Since the release of Bitcoin in 2009, cryptocurrencies and digital tokens powered by blockchain technology have garnered the attention of investors, financial intermediaries and government agencies. Sales of digital tokens representing cryptocurrencies or some other digital asset or utility in so-called initial coin offerings (ICOs) have provided over $10 billion in capital to technology startups, and the aggregate market value of digital coins has surpassed $325 billion. ICOs have been typically open to the public through website platforms that link to white papers describing a startup’s technological proposition. More often than not, ICOs fund little more than concepts and ideas rather than development stage businesses. Staying largely under the radar of financial regulators, many ICOs have been a source of fraud, market manipulation and the financing of illegitimate ventures.
The investigative report of the Securities and Exchange Commission (SEC) on The DAO in July 2017 served as a point of departure for the ICO marketplace. Over a 30-day period in mid-2016, The DAO, a digital decentralized autonomous organization initiated on the Ethereum blockchain, issued digital tokens worth $150 million to fund various “projects” that would be voted on by token holders. Investors in the tokens would share in the earnings from these projects and could sell DAO tokens on the open market over cryptocurrency exchanges. The SEC found that The DAO tokens were in fact securities under longstanding securities law principles and that any offer or sale of the tokens was subject to registration with the SEC unless there was a valid exemption. The SEC applied the Howey test, which dates back to 1946, in its analysis. Under the Howey test, a digital token is a security if it represents an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. The SEC concluded The DAO token squarely met the criteria under the Howey test, and found that the tokens were securities sold without registration or a valid exemption. The SEC also indicated that the platforms that traded The DAO tokens were required to register under a national securities exchange or operate under an exemption. Continue reading Cryptocurrencies and Digital Tokens as Securities