ICO in Legal Terms: Utility Tokens Sale@lawless
There are plenty of tokens, which give various functionality but from the legal perspective all tokens could be divided into two big groups: securities and non-securities. Due to the popularity of ICOs it’s an important question, which to choose. The previous article covered the ICO phenomenon in broad terms, and now it’s time to explain the first legal model of an ICO — a sale of utility tokens, which are, in their nature, non-securities tokens.
What is Utility Tokens Sale
In layman’s terms, utility tokens sale is a sale of the digital tokens required to get access to the product and/or to use one.
In legal terms, the seller, a company which issues utility tokens and holds an ICO, passes title to such tokens to the buyer, the ICO participant, for a consideration called price under the sale and purchase agreement published on the website.
ICO participants purchase utility tokens as simply as one shops online. And from a legal perspective, it's not much different from ordering groceries from your local supplier.
What are Utility Tokens in a Nutshell
Cryptocurrency industry is rapidly evolving, so new approaches and technologies get invented all the time. In 2017, which has become the year when the concept of ICO that had been conceived a few years before came to fruition and became subject to scrutiny by regulators and governments, the concept of utility tokens has become extremely popular with innovative entrepreneurs. Let’s figure out what it is.
According to monetary theorist Dima Bondar, utility tokens are the tokens which are designed and marketed solely as a means of access to a product. For instance, utility tokens entitle one to participate in eSport tournaments; to take part in a prediction market; or to rent storage space or computing powers. To find out more check Dima’s article on ForkLog (available in Russian).
Cooley LLP thinks that the category of utility tokens includes all blockchain-based assets that do not aim to replace traditional financial instruments. Utility tokens are designed to offer an internal utility that delivers goods or services to the users. For example, when the product is functional, tokens may act as a currency, much like bitcoins do. In other cases, tokens might act as a staking or betting mechanism, membership rights, or give various rights not related to the issuer company.
Peter Van Valkenburgh and Jerry Brito from Coincenter reckon that appcoins give many opportunities for businesses and developers as the latter can freely fund themselves via ICO or presale, give tokens to people willing to use their platform in the future for free, to gain audience, and so forth.
Some might be confused by the term “appcoins”. Dima Bondar explains: “Dubbing a token utility token / appcoin / access token, they usually mean the same thing: the token somehow grants the holder the access to the product or an app’s functionality.”
Thus, considering all above-mentioned, a utility token is a “win-win” situation as projects can fund themselves via selling these tokens and, at the same time, project tokens are useful and necessary for an ecosystem. In addition, a sale of utility tokens is the easiest way of conducting ICO from the law perspective as it requires almost no specific approval or licenses.
What Rights Utility Tokens Can Give to Their Holders
Utility tokens can give the following rights to their holders:
- 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 labour 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 companies 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 the general public.
For instance, Storj and Filecoin grant the right to rent and lease hard drive space, while iEx.ec and Golem give their owners the right to use computational power. Another notable example is Steemit and Golos.io where the tokens enable users to enjoy the platforms by writing posts, posting videos etc. First Blood tokens give their holders the right to play Dota 2 using the project’s platform; TrueFlip tokens enable their holders to participate in a lottery; and AdEx Network tokens can buy one an ad. Sometimes cryptocurrency startuppers go all the way when conceiving new ways to use their tokens: thus, SpankChain tokens entitle their holders to buy and watch adult content and pay to webcam models.
What are Terms of a Token Sale
Terms of Token Sale (or Token Sale Conditions) are an agreement governing the sale of tokens within the sale of utility tokens model. Legally, terms of token sale are a simple sale and purchase agreement with all stipulations inherent in such agreements.
This is further confirmed by the documents the projects used to sell their tokens. For instance, Storj Terms of Token Sale stated that user purchased ERC20-based STORJ tokens during the token sale period from Storj Labs for a payment for such tokens in Bitcoin or Ether. Pursuant to the Gnosis Terms of Token Sale, user also purchased Gnosis tokens (“GNO Tokens”) during the Token sale period from Gnosis Limited for a price as calculated accordingly with a so-called “Dutch auction” model.
The section stipulating Limitation of Liability deserves a closer look. It describes the instances where a company is held liable for its actions concerning ICO and ICO participants. Another important section in such agreements is Disclaimer of Warranties that provides various guarantees and, rarely, a possibility of refund. For those reasons, all potential ICO participants should read those passages carefully and make sure they fully understood them.
Still, such provisions can’t protect a company from all possible legal risks, the most important of them being the recognition of the token as a security. See our previous article to find out more about that.
A utility tokens sale might be the most efficient and affordable way to raise funds via ICO. It could be explained by the general lack of legislation but at the same time a sale of utility tokens provides companies with a great flexibility. Projects don’t have to obtain various licenses or follow the offering procedure applicable in case when projects tokens are securities. All that they need is to stay in line with anti money laundering (AML) legislation and conduct at least basic Know Your Customer (KYC) policy. Due to this projects can cut corners on the legal services.
In addition, utilities tokens give a plenty of options regarding the functionality while all securities tokens, generally, aim to give a profit sharing to their holders although it depends on a particular token model and project’s economics in general.
Simply proclaiming or stating in documents that tokens have their utility isn’t enough. It’s better to be careful and not to give any promises regarding the possible value growth of tokens. Also, a marketing campaign should be cautious regarding the wording it uses so as to not violate any laws.
In the next article, the lawless.tech team will analyze offerings of security tokens and so-called Howey Test that has been quite important for crypto enthusiasts around the world for a while now.
Join https://t.me/lawlesstech to keep the finger on the regulatory impact of lawless technology and learn more about the legal side of ICOs with this series of upcoming articles.