Interpretation of the new SEC framework: How to make your own Token not classified as a "securities"?

Last night, the US Securities and Exchange Commission (SEC) issued the Digital Asset Investment Contract Analysis Framework (hereinafter referred to as the "Framework"), which is a new regulatory guideline for "Token issuers" for analyzing startups' sales and sales. Whether the digital assets meet the investment contract.

The framework is mainly written by William Hinman, chief financial officer of the US Securities and Exchange Commission, and Valerie Szczepanik, head of the Financial and Securities Center of the US Securities and Exchange Commission (FinHub). The former was because "Ethernet may not be a security". The speech was famous in the digital currency world last summer.

As early as November last year, William Hinman said that he would release a vernacular version of the guidelines to help launching startups more easily determine whether their Token will be recognized as a securities product.

“The Framework is not a detailed overview of the law, but an analytical tool that helps market participants assess whether the federal securities laws apply to quotes, sales or resale of specific digital assets.” The US Securities and Exchange Commission said. These new terms are not final.

In fact, whether the Token issued by the startup company should belong to the securities is a topic that the outside world has been paying attention to.

More clearly than ever, yesterday's "Framework" not only confirmed that Bitcoin, Ethereum and other similar cryptocurrencies were not securities, but also defined the scope of the "Securities Law" for blockchain entrepreneurs.

A brief summary of the "framework" idea is: entrepreneurs can raise funds by selling Token, but only if they must comply with the securities law; whether the founder plays a decisive role in the sustainable development of the project, is to measure whether the project Token will be treated as securities. The key premise.

So, what are the details in the Framework? What does it mean for decentralized networks and their developers? What is the significance of digital currency investors?

In order to clarify the above issues, 31QU has compiled several excellent interpretation articles from abroad to readers:

Text / 31QU


Investment and airdrop

The US Securities Law stipulates that judging whether the behavior of enterprises and investors is classified as an "investment contract" in "securities" can be inferred by "Howey TestRule", which has the following four conditions:

1 Investing, that is, many investors use personal funds to invest; 2 investing in common projects, that is, many investors put funds into the same project; 3 expecting profit, that is, many investors investing in the purpose of making profits; 4 Profits come from the efforts or management of others, that is, investors do not directly participate in the operation, but expect the promoters or operators of the project to work hard and operate to make profits.

If the above four conditions are met, it will be recognized as an “investment contract” and the company will issue “securities” and will be judged to be under the jurisdiction of the SEC.

If these four conditions are used to judge ICO, almost all ICOs meet the first two conditions, namely funding and joint projects. But because of the ICO's airdrops, the situation is complicated.

The "Framework" pointed out that "digital assets lack currency considerations", airdrops may constitute the sale or distribution of securities, or airdrop receivers may not provide anything of value (such as currency) to airdrop project parties.

The latest Framework considers the first two points of the Howey TestRule as a set fact and focuses on "whether the investor reasonably expects the benefit to come from the efforts or operations of others."


Objective, not subjective

When it comes to the last two points of the Howell test, the Framework clearly states: "The investigation should be objective, and the focus should be on the transaction itself and the way in which digital assets are supplied and sold."

In other words, the survey does not need to take into account the subjective thinking of investors.

Some people buy Tokens because they think Tokens will appreciate or they just want to use them. Some investors may misunderstand the true purpose of the project side, thinking that the project side is cutting the leeks, but those who recognize the value of Token may hold for a long time and wait for Token to appreciate.

The Howe test is not based on the actual idea of ​​the investor, but on the objective facts of the Token sale and the seller's statement to determine whether it is a hypothetical rational person.

Under the premise of objective investigation, the Framework will examine the startup company Token from the two factors of “the efforts of others” and “profit expectations”.


The efforts and decentralization of others

Regarding “the efforts of others”, the Framework clearly illustrates the importance of network operations, which actually provide the advertising functions that buyers seek, as explained below:

If the network or digital assets are still under development and the network or digital assets are not fully functional at the time of sale, the buyer will expect the project side to further develop network functions or digital assets (directly or indirectly).

