Below I explain in detail why I think there are only two ways crypto-tokens are not investment securities:
- All the tokens are obtained for free, or essentially free when they issued. To correspond with how restricted securities normally become unrestricted without reporting under some exemptions, ideally 6 months to a year should have transpired before these tokens are significantly resold to the public for consideration greater than significantly no cost, so that it can't be argued there was a transfer gimmick obfuscating the actual economic substance; or
- The tokens are primarily obtained for use cases and/or for furthering the Inverse Commons that is the platform, and not any significant expectation of appreciation of value of the tokens.
Bitcoin had the best model to be honest. It got launched, everyone was free to access the software and start mining. Sure, the creator mined some, but who in hell would know that they would be worth anything? It was worth 0 back then. That's the main difference. Never will be the same post-Bitcoin. The scenario cannot be recreated. Now everyone is looking for "that coin". When people was back in the day playing with Bitcoin, they did it out of curiosity. The early investors mined and bought something that was basically worthless. They deserve a lot more Bitcoin than a guy that comes years later when it's stablished and very promising technology.
I thus argue that Bitcoin significantly avoids being an investment security. There is a bit of concern around newly created tokens since Bitcoin became an investment speculation, but classifying only some of Bitcoin's tokens as securities would destroy fungibility and the tokens may be quite tangled by now. It appears Bitcoin is too large of a phenomenon now for the government to attack it on such dubious technicalities, as a popular outrage would likely ensue.
I argue that most if not all Altcoins have failed to achieve the above two exceptions and thus are illegal unregisted investment securities. Whether you buy or sell them is dependent on your appraisal of risk, timing, and whether you think they will still appreciate in value regardless. In particular I would tend to avoid Altcoins which have had prominent community members spouting off about the size of their HODLings, their "holding forever" pledges, their "only buyers, no sellers", "buy the dip", and other forms of inciting an expectation of appreciation of value. IANAL so readers should consult their own attorney.
So considering the three Supreme Court Howey test criteria explained in detail in my prior post:
A. Investment of money
B. Common enterprise
C. Expectation of profits "significantly" due to efforts of others.
A. Investment of moneyNearly all crypto-tokens today require an investment of money, except perhaps for Dogecoin if the mined coins were donated away and certainly for those who mined in the early days of Bitcoin where you could obtain coins just by letting a miner run in the idle cycles of your laptop with inappreciable electrical cost. The only chance a new altcoin could have to avoid this specific criteria of the Howey test would be either give away all the tokens for no "specific consideration" that is an appreciable cost cost for the recipient. If all the users were able to obtain all the tokens they needed for the typical use case via mining on their home computer with idle cycle and inappreciable electric cost, then there would not be any investment of money. This is because the investor must be capable of sustaining a loss in order for an financial instrument to classified as a security:
https://scholar.google.com/scholar_case?case=4524095741732962732&hl=en&as_sdt=6,33&as_vis=1&kqfp=10330650611816444522&kql=132&kqpfp=14710406364156655404#kqAn "investment of money" under Howey means the investor must have committed his assets to the enterprise in such a manner as to subject himself to financial loss. SEC v. Pinckney, 923 F.Supp. 76, 80 (E.D.N.C.1996).
B. Common enterpriseAll crypto-tokens where the tokens have been otherwise classified as securities via the Howey test, are also common enterprises due the least restrictive horizontal commonality test, because all participants' gains on their token values are common since tokens are fungible. There does not appear to be any way for any crypto-token to avoid this criteria of the Howey test.
The following is an erroneous argument (from a law professor!) because the horizontal commonality violatedby the orthogonality of the success of the platform(s), applications that use tokens, and the appreciation of value of the tokens themselveshinges on the violation of the third criteria "
C. Expectation of profits "significantly" due to efforts of others". Meaning that if all those obtaining tokens are interested primarily only in the platform and value created from applications that use the tokens, and not significantly from any appreciation of value of the tokens themselves, then the third criteria is not fulfilled thus being irrelevant that then the horizontal commonality is also lost:
http://lawbitrage.typepad.com/blog/2014/11/cryptoequity-regulation.htmlCryptoequity may not meet the common enterprise requirement, either. Courts have interpreted a common enterprise to exist when an investor's gain is tied directly to the success of the promoter (or a third party), or at least generally dependent on the promoter's efforts. Applying this "vertical commonality" requirement to cryptoequities, however, indicates they are not securities due to the potentially massive gap between the success of a platform (i.e., the promoter) and an individual token holder.
Individual developers and entrepreneurs may fail using an otherwise successful platform. The converse may be true as well. Tokens may be interoperable so that holders can use them on multiple platforms, or export their underlying applications or projects to other platforms. The fact that Ethereum's platform was recreated on the Bitcoin platform suggests that very little intrinsic relationship exists between the success of a token holder and any particular platform, and certainly not something like a passive investor's relationship to a single company's management. And depending on how they develop their applications, individual token holders may find their purchase to be worthwhile or a waste of money. This potentially different payoff undermines the common enterprise in the "horizontal" sense (i.e., among token holders).
C. Expectation of profits "significantly" due to efforts of others.When tokens are created and issued (whether it be an ICO or tokens created+assigned during mining), if they are acquired primarily for investment and not primarily for use (in what ever ways a token can be used other than for holding for appreciation of value), then there is an expectation of profits due to appreciation of value.
