“I See You ICO”: The SEC Regulates Tokens

Can tokens be securities? The SEC just weighed in.   Background: As a decentralized ledger, blockchain enables users to exchange digital assets — called tokens — without a middleman. The earliest tokens functioned as currency.  No entity issued this currency; instead, the algorithm underlying blockchain dispersed tokens to miners, compensating them for processing blocks.  As cryptocurrencies have proliferated, tokens have found broader uses. Now entities issue tokens to fund projects.   ICOs: Many businesses have launched “token sales,” “token launches,” “initial coin offerings,” or “ICOs” to quickly and cheaply raise money.  ICOs have become so popular that they are “surpassing traditional early-stage VC funding.”  The Decentralized Autonomous Organization (DAO), for example, raised $150 million by selling DAO Tokens; the organization avoided both the expense and delay of complying with the SEC’s reporting requirements for selling securities.  But the DAO ran into trouble.  Hackers stole the equivalent of $50 million from the organization shortly after the financing’s launch.  Though the funds were recovered, this loss prompted the SEC to investigate. On July 25th, 2017, the SEC issued a report.  The “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The Dao” addresses the status of ICO tokens.   Securities? SEC says “It Depends”: The report disclosed when the SEC will consider ICO tokens securities and where they can be traded. According to the report, the SEC will consider the tokens offered in ICOs securities if the ICOs constitute investment contracts under the Howey test.  Under Howey, an investment contract involves the “(1) investment of money (2) in a common enterprise (3) with a reasonable expectation of profits...