Utility Tokens or Tokenized Securities

The recent SEC (Securities and Exchange Commission) announcement to consider Initial Coin Offerings (ICOs), as securities could actually be a good thing since it highlights the importance of Initial Coin Offerings(ICOs) as a new viable way to raise funds. It highlights the need for a new regulation.

The last 2 months have been spectacular ICOs success, but also caused a lot of confusion for traditional funding institutions. People are scrambling to understand exactly what an ICO is & how they can use it to their own advantage.

There are 3 main types of tokens.
1. Coins or Cryptocurrencies
These are digital currencies like Bitcoin in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. They are operating independently of a central bank.
Soon every fiat currency may become a cryptocurrency, in that case operating with central banks. This is what Singapore has started with their Ubin project.
2. Utility tokens
The utility tokens are services or units of services that can be purchased. These tokens can be compared to API keys, used to access the service.
They are a way to fund projects of shared infrastructure that couldn’t be funded before. To enable such ecosystems to be built some tokens can be “pre-mined” in addition to be sold in “crowd-sales” during tokens launches.
3. Tokenised securities:
Tokens are representing shares of a business. In addition, considering the SEC announcement any token that can’t pass the Howey test should be considered as a security and fall under the 1934 Security Exchange Act.
The Howey test consists of the following:
• Is it an investment of money or assets?
• Is the investment of money or assets in a common enterprise?
• Is there an expectation of profits from the investment?
• Does any profit come from the efforts of a promoter or third party?
The final factor of the Howey Test concerns whether any profit that comes from the investment is largely or wholly outside of the investor’s control. If so, then the investment might be a security.
This is what brings confusion and in a way makes any utility token potentially a security since they can be traded on third party platforms. Utility tokens that a startup would issue to finance future customer’s purchases should not be securities, since their purpose is to facilitate the purchase.

You should not rely on this Blog post as legal advice. It is written for general informational purposes only.*

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