So, follow-up question: are Team Fortress 2 hats securities? It arguably meets all four points: Valve gets money for releasing hats into the TF2 ecosystem, TF2 is a common enterprise, hat speculators expect to make a profit through simple capital appreciation, and the hat owners rely on the effort of Valve to develop TF2 for their profits.
In game digital assets is an interesting hypothetical. Whether or not it satisfies all the prongs of an investment contract analysis is less important than the overall size of the market. I think if blockchain tokens were doing daily vols similar to Team Fortress 2 hats, that the SEC would have never felt the need to comment. But that's just conjecture not anything you could hang your Team Fortress 2 hat on :)
Technically, I'd suggest the answer is yes. But there isn't enough money involved to warrant regulation or for a tax department to do the diligence to collect. Valve paying corporate tax on the hat sales is good enough.
The IRS still defines cryptocurrency as a "product", not a security. [1] It is to be treated as such in your taxes. I think that's the best indicator of the state of affairs. They provided detailed guidelines and answer many common questions 2014. [2] That may change but I'm pretty comfortable with not treating it as a security for the moment.
Also, since were treating it as a product, I view contributing to Ether based ICO's as not a sale of my "product" since the product is still the same, just tied to a smart contract. I see it the same as buying a physical product and then exchanging it for another physical product at the same store. I don't incur taxes when I exchange.
I think if you're offering your cryptocurrency/token in a crowdsale/ICO, then it should be seen as a security, because you're essentially offering people the opportunity to "invest" in your company's potential future.
I mean, maybe if the currency is pre-mined and you're buying a token from a seller. But what about Satoshi? Did Satoshi issue a security by releasing the blockchain? I mean, all he did was write a program and released it in the wild. That fact that other people decided to give value to his tokens doesn't mean he sold securities to the general public.
I think we need to reconsider from the ground up how securities should be regulated. There's been some promising rhetoric with the Jobs act but it seems like mostly talk with the SEC dragging their feet.
I remember explaining Reg-D to a progressive friend of mine. His initial reaction was that I'm making the law up, and there's no way the government actively prevents non rich people from early stage investing. We took a bet and I won. When I told him reg-d is backed by progressives then all of a sudden he saw the value in it. Funny how that works.
You can't patent software so thanks for making my point. You can't patent math either. Crypto is math based money so now the SEC is basically trying to regulate math. Any reasoning person will see the futility in that.
Paradigm shifts require new rules. You can't regulate a car the same way you regulate a horse. But when we allow buggy whip manufacturers to influence regulators for the interest of their personal bottom line, then the public looses while the intrenched interests win.
Wrong on all counts. Software was patentable in the US. And there was a long, long time where there were a lot of patents whose only "innovation" was doing something on a computer.
"Crypto is math based money so now the SEC is basically trying to regulate math. Any reasoning person will see the futility in that."
Any reasoning person will know that what you said is not accurate in the least.
"Paradigm shifts require new rules"
This is NOT a paradigm shift. Literally you are arguing to go back to the days when software was patentable, and that "on a computer" should be all that's required to get a patent.
"You can't regulate a car the same way you regulate a horse."
No, but I can regulate what they are trying to do, which is provide transportation, the same. Likewise, these coins are not doing anything new. They are doing the exact same thing, just in a new package.
what about airline miles? the only reason to get airline miles is an expectation of profit - if it's cheaper than paying cash. that difference is a profit. ( I don't think miles are a security, just as ethereum isn't ).
I think the SEC's position is that, for purposes of securities law, some cryptocurrencies are securities and some are potentially not. Presumably, it'll turn on the Howey test noted in this thread. Whether it counts as a security for tax law purposes is probably orthogonal.
The tying to a smart contract is what is important - otherwise the token would not have any value. This is like paper - which is a commodity (product) and ink which is also a commodity (product) - versus a security written with the ink on the paper which is something else.
What else could they be other than securities? That's the purpose they serve.
From Investopedia: "A security is a fungible, negotiable financial instrument that holds some type of monetary value. It represents an ownership position in a publicly-traded corporation (via stock), a creditor relationship with a governmental body or a corporation (represented by owning that entity's bond), or rights to ownership as represented by an option."
That was the design of tokens from the beginning, and they were created for the purpose of being securities.
It should be no surprise that they're regulated as such.
Would it be a security in a future where the world runs on Ethereum and it is used to secure the decentralized network? No.
Is it a security today? That's complicated.
There is a lot of legal discussion in the token space about when the transition from security to commodity happens. Unfortunately the SEC provided no guidance on how it thinks about this question, but lots of people are working hard to figure it out.
Can we make a cryptocurrency that automatically only has value iff it is not declared a security by the SEC?
Whenever it is not declared a security, there is an expectation of profits, which would now qualify it as a security under the Howey Test. But if it is then declared a security, then there is no expectation of profits, which would subsequently disqualify it as a security under the Howey Test.
