Analyzing Token Sale Models
vitalik.ca
vitalik.ca
While there are some parallels between coins and penny stocks, there are also some fundamental differences which means they aren't so easy comparable.
Sure, penny stocks are very highly speculative, just like coins, however unlike coins they have very well defined "value". That is, they are fractional ownership of a legally defined entity.
The value of a coin is much more difficult to understand and/or appreciate.
All fun and games till the SEC decides enough people have lost their life savings, and calling things tokens instead of shares is comedy.
> The term “security” means any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.
Quoting Marine Bank v. Weaver:
> The definition of "security" in the Securities Exchange Act of 1934 is quite broad. The Act was adopted to restore investors' confidence in the financial markets, and the term "security" was meant to include "the many types of instrument that, in our commercial world, fall within the ordinary concept of a security." The statutory definition excludes only currency and notes with a maturity of less than nine months. It includes ordinary stocks and bonds, along with the "countless and variable schemes devised by those who seek the use of the money of others on the promise of profits. Thus, the coverage of the antifraud provisions of the securities laws is not limited to instruments traded at securities exchanges and over-the-counter markets, but extends to uncommon and irregular instruments. We have repeatedly held that the test "'is what character the instrument is given in commerce by the terms of the offer, the plan of distribution, and the economic inducements held out to the prospect.'"
ICOs are almost certainly selling securities. Tokens look like a duck. They quack like a duck. They are sold by people promoting them as ducks. A ToS which says "n.b. Our quacking avians are not ducks; they're a totally different non-duck like thing which will supplant ducks in the future because they're so much better than ducks and cannot be regulated as ducks" will probably not mollify the SEC.
Or does the word "share" imply a "stock" and therefore voting?
Is an Amazon gift card a security?
In my opinion, the vast majority of token sales haven't advertised their tokens as representing a legal claim on an enterprise and its profits.
Orocrypt is one that has gone the route of issuing an equity-token, and if offered to US residents, would fall under US securities laws:
Again, none of this is legal advice. Consult with a lawyer if you're going to do or participate in a token sale.
I'm thinking specifically of bond-like assets or "evidence of indebtness" emitted by private persons on MMO rpg assets which have real-money trading options either as proposed by the game editor or in third party markets?
Even more specifically I'm thinking of EVE online's PLEX items who area open to in game market and have been known to change hands within various ingame organisations for very real money. Some of these organisations have schemes to offer tokens of indebtness in exchange for the acquisition of these digital items that could be construed as a proper security if I read this right. Am I missing something?
For example, one definition of a "security" is an "investment contract", and what is (or isn't) an "investment contract" is defined by the Howey Test, which looks at whether:
1. It is an investment of money (or other assets)
2. There is an expectation of profits from the investment
3. The investment of money is in a common enterprise
4. Any profit comes from the efforts of a promoter or third party
The typical ICO very obviously meets all 4 elements, inasmuch as it involves a company raising money via an ICO, where purchasers of the tokens 1) give money to the company 2) expected to profit from purchasing the tokens 3) the money was to be invested in building the company's core business and 4) their hope of profits would depend on the company's actions.
> Owning a token dies not necessarily mean you now own a portion of the company or profits.
That is correct, and one of many reasons why tokens are a bad investment, but it's not actually relevant. Securities come in a thousand flavours.
(And no, the argument that tokens just look like securities, but if you read the fine print they don't actually promise profits or whatever won't fly either. If someone can show they purchased a token based on a representation from the promoter that there would be profits, the fine print doesn't matter.)
"The typical ICO very obviously meets all 4 elements, inasmuch as it involves a company raising money via an ICO..."
Do we really know what a "typical ICO" is at this stage? And as fast as the sector is changing, how do we know what will be typical by the time new legislation is
(a) passed and (b) enforced?
Many (typical?) ICOs are not companies, registered as foundations to support free, open source software with crystal-clear terms of the token distribution:
Which explicitly state that it is not an investment and that it is likely that participants will lose all of their money.
This is just one exceptional example, and many more will follow.
Forward-thinking jurisdictions such as Switzerland which understand and actively support ICOs are quickly developing a strong competitive advantage against the more regressive ones.
Yes, we can look at the ICOs that have happened and draw conclusions.
