The SEC and CFTC finally clarified the status of crypto assets – or did they?
Last week the blockchain community celebrated the joint SEC + CFTC guidance on crypto assets. The guidance offers a clear taxonomy of crypto asset classifications and affirms the crucial distinction between tokens by themselves and investment contract relating to tokens which might be a “security”. And while the guidance offers much-awaited clarity, there are still ambiguity traps where crypto projects need to tread carefully and seek expert legal advice. I want to highlight two of these:
1. “Decentralized”. A crucial element for tokens that are classified as “digital commodities” is that the system in which they operate must be decentralized. Footnote 50 (p. 14) clarifies: “For purposes of this release, a crypto system is “decentralized” if the crypto system functions and operates autonomously with no person, entity, or group of persons or entities having operational, economic, or voting control of the crypto system.” This is quite general and vague. The guidance officially recognized 17 assets as digital commodities, but a quick analysis shows that these 17 display a wide range of on-chain and off-chain distributed network and governance models. Projects still need to decide for themselves how to decentralize, but my guess is that entities that merely operate through a thin offshore foundation to distance the founding team from appearing to control the system will come under scrutiny. (BTW, the draft market structure bill has a very high standard for “decentralization” that I wrote about in another post).
2. “Representations and Promises”. Under the new guidance, although many tokens are not inherently securities in themselves, an investment contract can be inferred from the “representations and promises” made by the issuer about their “essential managerial efforts” which would lead a purchaser to expect profits. This is established securities analysis based on the “Howey Test” that was central to the securities enforcement actions brought in the wake of the 2017 ICO craze. However, it remains to be seen how the current and future SEC administrations will apply this test under this new guidance to the ongoing statements and marketing efforts of crypto labs entities issue long after the initial airdrops and other early token distributions.
Crypto token issuers should not be complacent and think that if they distributed their tokens in a compliant manner the tokens are in the clear going forward and can’t be classified as securities. Crypto founding teams should be careful about making forward looking statements about plans to upgrade networks or product roadmaps that would lead token holders to an expectation of profits. Instead, founding teams should follow the guidance and declare at the outset of the project the efforts they plan to take to launch the token and issue a clear public statement when those efforts are completed.
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