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Comment by everdev | Hacker News Reader

I spent 30min on the phone with Mark Vilardo, special counsel at the SEC and the guy who will call you if you all questions about ICOs.

Basically, ICOs are 99% of the time classified as securities in the US. The main exception is if the token is non-transferrable or can be returned for what you paid for it. So, if you can't make money selling our trading it, it's not a security, which defeats the purpose of an ICO.

It sounds like who the SEC goes after is subjective, but at any point in time they could bring a suit against an ICO, even gimmick coins.

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This is very insightful. It is however a vast expansion from what they have publicly stated in the DAO report. https://www.sec.gov/litigation/investreport/34-81207.pdf

Mr Villardo's comments are chilling. If as you said "Basically, ICOs are 99% of the time classified as securities in the US.", the SEC needs to come out and say it.

This will of course lead to the freezing of US persons from participating in most ICOs, and lead most of our crypto community to move to Switzerland.

lead most of our crypto community to move to Switzerland

ICOs are not crypto. They use a small amount of cryptography in their implementation, but no serious member of the real crypto community is working on any ICO (based on Ethereum anyway. Yes, a proof of stake coin is worth working on).

Token sales are on track to raise over $2 billion worth of cryptocurrency this year, which is more than early-stage VC funding, and most of that for distributed application (mostly blockchain based) development.

Given crowd funding through token sales is the first major use-case for cryptocurrency, and is funding numerous cryptocurrency projects, I can't see how one could argue that it is not important to the cryptocurrency sector. Also, almost all token sales are on Ethereum.

What do you mean by "more than early-stage VC funding"?

Angel and seed VC funding:

http://static2.businessinsider.com/image/598c2fd427fa6b5e174...

Lets see how much of that money doesn't "vanish" by this time next year.

Are any of those real things where the ICO is a critical part of the app? All the ones I've seen are gimmicks.

I assume that by 'crypto', kenbaylor means 'cryptocurrency'. It's an unfortunate but common abbreviation.

Just to be clear, the quote is my interpretation. The SEC's official position is the DAO guidance and the Howey Test.

However, throwing any possible ICO idea at Mr. Vilardo, he was able to cite previous successful SEC lawsuits that the SEC could use as presedence.

The only token I could conceive that he thought there SEC would not be able to go after is a token that can only be bought and sold at a fixed price and only from the issuer (non-transferable).

He also reminded me that the SEC is one entity. States have their own securities law and you could easily be sued in state court under a different set of securities rules than the federal government has.

EDIT: Also, to be clear ICOs and securities are not illegal. Selling an unregistered security is illegal. If you want to sell a security you can register it with the SEC and be fine. That will of course be pretty expensive.

> The SEC's official position is the DAO guidance and the Howey Test.

Ethereum itself seemingly fails the Howey test, so it will be interesting to see if they are all prosecuted.

Please don't spread FUD. In the DAO guidance [1] you reference, the SEC explicitly calls Ethereum a virtual currency, and does not call it a security.

"From April 30, 2016 through May 28, 2016, The DAO offered and sold approximately 1.15 billion DAO Tokens in exchange for a total of approximately 12 million Ether (“ETH”), a virtual currency used on the Ethereum Blockchain."

They might change their mind on the matter, and expand their definition of virtual currency to be securities, but they went out of their way to publish a piece which references the word "Ethereum" 39 times, "Ether" 2 times, and "ETH" 15 times. None of those times do they refer to Ethereum as as security.

[1] - https://www.sec.gov/litigation/investreport/34-81207.pdf

Something can be a currency and still be a security, they are largely orthogonal concepts.

That's actually the entire point of the Howey test, which was established as part of a case to determine whether or not property that was classified as real estate could also be classified as a security.

The Capital At Risk test seems to cover every crypto currency in existence. And it's used by many states.

My followup question is, if exchanging World of Warcraft gold for currency was supported or facilitated by Blizzard, would the SEC classify it as a security?

