To Be or Not to Be a Security: Which Tokens Might Be Qualified as Securities in the USA

In July 2017, the United States Securities and Exchange Commission reported that some digital tokens can be qualified as securities. The Howey Test, Family Resemblance Test, and Capital Risk Test, to name a few, are applicable to determine whether certain tokens are securities, and they will be described in upcoming articles. Considering the recent SEC actions against Munchee and AriseBank, resulting in litigation and halted ICOs, the lawless.tech team finds it necessary to share the essentials about the border between a utility and security token, and how to avoid crossing it.

The primary complication entailed by launching an ICO relates to the risk of being subject to securities laws and restrictions if the project’s token has been deemed a security. This may lead to increased token sale costs while also making the whole process longer and much more complex. In addition, an issuer company can get involved into some litigation, both by the regulators or its own token holders. Notable examples include the lawsuit filed against Tezos, Giga Watt mining project litigation, and the contributors’ lawsuit against Centra startup.

However, it is possible to minimize the chances for a token to be deemed a security by following several key principles and exercising basic caution while planning and implementing a project promotion campaign.

What are Securities?

According to the Securities Act of 1933, 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.”

In fact, considering the spectrum of concepts combined under the word “securities.” the SEC doesn’t need to go for some bureaucratic tricks in order to accuse projects of securities laws violation.

Which Tokens Might Be Considered as Securities?

Therefore, if a token meets one or several of the interests below, it is likely to be considered a security token:

• Ownership rights and interests in a legal entity, including a general partnership.
• Share of company's profits and/or losses, or assets and/or liabilities.
• Partnership in a legal entity.
• A creditor or lender status, or rights to claim in case of bankruptcy.
• Option to convert a non-security token into an asset with one or more aforementioned interests.
• Repayment or dividends obligation from the issuer.
• An option to purchase said investment interests in some form.
• If tokens are marketed with promises of profits.
• If an ICO is conducted for developing of the platform, it will also be considered as a security.
• Company's equity interest.
• A feature allowing to convert a non-security token into a token or instrument with one or more investment interests.

Which Tokens Shouldn’t Be Qualified as Securities?

In addition to not meeting the aforementioned criteria, a token is less likely to be defined as a security when it gives its holder at least some of the of following rights:

• To program, develop, or create the platform features or mine digital assets within the system.
• To access or license the system.
• To collect fees for said access or license.
• To provide the system with a service.
• To use the system and its outputs.
• To trade the system’s produce.
• To contribute labor or efforts to the system.
• To sell the products of the system.
• To vote for changes in the system in terms of its functions and features.
• To receive a discount for company services if such discount is fixed.
• To receive a product of the company with a fixed discount or bonus.
• To receive a product earlier than wide audience.

Companies should plan their marketing campaign wisely and don’t market tokens as investments. Also, it’d be better to avoid  promises on future profits and exchange listings. Regulators clearly define that it isn’t enough just to label tokens as “utility.” The two more important points are to develop a platform or at least a MVP prior to the token sale and to make the code of the future product open-sourced. It’ll help convince the SEC that the token holders are simply willing to participate in the platform’s development and aren’t expecting any profits derived from the efforts of the project’s team.

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