
Has this person
or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in
value in the digital asset Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their
investment in the digital asset
Has the promoter raised an amount of funds in excess of what may be needed to establish a functional
network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the
enterprise Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system
within which the tokens operate
Are purchasers &investing,& that is seeking a return In that regard, is the instrument marketed and sold to
the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or
service in the network
Does application of the Securities Act protections make sense Is there a person or entity others are relying on that
plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors
Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset
Do persons or entities
other than the promoter exercise governance rights or meaningful influence
And here another set of questions that founders and potential
coin offerings should consider
Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation
Are
independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading
Is it
clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment Have
purchasers made representations as to their consumptive, as opposed to their investment, intent Are the tokens available in increments that
correlate with a consumptive versus investment intent
Are the tokens distributed in ways to meet users& needs For example, can the tokens be
held or transferred only in amounts that correspond to a purchaser expected use Are there built-in incentives that compel using the tokens
promptly on the network, such as having the tokens degrade in value over time, or can the tokens be held for extended periods for
investment
Is the asset marketed and distributed to potential users or the general public
Are the assets dispersed across a diverse user
base or concentrated in the hands of a few that can exert influence over the application
Is the application fully functioning or in early