It likely wouldn't cause anything interesting to happen because real-world law doesn't work like "smart" contracts or computer code. You probably want to read this classic article for a good explanation:
The expectation of profit is at the moment of investment. So even if the SEC declares it a security, you cannot go back in time and change your investors' expectations...
In order to make this happen you'd need to give away your token to intended users for free, convince them to use it enough to prove it has utility without expectation of direct profits from appreciation of the token itself. That should be justification for the SEC to declare it NOT a security. Then you register it as a security and everybody makes a profit. I think it's an interesting approach and really the right approach. Prove utility before investment.
I struggle with point number 4, "Did token holders rely on the efforts of others for their (expected) profits?".
It is the effort of (early) investors that make/made Ether out of their own work (mining) that creates the token supply and because Ether is needed in order to interact with Ethereum DApps, it's the demand for the token that makes it gain market value in exchanges. This seems to suggest that there is an effort on the part of the investor.
Many ICOs will simply state they are out of limits for US investors and again we see that regulators like democracy and capitalism but don't really want it to be accessible to _everyone_.
That's what I thought. If I buy an Apple stock, I can't meaningfully contribute to the success of Apple (outside of investing more money). But if I was an early investor of ETH, I could build an Ethereum smart contract that is useful and thus provides value and thus makes the price of ETH go up as more people buy it to use my smart contract.
Would it be correct to say then that as long as there is at least 1 useful smart contract that the Ethereum Foundation does not solely control, ETH would fail prong 4?
The issue isn't whether you can hypothetically contribute to the potential security's value but rather is whether the success of the venture depends primarily on the efforts of others. There's a lot of grey area between being a regular Joe small shareholder in a massive publicly traded corporation (no participation) and being the sole owner and manager of a closely held corporation (clear participation). Its worth noting that commodity market fluctuations don't count as the efforts of others (e.g. Noa v. Key Futures where silver certificates weren't considered a security even when sold by an investment firm which marketing the certificates as investments).
There's a trend in the modern interpretation of Howey toward something called the "risk capital test," which states that a scheme which raises capital to finance a venture should be considered a security. I'm not sure Ether meets that test and it's a minority rule anyway but modern Howey jurisprudence is quite flexible because scam artists tend to be extremely inventive in getting around the Securities Act.
Ultimately the decisive factor in court is likely to be the unfortunately vague but essential standard "Do the investors in the scheme require the protection of the Securities Act of 1933?" The lack of a comparable regulatory system to protect the public against Ether scams counts against exclusion from the Securities Act. Otherwise, I personally think the case for Howey is weak here, but that's because the case law hasn't caught up to the tech yet. So we can't predict how a federal court might decide because they very well may revise the existing standards.
I think there might be some missing detail in the article. It could be that the definition of 'others' might be broad, and that the only value requirement is that your expected value would be changed (lowered) if anyone but you invest or work in/with the enterprise.
As such others would refer to both investors and workers/participants in the enterprise. There are parallels to this thinking in other (non US) legislation, which quite likely come from the same source.
And both Apple and ETH would certainly lose value if I were both the only investor, and active participant in the enterprise.
Doubtful. While you can't contribute to the success of Apple, you can certainly buy securities in a startup and meaningfully help them succeed (VCs) or buy 5% of Apple and assume some control of Apple (Hedge Funds).
"Many ICOs will simply state they are out of limits for US investors and again we see that regulators like democracy and capitalism but don't really want it to be accessible to _everyone_."
No. They just said that adding the phrase "on a blockchain" is not enough to make what you're doing suddenly different.
I think you misread my comment. What some ICOs already do is to explicitly state they are not available to US taxpayers, it has nothing to do with where the blockchain is located or if one is used.
Since the SEC investigative report concluded the DAO tokens were securities, one of the biggest questions is: are there any factual distinctions between the sale of DAO tokens and the sale of Ether.
I really can't understand why the SEC spent its time on the DAO seeing as the token purchasers essentially agreed by majority vote to null and void their purchase, meanwhile the Ether sale did in fact become binding.
Very interesting, but SEC could have gone after Ethereum but explicitly did not and went after the DAO which was issued on top of Ethereum. My interpretation is that SEC doesn't think Ether is a security
The SEC notice also mentions buyers violating some Section 5. Does that mean that buyers are also at risk here for simply purchasing some tokens that were later found to be unregistered securities? That seems rather chilling.
I think the key language to focus on in the SEC notice is those “participants” who have a necessary role in the transaction of an unregistered offer and sale of securities are liable for violating Section 5 (page 16). Taken to the extreme, one could argue that even buyers of unregistered securities have a necessary role in the transaction but this is not the kind of activity relevant for Section 5 violations. Section 5 activity is more concerned with things like underwriting, offering, issuing, promoting, and soliciting the offer and sale of unregistered securities that lack a valid registration exemption.
