Which Tokens Are Securities and Which Are Not? A User’s Manual to SEC Qualifications

The legal status of ICO tokens is a matter of contention, especially since the US SEC has been cracking down on the illegal sale of securities. This article explains in more detail what the SEC is looking at.

Recent moves by the U.S. SEC suing cryptocurrency-based projects for violating securities legislation have troubled the wider community of innovative entrepreneurs. The legislation in question seems to be too complicated to be comprehended by a single person who is not an expert in red-tape complexities of the SEC’s inner workings.

However, recently a team from lawless.tech has published a post explaining in layman’s terms what a company should do and what it shouldn’t if it doesn’t want its tokens to be handled by the SEC, and to find itself in a courtroom.

The primary complication entailed by launching an ICO relates to the risk of being subjected to securities laws and restrictions if the project’s token has been deemed a security, the lawless.tech team writes. This may lead to increased token sale costs while also making the whole process longer and much more complex. In addition, an issuer company can get involved into litigation, both by the regulators or its own token holders. Notable examples include the lawsuit filed against Tezos, Giga Watt mining project litigation, and the contributors’ lawsuit against Centra startup.

The post quotes the Securities Act of 1933 which defines a security as  “any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a ‘‘security’’, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.”

Tokens that are likely to be deemed securities

This seems too complicated to comprehend, and effectively means that the SEC, if it wills, may consider almost anything a security. Well, it only seems so. According to lawless.tech, there are certain criteria that draw the SEC’s attention.

  • Ownership rights and interests in a legal entity, including a general partnership.
  • Share of company's profits and/or losses, or assets and/or liabilities.
  • Partnership in a legal entity.
  • A creditor or lender status, or rights to claim in case of bankruptcy.
  • Option to convert a non-security token into an asset with one or more aforementioned interests.
  • Repayment or dividends obligation from the issuer.
  • An option to purchase said investment interests in some form.
  • If tokens are marketed with promises of profits.
  • If an ICO is conducted for developing of the platform, it will also be considered as a security.
  • Company's equity interest.
  • A feature allowing to convert a non-security token into a token or instrument with one or more investment interests.

What makes a token not a security

However, this isn’t enough, lawless.tech points out. A project has to meet at least some of the requirements below so that SEC will be convinced it doesn’t illegally sell securities.

  • To program, develop, or create the platform features or mine digital assets within the system.
  • To access or license the system.
  • To collect fees for said access or license.
  • To provide the system with a service.
  • To use the system and its outputs.
  • To trade the system’s produce.
  • To contribute labor or efforts to the system.
  • To sell the products of the system.
  • To vote for changes in the system in terms of its functions and features.
  • To receive a discount for company services if such discount is fixed.
  • To receive a product of the company with a fixed discount or bonus.
  • To receive a product earlier than wide audience.

The lawless.tech team recommends companies to avoid marketing their tokens as investments, i.e. they shouldn’t promise value growth, profits, and exchange listings. Additionally, it would be reasonable to develop an MVP or a whole platform prior to holding an ICO, and to make the code open-source as it would convince the SEC that anyone participating in the campaign isn’t seeking profits on investment but merely contributes to the development of a project.