The fact that no investor is in control of the decentralized collective "common enterprise" qualifies for the "due to efforts of others" clause of this criteria of the Howey test:
https://scholar.google.com/scholar_case?case=4524095741732962732&hl=en&as_sdt=6,33&as_vis=1&kqfp=10330650611816444522&kql=132&kqpfp=14710406364156655404#kqinvestment contracts may be found where the investor has duties that are nominal and insignificant or where the investor lacks any real control over the operation of the enterprise
So the only way a crypto-token can potentially avoid qualifying for this criteria is for there to be no expectation of profits, either because the tokens are never obtained for investment or always the primarily consideration is the use value and not the appreciation of value. As documented in my prior post and here in another example, if the primary consideration is the use value, then there is no expectation of value appreciation:
http://law.justia.com/cases/oregon/court-of-appeals/1975/535-p-2d-109-2.htmlJet Set is a nonprofit corporation, organized under the laws of Washington in 1970 for the purpose of owning and operating an airplane in order to provide vacation travel for its members. The club scheduled flights to fixed destinations. Members were permitted to reserve space on any flight on a first-come, first-served basis; however, scheduled flights were often canceled if there were insufficient reservations. Members, in addition to membership fees, paid approximately one-half the cost of commercial airline fares for their flights. Flights were limited to particular dates and destinations. Membership also included participation in certain social activities sponsored by the club, including parties, ground accommodation packages and social activities at some destinations. Memberships in Jet Set were transferable.
After Jet Set was incorporated in 1970 "select memberships" were sold for a price of $1,000. The proceeds from the sale of these memberships were placed in escrow until Jet Set secured the use of an airplane. Approximately $70,000 was raised from the sale of these memberships, which were lifetime and nontransferable in nature, and entitled the holder to fly on any Jet Set flight for $20. These memberships were also subject to monthly dues.
One might argue that proof-of-work miners sell tokens for profit margins (not gains) and thus the tokens are not initially obtained for investment. But I think the court has made it clear that no obfuscation gimicks will outweigh the actual economic substance, which is that miners are essentially issuers who transfer the created tokens to recipients in exchange for specific consideration and if those recipients are obtaining them with an expectation of appreciation of value, then this Howey criteria is fulfilled.
The following correct argument (from a law professor) is basically stating that if the primary reason for obtaining tokens is for use cases and/or developing an
Inverse Commons ("the platform") and not significantly for appreciation of the tokens' value, then there is no expectation of profit due predominantly from the efforts of others, but rather an expectation of benefits of a common ecosystem. The key is that all those obtaining the tokens must have this expectation. In the case of Ethereum, it is obvious that buyers of their ICO were expecting gains from appreciation which meant they were depending on the efforts of others. That can be probably be documented from threads in this forum Bitcointalk.org.
http://lawbitrage.typepad.com/blog/2014/11/cryptoequity-regulation.htmlLikewise, what cryptoequity holders actually purchase with their funds may undermine the sale from being classified as a securities offering. The expectation of profits requirement does not exist when a buyer receives a good, service, or property. This is why crowdfunding platforms like Kickstarter are not subject to federal regulation. It is also why courts, including the U.S. Supreme Court, hold that shares in housing cooperatives or condos are not securities, even when they come with a reduction in rent or income from renting common areas. If cryptoequity is viewed as conferring a right to use "real estate" on a ledger, then, like housing shares, they may not qualify as regulated agreements.
The active involvement of cryptoequity holders--either as developers or entrepreneurs--may limit the applicability of federal law as well. Passive parties that rely on managers to generate a profit are the hallmark of securities investors. On the opposite extreme are partners that equally manage a business: the law presumes that partnership interests are not securities. This is because a partner, as opposed to a mere investor, does not rely on the efforts of others and does not need to be protected by the securities laws in doing so. (The same approach applies to LLCs managed by its members.) Buyers of Ethereum's tokens may be viewed as active participants because they promised their purchase was to use and develop on its software platform (and not as an investment). According to Howey, a purchase motivated to actively "develop" property is not a securities investment.
The following argument (by the same law professor) is a contrived, nonsense (loony), conflation of orthogonal categories (i.e. an ontological or category error). Too often I find people commit these sort of errors of logic. The Supreme Court decided that investments are not securities when they are notes paying an interest rate which were backed by commercial interests and thus not tied to the appreciation of value due to the efforts of others in an enterprise. Crypto-tokens do not pay an interest rate and their return on investment is not primarily due to facilitating short-term cash flow from commercial interests. Although it is true that crypto-tokens may be utilized in some cases for facilitating commercial interests, these are not the only thing backing the return on investment for those who hold the tokens.
http://lawbitrage.typepad.com/blog/2014/11/cryptoequity-regulation.htmlFinally, based on the 1990 Supreme Court case of Reves v. Ernst & Young, cryptoequities may not be regulated because they closely resemble commercial contracts that are obviously not securities. The Reves court held that promissory notes secured by home mortgages or business assets were obviously not securities, and neither were agreements that resembled them. The commercial nature of cryptoequity tokens in providing access to software and fundraising platforms may lead a court to hold the same.