*“If it looks like a duck and walks like a duck, it is a duck” *
The day of reckoning for ICO scamsters might not be very far away as the SEC is seemingly moving things at a breakneck pace to clamp down on the frenetic ‘Token Offerings’ market. Not so long ago, in an attempt to alert investors on how ICO scamsters disguise themselves as legitimate projects by making false claims and bald assertions, the SEC launched a spoof ICO site called ‘Howey Coins’ - which claims to provide token investors a guaranteed upside through monetization of reward points in a regulatory compliant way. They also went to the extent of publishing a convincing whitepaper on that website and clicking on any of the links will direct the user to this page. The SEC followed it up with the appointment of a new Crypto Head to advise on Digital Assets and ICOs and publicly issued a statement in support of ‘Operation Cryptosweep’ - a concerted effort by regulators across the US and Canada to fight fraudulent ICOs and Token Offerings in the cryptocurrency space.
2017 was a landmark year for ICOs in that they supplanted traditional Venture Capital by raising over $6B, and most of the offerings were unregistered. The huge amount of capital raised alarmed regulators across the world, resulting in ICO bans in certain jurisdictions such as China and Korea. The SEC published a detailed report in which they clearly stated that the DAO tokens issued in 2016 were to be considered securities and are therefore subject to the securities laws of the US. Subsequently, the regulator sent subpoenas to ICOs suspected of circumventing the legal procedures involved in a traditional securities offering. This created uncertainty and bewilderment in the crypto community as to which tokens fall under the SEC’s definition of a security and which do not. While the SEC is yet to come out with an update on the classification of tokens as securities, the four-pronged Howey Test is being used as a litmus test to segregate tokens into two buckets: Security Tokens and Utility Tokens. According to the Howey Test, an investment is deemed as a security if it meets all the four criterion defined below:
- It is an investment of money
- There is an expectation of profits from the investment
- The investment of money is in a common enterprise
- Any profit comes from the efforts of a promoter or third party
Utility tokens, by definition, allow token holders to pay for a service offered by the decentralized platform. For example, payment in Ether is required as transaction fees to run computations on the Ethereum platform and users need to pay Siacoin (SC) in order to use Sia’s decentralized cloud storage service. This is similar to loyalty rewards issued by a company to purchase their products and services (Amazon gift cards). However, most ICOs do not have a working product yet and the token-holders holding these tokens are mostly speculators who do so with the explicit aim of making profits on their investments. This could potentially make the case for numerous ICO tokens to be labelled as securities. Projects such as Bitcoin, ZCash, Monero, etc. that have not raised capital through a formal offering of tokens will most likely fall under the bucket of utility tokens along with token offerings that are sufficiently decentralized in the current state such as Ethereum. However, most tokens have the characteristics of both security and utility tokens, which makes it extremely hard to bucket them into one of the categories. At this point, we can only speculate as to where the SEC is expected to draw the line along the utility-security spectrum. On the other hand, some ICOs that focus on tokenizing real word assets are obviously going to be called out as security tokens and, therefore, should register with the SEC. The biggest downside to labelling ICOs as security tokens is that it makes a lot of retail investors ineligible to invest in these risky opportunities and leads to lower demand for their product/service and limited upside to the token value.
In other news, the Indian courts firmly shut the door on retail fiat access to cryptos. A ton of further regulations and announcements are expected in July. Our view is that the Indian elephant will muddle through the whole process of approaching crypto, in time-honoured fashion, but will finally figure it out. In the meanwhile though, these will be interesting times for crypto aficionados in India.
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