In addition, the network of a project is run by multiple non-associated people (that is, the decentralization of the network has several different levels):

Basic tasks or responsibilities are performed by the AP, or are expected to be performed by the AP, rather than an independent, decentralized community of network users (often referred to as a "decentralized" network).

But many blockchain projects are open source, let's look at a simple example: Bitcoin.

When you buy Bitcoin, you do not need to enter into any investment-related agreements with any third party. You use Bitcoin as a point-to-point e-cash (transaction on the Bitcoin network). You think Bitcoin will appreciate in the future as a medium of exchange, just like silver or gold (as currency or any commercial purpose). Investors get income.

Who makes Bitcoin a peer-to-peer electronic cash system? It is a network of thousands of independent nodes and miners.

At the same time, bitcoin prices are also rising as the popularity increases, and the appreciation process is determined by the market composed of buyers and sellers. As described in the Framework: “The price appreciation caused by external market forces.

But what about the code developers who support the network? Even Bitcoin's core software still requires regular updates and bug fixes, and even Bitcoin may benefit from the development of new features and architectures (such as more privacy or scalability), providing people with these ongoing development efforts. It is the guidance of the so-called active participants (AP).

Will the AP affect the value of Bitcoin?

Developers are still indispensable even if Bitcoin's core software still requires regular updates and bug fixes, while Bitcoin value benefits from new features and architecture development (such as more privacy or scalability). .

So the question is, should the staff who promote the development of these functions become the decisive factor in your investment target? Who is paying for these code providers?


What does open source software mean?

These questions touch the core, that is, if a project is open source and the network driven by an open mechanism provides "consensus" momentum, what does this mean?

If the source code of the network is patented, by default, developers with intellectual property are essential to the continued development of the network. They can prevent anyone from participating in the network by implementing patents or copyrights; they can even prevent people from developing branch-based derivatives because copyrights often also give results monopoly rights to derivatives based on related technologies.

However, if the code is open source (all major cryptocurrencies are open source), then anyone can join the development work, the development is transparent, publicly auditable, long-term contributors (even if they have developed to It is important to leave the project without compromising the viability of the ongoing software (we can call it the Satoshi test).

Similarly, if the network supported by the software uses a license negotiation mechanism (non-open source system), how to approve or reject third party participation and verify a transaction will become a critical issue.

If the network consensus is open, anyone who provides a valid work certificate or equity certificate can generate a block or add a transaction to the block to add redundancy to the system. The result of this will make the entire network sufficiently decentralized to prevent the emergence of oligarch nodes.

For example, Bitcoin's powerful, open PoW consensus allows thousands of miners around the world to freely provide a constant stream of computing power to the network.

Therefore, the Framework lists several judging factors of “the efforts of others”:

“Core Developers” play an important or central role in determining community governance issues, code updates or digital asset enrichment; they “reserve shares or interests in digital assets”; they “directly or indirectly” own or control networks and digital assets And intellectual property ownership of technical achievements.

These clearly stated factors further clarify the SEC's policy that decentralized cryptocurrencies such as Bitcoin and Ethereum are not securities.

There is no doubt that these networks have core people to perform important functions to keep them up and running, but no one has a decisive influence on the continuous operation of the network, because no one can control the open source software development process (bitcoin And more than 1,000 people in the Ethereum are developing for the network, and no one can control their blockchain).



Last summer, William Xinman, director of the SEC's finance department, said in a speech that with the changes in the network and technology environment, the assets originally sold in the investment contract may eventually be traded as "non-securities". Although Hinman did not explain what users need to pay attention to during the transition, in the Framework, we can get a glimpse of it:

Whether digital assets previously sold as securities should be re-evaluated and re-released and sold in the form of non-securities. 1 Are active participants always playing a significant role in the value of the investment in digital assets? 2 Will digital assets still function when buyers no longer expect active participants to manage and invest? 3 Can the success of a project be no longer affected by active participants?

A decentralized project has a community because of open source, which greatly reduces the impact of individuals on the project, and will also involve more and more people to participate in the work of blockchain verification.

Taking gold as an example, although gold is not a kind of securities, gold mining companies can still have a huge impact on gold prices. For active participants in the cryptocurrency market, perhaps their presence will also have an impact on the project. Therefore, for the SEC, it is not only the influence of the active participants on the price, but the desire to regulate the life and death of the entire project network.