Could Blizzard have an ICO for WoW gold that could only be used as it is now with no attached ideas of selling equity?

They would classify it as a security if they could conclusively prove that people were buying WoW gold "for the expectation of profits solely from the efforts of a third party or promoter."

Doesn't have to be wide spread. Even one investor complaining they thought they were going to make money is enough to satisfy the test. However, the SEC will probably only act in cases of high dollar value or many complaints.

Is that really how the law is technically phrased? I doubt it. You're telling me that if Jose does an ITO (Initial Taco Offering) to open his new taco joint, selling 1000 tacos to anyone that wants to eat one, and I complain to the SEC that I thought Jose's tacos would be worth more if I resold them tomorrow, then his tacos fail the Howey Test and are classified as securities? Obviously that's not the case, but are you saying that's only due to selective SEC enforcement, not because the law has a higher standard than "Even one investor complaining they thought they were going to make money"?

> I complain to the SEC that I thought Jose's tacos would be worth more if I resold them tomorrow

They would dismiss your complaint as silly, trivial, and obviously frivolous. That is, your complaint would fail the test of common sense.

That doesn't exclude the possibility of him being prosecuted tho and the regulation being abused.

If Jose was communicating with an ISIS recruiter but they couldn't pin him on that - could they pin him on the Taco racket?

That's what I understood from my call with the SEC. That if anyone could reasonably expect a profit it satisfied that bullet in the Howey Test.

For your tacos to be securities, the company would have to be working in some capacity to give those tacos more value in the future. Since tacos expire, all reasonable taco investors know that their investment will go to $0 in the near future, therefore no expectation of profit.

It's amazing how broadly security is defined and enforced. The only examples I was able to discuss with the SEC that were not securities were when the asset being sold could not reasonably generate a profit and could not be transferred. Basically like selling a product or accepting a donation.

There is also securities case law where a company sold a security to a single person or very few people and they were sued successfully.

> That's what I understood from my call with the SEC. That if anyone could reasonably expect a profit it satisfied that bullet in the Howey Test.

“reasonably expect”, in law, imposes an “objective” standard; the mere subjective expectation of a buyer won't meet it, the court applying the test will need to find that the expectation was objectively justified in the concrete circumstances that existed. It's a much higher bar than merely did any individual buyer have a subjective expectation of profit.

I agree, the expectation has to be objectively reasonable.

If the coin has a mechanism where it can always be bought for $1 forever it's reasonable that you can't expect a profit.

But ICOs don't do this. They limit quantity to drive demand of people hoping their limited resource will be worth more in the future.

What about taco futures? I would prepay for tacos now, knowing that it's a stable investment that will likely have returns at least as good as inflation.

If you invest money and the money is used by the taco company to grow their business and your taco futures are transferrable and the value of a taco future can go up through the efforts of the company (their tacos becoming more delicious and therefore going up in price), then I think so.

In other words, you’re buying shares in a Taco company...

I think the example was transferable coupons for free tacos which don't expire.

They are certainly not shares. But could you turn such a token into an investment opportunity? Certainly you could.

The stunning reality is that Blockchain technology makes practically everything a security. SEC's wet dream.

It's probably why, on some level, all coupons carry the disclaimer that they have no (or nominal) cash value, and are void if tranferred.

Yes, ITOs would fit the bill, IMO, of a security.

Here is the big reason why. If you are creating an ITO, you are implicitly promising that you will provide tacos to someone in the future.

It is a taco future. You can't just create futures, even taco futures, without falling under regulations.

THAT is the problem with ICOs. Look, if you just want to sell a cryptocurrency, that has ALREADY been created, you won't run into any issues with the law. There is nothing illegal about premining, and selling a crytocurrency.

The problem is when you say "This cyptocurrency represents stake in something that doesn't exist yet, but I totally promise that it will exist in the future". No. Thats a future. Thats a security. If it doesn't exist yet, you can't sell it without falling under security laws.

