Home Crypto Altcoin News Future of ICOs, SEC verdict, and the Howey Test

Future of ICOs, SEC verdict, and the Howey Test

This piece details the implications of the “SEC Issues Investigative Report Concluding DAO Tokens, a Digital Asset, Were Securities” from the perspective of blockchain compliance expert Haonin Lin. The SEC report can be found in full here.

This article does not constitute legal advice and should not be exclusively relied upon by any person.

What does this report mean for ICOs?

It’s certainly a warning given to those who are try to get around US securities regulation by using a distributed ledger, or blockchain technology. The SEC verdict is that “The DAO” was one such agent. 

In order to decide whether something is a security, the SEC will normally apply the “Howey Test”. Under the Howey Test, a transaction will be classified as security if:

  1. It’s an investment of money
  2. There is an expectation of profit
  3. The investment of money is a common enterprise
  4. The profit comes solely from the effort of the seller or third parties

The DAO token is deemed suspicious because it arguably fails the Howey Test. Contrary to common opinion, this could be good news for the ICO market. The SEC are not trying to kill the ICO model, but rather trying to apply regulation to players in the market that are exploiting consumer ignorance, or launching coin offerings with no intentions to deliver on the promises made. Positive legislation and collaborative regulation is key to mainstream adoption of cryptocurrencies.

“[V]irtual coins or tokens may be securities and subject to the federal securities laws,” reads the report. “Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.” 

The ICO market moving forward

There are predominantly two kinds of ICOs presently being conducted:

  1. Selling token with actual functions, similar to a virtual product
  2. Selling certificates for the receipt of a functional app coin in the future

Most of the tokens being sold in ICOs today are similar to virtual products. These tokens are designed as a “permission slip” for the use of a protocol. Unlike a pure investment, they have literal functions. For example, you have to consume a certain amount of tokens before you can use the certain function of a decentralized application. Participating in these tokens sales is similar to supporting your favorite program on Kickstarter. These ICOs are less likely to be classified as securities because they are more like selling a virtual product than promoting an investment plan. 

The second type is purchasing certificates for the future expectation of a functional app coin. The only effort made by the coin’s team is to make sure that the whole network is operating properly. The team did not spend any effort on creating profit. For example, let’s look at NEO (XiaoYi), an open source public chain program from China. If you are a participant in their ICO, you can get NEO (governing token) and that is the key certificate for receiving NeoGas (gas token) in the future.

After a purchase of NEO tokens through the ICO, a certain amount of NeoGas (app coin) is sent to the designated blockchain address. In order to maximize the efficiency of transaction in their network, they designed a gas token system. This means you can use the gas token to incentivize the miners to guarantee your transaction over the huge volumes of junk transactions in any given network. The generation of NeoGas solely relies on the algorithm of the network. The NEO team does not spend any effort on creating profit.

In sharp contrast, The DAO is more like a VC: it will literally invest in real life businesses if a proposal was passed within its network. It’s like putting money in a pool.

Selling the certificate for receiving an app coin in the future, on the other hand, is more like selling a virtual product. Only this time the product is a certificate for a future functional app coin. But since how much you might earn is totally based on the algorithm, no real life business is involved. You are not relying on anyone’s effort for future profit.

With significant discrepancy between The DAO and virtual good-esque ICOs, we can expect the latter to be safe from the vice grip of US regulators for the foreseeable future. Entrepreneurs can still look towards ICOs as potential opportunities post this investigative report – but keep an eye out for further developments.

To read another take on SEC regulation, read this piece here. If you want to learn more about ICOs without sifting through walls of text on compliance and regulation, then read our go-to guide on how to plan an ICO!

Photo by Gianpaolo La Paglia on Unsplash

The above is to be considered opinion and not investment advice in any way, as an unbiased media, no one interferes with the Editorial content of CryptoInsider.com, writers have freedom to choose their own direction, members of Crypto Insider do not participate in trades based on content.

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