Security or utility tokens? The SEC's FinTech department presents a framework for digital assets
Has the struggle for coherent overseas crypto regulation finally come to an end? A framework recently released by the FinTech division of the US Securities and Exchange Commission (SEC) seeks to clarify the question of whether a token is a security. The guidelines provide guidance for evaluating a token according to Howey test criteria. According to the Howey standard, an asset is a security when a person invests their money in a joint venture with profit expectations based solely on the efforts of the promoter or a third party. The FinHub publication states:
Typically, the main question when analyzing a digital asset in the Howey test is whether a buyer has a reasonable expectation of profits (or other financial returns) derived from the efforts of others. A buyer may expect to generate a return by participating in distributions or by other methods of increasing the value of the asset, such as: For example, selling at a profit on a secondary market.
The Howey test as a benchmark
The Howey test is considered the standard tool for asset valuation in the US. Given its requirements, it is little wonder that the SEC mercilessly punished pretty much every initial coin offering that ran before her gun on her ICO hunt. The Authority has classified most of the ICO-derived tokens as unregistered and therefore illegitimate securities. The framework encourages publishers of tokens to re-evaluate them from the Howey test standpoint. It is mainly about the aspect of "justified expectation of profits, which result from the effort of third parties."
Thus, a "reasonable expectation of profit" may be present, for example, if:
- A token gives the holder the right to participate in the profits or profits of the company or to realize profits from the increase in value of the digital asset
- is tradable or traded through a secondary market
or that is expected for the future
- There appears to be little correlation between the buy and offer price of the token and the market price of the individual goods and services that can be purchased with the token
- The issuer of the asset / token could collect significantly more capital than would be needed to set up a functioning network
- the token will be marketed, directly or indirectly, so that the "expertise" of the publisher will provide for growth of the asset or network
- the transferability of the token is one of the most prominent buying arguments
Howey, the second one
The list above includes only a few of the items in the list provided by the FinHub staff framework.
The same applies to the aspect of "dependence on the work (/ expenditure / efforts) of others". The following indicators speak for this:
- The asset publisher, rather than a decentralized network of users, assumes key responsibilities and responsibilities.
- The publisher creates a market for his asset, determines the number of created tokens, sets their course or …
- … undertakes actions (such as token burns) to promote the course by reducing the total number of tokens.
- The publisher plays a leading or central role in deciding on governance issues, code updates, or third party participation in the validation of transactions related to the Digital Asset.
- The issuer owns or controls the ownership of the intellectual property rights of the network or digital asset – directly or indirectly.
These criteria make it easy to understand why the SEC sees most of those tokens as securities that explicitly market themselves as utility tokens. The latter has the advantage that even small investors may invest in an ICO.
Narrow laced corset for utility tokens
But when is there a talk about a utility token? The FinHub employees have also tried to provide more clarity here. A utility token must not pass the Howey test. This is more likely the more points in the following list apply to the token:
- The distributed ledger network and digital assets are fully developed and ready for use.
- Owners of the token are immediately able to use it for the intended functionality.
- The creation and structure of digital assets is designed and implemented to meet the needs of users rather than speculation about their value or the evolution of their network.
- The chances of an increase in the value of the token are limited.
- Marketing emphasizes the functionality of the token, not the potential for increasing its market value.
- Restrictions on the transferability of the token are consistent with its use and do not favor a speculative market.
- If the AP allows the creation of a secondary market, transfers of the digital asset may only be made by and between the users of the platform.
Again, this is an excerpt of the assessment guidelines proposed by FinHub employees.
FinHub experts Bill Hinman, Director of Corporation Finance, and Valerie Szczepanik, Senior Advisor on Digital Assets and Innovation, emphasize that the framework is intended primarily as a guide and should not be construed as legally binding:
This framework reflects the views of [FinHub-]Employee and is not a rule, regulation or statement of the commission. The Commission has neither approved nor rejected its content. This framework, like other guidelines for staff, for departments and the Commission, is not binding.
Turn to STO
However, the effort by FinHub staff should not help the other departments of the agency regulate crypto assets; The framework is intended to provide (prospective) publishers of tokens with directions for correctly ranking their assets. In addition, she understands the rigorous attitude of the SEC regarding the classification of tokens.
Because as the SEC has often proven, a mislabeled ICO can be expensive – for investors as well as for initiators. This is one of the reasons why Security Token Offerings (STO) are becoming increasingly popular.
On our own behalf: In the March issue we dedicated the topic STO to a special cryptocompass special – it's worth taking a look!
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