> And as fast as the sector is changing, how do we know what will be typical by the time new legislation is (a) passed
This isn't about new legislation. The Howey Test dates from 1946. The fundamental characteristics of ICOs are not new (and have nothing to do with blockchains).
> Many (typical?) ICOs are not companies
I have no idea why you think this changes anything. It doesn't.
> Which explicitly state that it is not an investment
As I already mentioned, fine print doesn't fix the problems being discussed here.
You've selectively skipped over critical parts of my argu ment. But never mind... ;)
From your perspective, even in-game virtual limited-edition collectors items that might appreciate in value could be considered "securities". As would limited edition digital art work or, let's say, protected hashes of such works.
Or a limited gift voucher to purchase the first edition of a product funded by Kickstarter....
Basically you can try to draw conclusions of what a typical token crowd sale is or isn't at this stage, but -- at least in my view -- you would probably be jumping to a superficial conclusion.
> This isn't about new legislation. The Howey Test dates from 1946.
Which may or may not be suitable for technology developed and used in 2017, let alone 2018, 2019 or further down the road. So you're completely missing the point.
But if your only argument is that government authorities "could" interpret the law in the most aggressive way, few would argue.
If they were being marketed as an investment, yes, of course. "Buy a limited edition Golden Sword so we can launch our new expansion; you'll make a huge profit when you resell it to the people who join after we ship the expansion!"
That would fairly clearly fall afoul of the SEC; they don't care if you call it a "Golden Sword" or an "no-lose investment contract"; they care about how it behaves and (especially) marketed by the promoters. Scammers are constantly looking for new ways to package the same old schemes.
And because it would be so clearly illegal, no legit game company does that. Similarly, Kickstarter will shut down a project in a heartbeat if they even hint at doing something shady with the promotion. Did it ever occur to you that there's a reason why your examples of other equivalent things that would also be prosecuted by the SEC are all hypothetical? It's because if they existed, they'd be prosecuted by the SEC.
> Which may or may not be suitable for technology developed and used in 2017
But is undeniably applied to the technology used in 2017. This is like Zenefits arguing that laws about insurance brokers are totally not relevant to the new internet-enabled 21st century. Turns out, those laws were very relevant to Zenefits.
Some US securities experts have opined that a token where a holder can only earn a profit from holding the token in conjunction with their own efforts in utilizing the rights that the token provides them is not a security token.
It is more akin to a franchise or software license. The argument has also been made that the existence of a secondary market where these tokens are traded, and where these tokens can appreciate in value, does not make such a use-token a security token. A license or franchise right can also increase in value over time through secondary market trading, and neither are securities.
Again, this comment implies no notion of ethics in the existence of the SEC or the tokens. I'm only promoting buyer-awareness.
First, it's not clear to me that the coins need to be locked up at all - why can't participants deposit or withdraw their funds as they please, with the funding contract relying on the current state at the end of the funding period?
Second, even if they do have to be locked up, I'm not at all sure that it results in deadweight loss. Certainly not appreciable amounts compared to traditional methods of funding.
To me, this is pretty clearly the best system currently available. It avoids problems like scammy, uncapped sales (Bancor) and sales that instantly sell out to a few buyers (BAT).
The reason I had this idea is: If you are in finance and accepting US customers you'll need to oblige to US laws. It'd be better if an experienced person clear this more.
European commission directive from around 2013 states that place of sale is in the origin country of the seller which means it's bound to origin country law which means it's bound to EU law.
[1] https://hackernoon.com/dear-sec-icos-tokens-are-killing-inno...
As for DeRose, if he isn't actually an asshat, he's certainly doing a flawless impersonation of one. But many of his points are correct nonetheless. Though do note that as a Bitcoin maximalist he would be making very similar arguments even if he were wrong ;)
Also, how often has SEC gone after the purchaser of an unregistered/unexempted security. Not very often, I would guess.
In some ways cryptocurrencies that are tied to specific companies/business endeavors become unregulated stocks in those companies. Thus it much of market the of cryptocurrencies is some sort of an unregulated stock market.
Thus, I'm not happy to see, or help others see ways to further screw the people getting crypto gift certificates instead of shares for their hard earned money, or I'd make more comments on the article.