Are Ethereum and Blockchain Based Token Sales Securities?


The invention of ethereum has unleashed a boom in token sales with hundreds of millions of dollars raised so far from the general public, but are these token sales securities?

That is the question addressed by Perkins Coie partner Dax Hansen and associate Josh Boehm in a presentation at the Cyber Initiative at Stanford Law School.

The lawyers say that “substantial funds” are being raised through token sales and “regulators, law enforcement and law makers are paying attention.” Suggesting that legal advice may be necessary when raising funds through blockchain based ICOs.

The test is laid out in the case of Howey which “requires (1) investment of money, (2) in a common enterprise, (3) with expectation of profits, (4) from the efforts of others.” As can be seen this is a very broad definition with final classification much dependent on specific facts.

Let’s begin with the first requirement: investment of money. Is eth money? Here, bitcoin might come to assistance as it is somewhat similar to eth and has had a number of cases.

The general conclusion from these cases is that bitcoin is money or commodity/property depending on whether the statue refers to money or property. That is, bitcoin is both.

Eth differs somewhat from bitcoin, including in monetary qualities such as not having a fixed amount as far as is currently known, therefore judges may take a different view, but it is probable they would conclude eth is money.

The partners say, without much elaboration, that “token sale are generally an investment of money. The common enterprise prong is easily met in most cases where there is promise of financial return.”

Most ICOs suggest there would be some sort of profit for the investors, whether through transaction fee shares, token purchases through profits or a distribution of profits in a dividend format. Therefore, that requirement is also met in most cases, but the partners say:

“The “expectation of profits” and “efforts of others” prongs are often pivotal in token context as, ideally, token purchasers are incentivized to use tokens as active contributors in the network.”

Meaning that profits may be from their own efforts, or so perhaps classified, based on the specific facts. These, however, are the easier questions but in some cases we may need to ask who exactly is undertaking a token sale, is it the developers or the smart contract code?

The case of the DAO, for example, doesn’t easily fit with Howey’s test because the eth didn’t quite go to anyone, but to the smart contract.

We can say the developers coded this smart contract, but we can easily imagine numerous off-the shelf templates and, if not, the developers are not being rewarded for their code because they have no control over the smart contract.

In a typical crowdsale (and many ICOs appear to be no different from a typical crowdsale in which case the partner’s analysis seems to apply), the money goes to a human or a company with directors. In ethereum based token sales, the money might go to a machine which is controlled based on specific unchangeable rules by all the investors.

In effect, this is very much decentralized, so who would be liable to comply with all sorts of requirements that apply if Howey’s test is met, including potential FinCEN requirements to register as a money transmitter? The smart contract certainly can’t do so.

If we are to say the developers, then we might have to ask whether the developers are investing money, whether they are engaged in a common enterprise, for profit, and through the efforts of others.

The last leg clearly fails on a prima facie analysis. However, we can imagine more complex scenarios. For example, if developers willfully mislead the public regarding the functions of the code. As in, if they say it can’t be hacked, or if they say it does one thing when it does something else.

Conceptually, we would want to prevent developers from doing so, therefore most may think some sort of accountability, including criminal sanctions, may be desirable. On the other hand, the code is open to all to see, but, not all can read code.

The preferred way here is for the industry to set up a non-governing body that audits or quality checks project, in an indicative manner. We can then assume those projects which do not willfully submit to the process are to be avoided and those investors who invest in them when aware they have not submitted to the process should bear all responsibility, including being misled.

For this to work, the body should be supervised by a regulator so as to keep the quality checkers in check. However, America’s civil servants have shown little innovation in their regulatory approach to this very new space.

That means other jurisdictions, in particular Britain and Switzerland, have a strategic opening to gain potentially considerable competitive advantage at insignificant cost by taking the initiative.

If they do, then cutting edge innovation may descend to their shores which, even if it is a small amount such as half a billion, would nonetheless provide their nations with considerable marketing advantage, making them more attractive for other, related areas.


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