When Are Tokens Securities? Some Questions from the Perplexed
Lowell Milken Institute Policy Report (Dec. 2018)
13 Pages Posted: 11 Dec 2018
Date Written: December 10, 2018
The sudden rise of Initial Coin Offerings (ICOs) has created unprecedented challenges for the Securities & Exchange Commission (SEC). Rather than selling stock, ICOs typically raise funds by selling tokens (a type of cryptocurrency) to investors, many of whom hope to profit as the value of such tokens increases. Hundreds of companies developing projects relating to blockchain technology have sold tokens through ICOs directly to public investors without filing a registration statement with the SEC. Such sales are unlawful if such tokens fall within the ambiguous definition of a security.
This policy paper examines the SEC’s response to ICOs. It argues that selling tokens through an ICO without SEC registration requires escaping what we call the “Hinman paradox.” A token can only be widely distributed to the public if the project it is associated with is functional. But a blockchain project can only be functional if its tokens are widely distributed. Blockchain projects with simple, well-defined, and compelling objectives may be able to achieve the requisite degree of functionality and de-centralization so they can sell utility tokens without being subject to securities regulation. However, the SEC’s November 16, 2018 enforcement settlements send the message that non-functional token sales without a clear path to de-centralization will not be tolerated.
Keywords: securities regulation, SEC enforcement, blockchain, cryptocurrencies
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