Getting our hands around the fast-evolving ICO and cryptocurrency markets may seem like being whipped around in a never-ending spin cycle.
One critical question revolves around SAFTs, or Simple Agreement for Future Tokens.SAFTs, broadly defined, are investment contracts offered by cryptocurrency developers to raise money from accredited investors; as such, SAFTs are considered a security, and an offering of SAFTs must comply with securities regulations. Legal roots of SAFTs extend back decades to U.S. Supreme Court rulings on what does and does not constitute a security.
Some claim SAFTs are dying or getting increasingly obsolete or ill-suited for modern crypto markets. This mindset is based on a certain interpretation of the regulations — that to raise money, you need a security token, and, as such, the delivery of a future non-security token is not legitimate.
I disagree with this notion, in part because in reality, a securities exemption is required to raise capital, but you do not necessarily need one for a token to function in a network.
As cryptocurrency and crypto tokens markets grow, SAFTs are actually becoming more important than ever. Why? Consider a metaphorical trip to the laundromat, as described by Jay Clayton, Chairman of the U.S. Securities and Exchange Commission.
Use Can Evolve Toward — or Away from — Security
In an April 5 address at Princeton University on cryptocurrency and initial coin offerings (ICOs), Clayton said defining a security versus a token in large part hinges on how each will be used.
“If I have a laundry token for washing my clothes, that’s not a security. But if I have a set of 10 laundry tokens, and the laundromats are to be developed and those are offered to me as something I can use for the future and I’m buying them because I can sell them to next year’s incoming class, that’s a security,” Clayton said, according to CoinDesk.
In the regulators world, such a definition can evolve, Clayton indicated. “The use of a laundry token evolves over time,” he added. “The use can evolve toward or away from a security.”
The words of Clayton and other regulators, including the U.S. Commodity Futures Trading Commission, are obviously important to follow and understand if we want to use cryptocurrencies and tokens properly and unlock the full potential of crypto markets.
Two Key Distinctions
Indeed, we’ve recently witnesses a growing appreciation of both the relationship between a “security” token and a “utility” token, and the relevance of SAFTs. On the latter, there are two very important distinctions:
· One, SAFTs absolutely can work the way they’re supposed to — if the issuers understand that an SAFT still a security;
· Secondly, the issuers must understand that the security-holder — not the issuer — has the option to exercise the SAFT and convert it into a token, and that the SAFT needs to be classified initially as a security.
In recent years, many crypto-issuers have taken the position that they have the right to convert the buyers into an SAFT. Effectively, they’re saying, I’m doing it “my way” and going outside U.S. jurisdictions (though most credible jurisdictions have roughly the same definition of a security).
But again, it’s the security-holder who needs to have that right to convert.
Why are these points important? We must reiterate that the people buying a security have expectations for a return. For securities in general, this expectation is effectively spelled out in the offering memorandum under which money is raised; The same thing applies to SAFTs.
Other vital questions revolve around whether an SAFT has potential to turn into a token. Could it be part security, part something else? The security holder needs to be able to make the conversion determination.
That’s because the issuer can’t legally assure what the ultimate state or outcome will be (security token, or utility token?) — they can’t sell an investment they represent as one thing, but that may end up being another.
Next Phases in the Evolution
How might the security-versus-token question play out the next few years?
Some recent developments that offer clues. For example, the SEC has said it considers Ripple to be a security because money was raised (Bitcoin, by the way, is not a security, because no money was raised when it was launched and many people use it as utility).
Ethereum is an unintended but great example of something that really started as a security and has evolved into a utility as it was deemed to not currently pass the Howey test.
Crypto markets are evolving rapidly and regulators are still getting their arms around it all. But there is abundant room for various iterations to prosper, and I see both major types of token markets poised to flourish because, really, of their interdependence. The possibilities are endless.
Cameron Chell is Chairman of ICOx Innovations, Chairman of KODAKOneand is the co-creator and architect of the KODAKCoin. A serial entrepreneur with over 25 years experience in the technology, energy and finance sectors, Cameron has helped lead numerous successful teams as well as founding and co-founded ventures including Business Instincts Group, Draganfly, Raptor Rig, ColdBore, FutureLink, Slyce and Urthecast.
“The information contained in this article is strictly for educational purposes and is not intended to be legal advice or to be relied upon by anyone without doing their own research and consulting their own legal counsel.”