The guidelines also refer to Glen Turner's original words: this part of the conversion does not include the impact of open source code development and price, but about the impact of active participants on the business. The court believes that it is not that developers must have no or no importance to the projects they develop, but rather try to avoid that these people are no longer decisive about the projects they develop.


Expected profit

After discussing "the efforts of others", let's discuss the "expecting profit" section.

In this section, we find that the secondary market has so far been the key to Token sales. It is true that in the Howe test, no test is asking whether the user's assets are traded in the secondary market, but one thing is worthy of recognition. The secondary market may indeed make a rational person make an irrational decision, ie It is considered profitable to sell assets in the future.

Because the Framework clearly states that the promises that developers can make for future projects tradable will, without exception, develop in the direction of expected profit.

But the Framework also expressed doubts about Token's investment, that is, whether Token's sales can't show the actual number of users.

According to William Hinman, Token's investment can only show people's investment intentions, because when money appears as a medium of exchange, the number of users is only equivalent to the number of people trading in the short and medium term. Bitcoin also If so.

But we can't ignore another basic feature of money: value storage. If the current price does not match the user's expected transaction price, then the user will begin to rationally consider the long-term benefits, which is no different from the logic that Southwest Airlines used to purchase aviation fuel in order to hedge market risks. At the time, many market observers said that Southwest Airlines’ actions effectively avoided the consequences of worsening the company’s financial situation.


Expected profit

In other aspects of the guidelines, it is stated that cryptocurrencies should provide users with some valuable features. such as:

1 Distributed ledger and encrypted assets can be fully developed and operated. 2 Cryptographic currency asset holders can immediately use the expected functionality of the cryptocurrency network, especially where there is a built-in incentive to encourage the use of this feature. 3 Potential buyers can also use the network and use the intended functionality. 4 Encrypted assets with consumer characteristics are not considered as investment contracts.

In addition, innovations in cryptocurrency networks are also interesting.

If the goods or services on the basis of the encrypted assets can be obtained by using the encrypted assets, then the intention of the user to consume the encrypted assets will be greatly promoted.

If we want to use the convenience of blockchain, such as online payment, digital identity protection, etc., we also need a token of value to stimulate the blockchain workers. Only then will these features work.

Interestingly, there are many Token scams on the market, and the US Securities and Exchange Commission should continue to trace, but this does not affect us to embrace the blockchain. Coincidentally, the US securities law industry has been carefully adjusted to continue to combat fraud and illegal fund-raising. On the other hand, it also aims to eliminate the dependence on third parties, so that blockchain technology can flourish.

Katherine Wu, founder of MessariCrypto, concluded that under the “Hooway Test” framework of this cryptocurrency, the cryptocurrency of securities is not the following two characteristics:

The network and tokens are fully functional, and the network is decentralized as much as possible; the prospect of appreciation in Token is limited, that is, people do not expect long-term holding of Token to make money.

The introduction of the "Framework" set off an uproar in the field of digital currency, which released a positive signal.

According to Jake Chervinsky, a US government law enforcement defense attorney, the Framework provides a more in-depth and comprehensive Howey test for digital assets, clearer than any previous announcement by the SEC. “The framework will replace the DAO report as a criterion for determining whether a digital asset is a security and a Howey test specification for digital assets that is more helpful than a DAO report.

The SEC released the famous investigation report on July 27, 2017 – "Report of Investigation Pursuant to Section 21 (a) of the Securities Exchange Act of 1934: The DAO (July 25, 2017)" ("DAO Report"), The corresponding regulatory principles are derived from the nature of the “Daily” issuance project “The DAO”, if and only if the digital assets comply with the “securities” defined by federal law, related acts, including issuance, sales, trading, circulation, and investment, Consultation, etc., will be included in the supervision.

Andrew Hinkes, general counsel of investment bank Athena Blockchain, agrees that the cryptocurrency industry's continued exposure to the market is a good sign.

“Regulators are in contact with the digital asset market and bring better clarity to the market, which is a positive sign for the industry.”

Reference article: Coin Center analysis of SEC cryptocurrency guidance