SEC Official Explains When Tokens and Coins are Securities
William Hinman, Director, SEC Division of Corporation Finance, gave his personal views on when tokens and coins, which he referred to as digital assets, are securities and when they are not.
Mr. Hinman framed the question as follows: A digital asset that was originally offered in a securities offering likely cannot be later sold in a manner that does not constitute an offering of a security where the digital asset represents a set of rights that gives the holder a financial interest in an enterprise. On the other side of the ledger, Mr. Hinman noted a digital asset likely could be sold (a “qualified yes” in his words) where there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created.
While he elaborated in great detail on the foregoing themes, he noted that whether a digital asset is a security will always depend on the particular facts and circumstances. However, he offered the following non-exhaustive list as being illustrative of key considerations to determine if a digital asset is a security:
- Is there a person or group that has sponsored or promoted the creation and sale of the digital asset, the efforts of whom play a significant role in the development and maintenance of the asset and its potential increase in value?
- Has this person or group retained a stake or other interest in the digital asset such that it would be motivated to expend efforts to cause an increase in value in the digital asset? Would purchasers reasonably believe such efforts will be undertaken and may result in a return on their investment in the digital asset?
- Has the promoter raised an amount of funds in excess of what may be needed to establish a functional network, and, if so, has it indicated how those funds may be used to support the value of the tokens or to increase the value of the enterprise? Does the promoter continue to expend funds from proceeds or operations to enhance the functionality and/or value of the system within which the tokens operate?
- Are purchasers “investing,” that is seeking a return? In that regard, is the instrument marketed and sold to the general public instead of to potential users of the network for a price that reasonably correlates with the market value of the good or service in the network?
- Does application of the Securities Act protections make sense? Is there a person or entity others are relying on that plays a key role in the profit-making of the enterprise such that disclosure of their activities and plans would be important to investors? Do informational asymmetries exist between the promoters and potential purchasers/investors in the digital asset?
- Do persons or entities other than the promoter exercise governance rights or meaningful influence?
Mr. Hinman noted that while the foregoing factors are important in analyzing the role of any third party, there are contractual or technical ways to structure digital assets so they function more like a consumer item and less like a security. It depends on the economic substance of the transaction. Mr. Hinman offered the following non-exhaustive list as being illustrative of key considerations to determine if a digital asset is not a security, noting that he does not believe each and every one of these factors needs to be present to establish a case that a digital asset is not being offered as a security:
- Is token creation commensurate with meeting the needs of users or, rather, with feeding speculation?
- Are independent actors setting the price or is the promoter supporting the secondary market for the asset or otherwise influencing trading?
- Is it clear that the primary motivation for purchasing the digital asset is for personal use or consumption, as compared to investment? Have purchasers made representations as to their consumptive, as opposed to their investment, intent? Are the tokens available in increments that correlate with a consumptive versus investment intent?
- Are the tokens distributed in ways to meet users’ needs? For example, can the tokens be held or transferred only in amounts that correspond to a purchaser’s expected use? Are there built-in incentives that compel using the tokens promptly on the network, such as having the tokens degrade in value over time, or can the tokens be held for extended periods for investment?
- Is the asset marketed and distributed to potential users or the general public?
- Are the assets dispersed across a diverse user base or concentrated in the hands of a few that can exert influence over the application?
- Is the application fully functioning or in early stages of development?
It should be noted Mr. Hinman’s remarks express his views and do not necessarily reflect those of the SEC, the SEC Commissioners or other members of the SEC staff. The SEC disclaims responsibility for any private publication or statement of any SEC employee or Commissioner.
Contact Steve Quinlivan for more information.