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A ruling on DAO tokens and what it means for other digital coins

I hear a lot of buzz going on in the cryptocurrency and blockchain community with many of them not taking the advice to pay attention to laws and regulations. They simply believe the crackdown on the DAO by the Securities and Exchange Commission (SEC) was specific. Coin Center, an advocacy group for cryptocurrency, remarked that the recent SEC decision was specific to The DAO and would not apply to other tokens:

"We believe that applying the same facts and circumstances test to other tokens will mean that some do not fit into the definition of securities, particularly tokens with an underlying utility rather than a mere speculative investment value."

And I get it. Most of those heavily invested in this space don't have finance, economic, or law degrees. They never worked for a large bank or brokered deals between traders. They see themselves as the next Steve Jobs or Larry Page not realizing that regulations eventually caught up to the technology these founders developed. Cryptos and tokens are no different, especially when it comes to ICOs.

If you read the roughly 20 page report the SEC made public, the SEC is making it clear that they are going to pay more attention to ICOs and cryptocurrencies as the rise of distributed technology is disrupting financial markets. They highlight that the automation of certain functions through this technology, “smart contracts,” or computer code, does not remove conduct from the purview of the U.S. federal securities laws. They then conduct an analysis to find that The DAO tokens are securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. To those investors and developers who did not see this coming, a wake-up call is in store.

The report states:

"All securities offered and sold in the United States must be registered with the Commission or must qualify for an exemption from the registration requirements. In addition, any entity or person engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration."

This means those entities selling tokens to raise funding for infrastructure need to pay attention whether they are financing like traditional corporations by issuing shares. Is there an investment contract in place? Do stakeholders expect to earn a profit on their investment? Are voting rights limited just like the voting rights of corporate shareholders are limited? The report answers these questions stating the following:

  • "Under Section 2(a)(1) of the Securities Act and Section 3(a)(10) of the Exchange Act, a security includes “an investment contract.” See 15 U.S.C. §§ 77b-77c. An investment contract is 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."
  • "In determining whether an investment contract exists, the investment of “money” need not take the form of cash. See, e.g., Uselton v. Comm. Lovelace Motor Freight, Inc., 940 F.2d 564, 574 (10th Cir. 1991) (“[I]n spite of Howey’s reference to an ‘investment of money,’ it is well established that cash is not the only form of contribution or investment that will create an investment contract.”)."
  • "These facts diminished the ability of DAO Token holders to exercise meaningful control over the enterprise through the voting process, rendering the voting rights of DAO Token holders akin to those of a corporate shareholder."
To break it down further, the SEC found that The DAO tokens are securities for two main reasons:
  1. Investors in The DAO invested money and did so with a reasonable expectation of profits
  2. The prospect of profits on their investment in ETH in the DAO was derived from the managerial efforts of others. 

If your ICO meets this criteria or you're investing through a ICO, heed caution. And if you have to sit there and question whether or not your "token" is a security, go the SEC website, contact a lawyer and do more research before thinking laws and regulations won't apply to you.

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