Thank you for the response. Could you see this affecting sellers in secondary markets? Most that purchased DAO tokens likely went on to sell them in secondary markets. Would their role as a seller be applied to Section 5?
I think these are also important questions to consider. The valuation of a token is affected if you can't later sell it without commiting securities fraud. I really hope this is not the case.
What about cryptocurrencies then that could as well be seen as crypto assets. Instead of launching a token on Ethereum they could launch a copy of Ethereum. Investors can buy "in" or use it to trade/pay. Premining is common and used to pay for building out the infrastructure of such a system. How can one gov entity power grab and be in charge of an entire global emerging technology. Something does not seem right in this picture.
Ether tokens have a clear use-value. They don't provide holders with any passive income from profits earned by a common enterprise. I am not a lawyer, but in my opinion, the idea that they're securities is ridiculous.
This is a good analysis of how US securities laws relate to tokens:
Something can be useful and a security, according to the SEC. They published an Investor Bulletin yesterday saying as much:
"A virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, unit of account, or store of value. Virtual tokens or coins may represent other rights as well. Accordingly, in certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the SEC or pursuant to an exemption from registration."
Yeah, I also helped out with this. It's a good starting point but is by no means conclusive. Debevoise's franchise argument is wayyyy offbase and is subtle legal marketing BS imo
Is selling new Kanye West sneakers, yeezy's, a security? The resale price is usually 5x the retail price. I know there are some edge cases but how you market it can be the difference between illegal and legal. I think a problem with the DAO token, there was voting rights. A simple token coming off as a commodity should be safe
Neither of your points (price going up and voting rights) are what determines if something is a security. The article does a good job of running through what the law says makes something a security.
No, because it doesn't meet the Howey test. You may buy them with an expectation of profit, but they aren't a common enterprise that depends solely on the efforts of a third person. The effort to resell is solely yours. Now if you and your friends pooled money to buy them and you handled all the transactions, then maybe it'd meet the Howey test.
The issue with the SEC opinion is that the Howey test may come out differently if applied to Ethereum miners as opposed to purchasers. Since miners are not relying solely on the efforts of others. So it's an odd fact pattern for existing case law.
"It represents an ownership position in a publicly-traded corporation (via stock), a creditor relationship with a governmental body or a corporation (represented by owning that entity's bond), or rights to ownership as represented by an option."
"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."
If I presell tickets to my music festival to a reseller who in turn profits in selling it to festival goers, you're basically saying my tickets were securities and need to be registered with the SEC. you see how crazy that sounds. :)
DAO tokens were obvious everything else is just a funny money commodity. Yes, some kid made a way to print your own money in under 30 secs. enjoy it!
I'm so torn. On one hand, I want you to be right, but on the other hand I would love to see the likes of Ticketmaster and StubHub going down in flames at the hands of the SEC.
Nah disagree. Most folks building on top of Ethereum are using token sales as a fundraising mechanism to bootstrap their projects, and these projects are raising $100ms of dollars.
The whole "but, but, these tokens have utility" will get old pretty quickly imo and you can see the signaling with sophisticated projects like Protocol Labs' filecoin offering going the Reg D route.
> Are its profits to come solely from the efforts of others?
I'd say by that standard many tokens do indeed count. Also from Investopedia, by the way. Among the things which count as securities are commodity future options, which I would say is about equivalent to most tokens currently on the market.
again, just because there's speculators on a secondary market buying and selling doesn't mean it's a security. a commodity future option is by default NOT the commodity. In the case of a token – you own the commodity and you have the right to use or sell to someone else – like a carton of milk.
The only difference here it took no cost to create the commodity which is why there exists a market to resell at unbelievable margins.
By this criteria, wouldn't this make art of an artist (fractional ownership) sold by an art dealer a security and therefore subject to SEC registration? Basically tokens are a security because the SEC says so. I haven't seen a good explanation otherwise.
IANAL but I'd assume it is hard to argue that there is a common expectation of profit when purchasing art, even though this is why some people buy art. Furthermore, the profits you would make upon reselling the piece of art are not coming solely from the artist's efforts. The artist got paid for their efforts and your profits are coming from your ability to market the piece and negotiate a better deal. In other words, you have some control over how much profits you gain and the artist is out of the picture (ie. they are no longer spending effort to help you make profit).
But a securities law expert would have a better explanation
I guess something that's important to consider here is that when I wrote this I was considering whether the Ethereum presale in 2014 would be likely to be classified as a "security". I thought theDAO was a pretty terrible project and wanted to illustrate just how broad "investment contract" analysis could be stretched.
So to take your example, should I decide to pre-sell a commission of several pieces of art that I plan on working, the reasonable expectation of profits seems like a reach bc those who buy art do not solely do so to flip it and make a profit. I wonder whether the same could be said for those who invested in Status, Bancor, and Tezos?
Unfortunately, common law tests like "investment contract" analysis are, by design, super ambiguous.