Agree with the idea re: futures in general, but there are presales for physical goods that most agree aren't a security...

The SEC uses the Howey Test:

1. Was there an investment of money? (money is actually broadly defined to mean anything of value)

2. Was there an expectation of profits from the investment? (this is easy to prove because it's the opinion of the investor)

3. Was the investment of money in a common enterprise? (this means are the interests of the investor and company aligned, or does the investment go into running a business)

4. Does profit come from the efforts of a promoter or third party? (This means is the investor mostly powerless in having their investment go up our down in value)

In your WoW example:

1. Yes

2. Probably for someone

3. Yes, the money is used to develop the platform

4. Yes, if Blizzard hypes their coin or if you can trade it on an exchange

I think the biggest difference between an ICO and a digital good is that ICOs are traded on exchanges. If you buy a digital good and can only use/redeem/trade on the company's platform then it is not a security.

Not being that familiar with WoW, wouldn't it be classed as income more than speculation? These people grinded away at a game and earned "gold", now they want to convert it into a different currency.

Doesn't seem speculative for the people playing the game. Though for a trader it is.

Fail to see the difference between buy/sells on the company platform compared to a third party. Both could be used for speculation.

The difference from what I understand is an exchange vs a platform. A platform has utility, an exchange is investing. On an exchange you can trade one currency for another to ideally make a profit. On a platform you buy/sell as part of using the system.

An exchange is a platform...

I'm not sure you can hand wave the "expectation of profits" factor as easily as you did. Seems like it would have to be a reasonable expectation of profits and would probably have to be true of the majority of the purchasers.

Imagine that I bought $10k worth of Chuck E. Cheese tokens and I could convince the SEC that I sincerely expected the value of those tokens to go up substantially. I doubt that would be enough to meet the Howey requirements, even if my expectation was sincere.

From my conversation, I understood "an expectation of profits" to mean from a reasonable investor. In fact no one even has to complain if the SEC thinks someone could have expected profits then it satisfies that bullet in the test.

Fraud is more about whether you were lied to not whether a product could be lied about.

Probably not a security. But transferable WoW gold has bigger problems -- money transmitter laws. It would make Blizzard a money transmitter like E-gold, [1] or liberty reserve. Any centralized e-money issuer is doomed. That is an important part of why bitcoin exists.

[1] https://www.wired.com/2009/06/e-gold/

Can you please elaborate on this exception:

"can be returned for what you paid for it"

This seems like a safe harbor if it's true! This is huge. So, an ICO with this clause would require the company to keep all the money raised on reserve, but then if the token goes up in price and never goes back down to the original level they can start using that surplus money. Kind of like a bank does with fractional reserve lending.

Do you have any more info on this?

What surplus money? The issuer no longer has the coins, but USD instead. If they make a second offering at a higher price later, they'll need to keep that money in reserve as well or else the new coins will be unregistered securities.

Well, the issuer has USD / BTC whatever but has to keep full reserves to be willing to cash everyone out in a case of a "run on the issuer".

This is a worst case scenario and realistically they can probably spend half of the USD / BTC / whatever raised on actually running the business.

As the token goes up in price, less and less people will want to buy at the current price. At some point issuer insure themselves against the remote possibility of the price crashing and people making a run on the issuer, by buying out-of-the-money call options if they can find some underwriter.

Then the underwriter's issuing the securities, and the issuer can spend some or all of the money protected by the call options / insurance.

This is completely wrong on so many points, I truly doubt that you are even honest about talking to Mr. Villardo. He wouldn't be that stupid to even insinuate something along those lines. Magic the Gathering Trading Cards would be classified as securities by the card printing company with your silly interpretation. After all, they are transferable, the value of the rare cards go up the more popular the game/network becomes, you can't get your money back from the store or the company if you wanted to return your pack of cards, so it's a security? Please. I'd recommend editing your post so you don't come off as clearly clueless.

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