Hardcore interpretation: The first cryptocurrency that meets the SEC compliance framework is about to come out, is it good or bad?

Last week, the US Securities and Exchange Commission (SEC) issued a framework guidance document on ICO and securities law (Framework for 'Investment Contract' Analysis of Digital Assets (hereinafter referred to as the "Guidelines"), again discussing "startups issued The question of whether Token should be attributed to securities, which has caused widespread concern in the field of cryptocurrency.

Just yesterday, Blockchain, the US blockchain company, has submitted an application for the issuance of Token to the SEC in accordance with this Guidance Document.


According to Bloomberg, Blockstack said it sold a token STX that complies with A+ regulations to raise $50 million for financing the development and construction of the platform. Once the application is successful, this will be the first Token financing project that meets US SEC regulatory standards.

In fact, 31QU has released an interpretation of the SEC's Guidance Document last week (“The SEC's New Framework Interpretation: How to Make Your Token Not Classified as a “Securities”), but for readers who don't understand the history of US cryptocurrency regulation. In fact, there are still too many difficult professional knowledge in the file, such as why the "Hoowei test" is the basis for evaluation, why should the "block re-examination" of the blockchain startup Token and so on.

There are more questions worth exploring, such as when did the SEC start focusing on cryptocurrencies? What are the considerations behind the introduction of the cryptocurrency guidance document? What is the actual impact of the guidance document on the cryptocurrency market? Today we use the Blockstack example to clarify the past and present of the SEC cryptocurrency Guide Document.


Is the cryptocurrency a security?

As an emerging technology industry, on the one hand, the impact of cryptocurrency on the securities industry is greater than the impact of any technology in terms of breadth and depth. On the other hand, the cryptocurrency industry is full of project scams with various new concepts and new technologies. For example, the pyramid schemes and banker's fraudulent behaviors, the uneven ICO projects, the endless market manipulation, direct running and other chaos Elephant.

The SEC has been cautiously controlling cryptocurrencies. “Protecting the interests of investors and maintaining the healthy and orderly development of the securities market” is the responsibility of the SEC. However, the cryptocurrency market is too risky and the market is easy to be manipulated, which not only discourages investors and institutional investors, but also makes the SEC very big head.

The SEC's regulation of cryptocurrencies began with the famous The Dao project.

On July 25, 2017, the US SEC issued a survey report for The Dao project, and issued a document stating that the ICO project represented by DAO was characterized as securities and under the control of federal securities laws.

Although the report does not clarify that all ICO issued tokens are securities, the report identifies some basic criteria. For example, an ICO project that meets the securities attributes must comply with US securities laws and require registration, registration, and investor certification. The strict regulatory requirements of the series; ICO tokens that do not meet the definition of securities do not need to comply with US securities laws, but are subject to other laws.

It was also in this year that Ethereum, which had a market value of the second highest in the industry, began to receive close attention from the SEC. According to the then SEC chairman, projects that were issued in the form of fundraising may be securities. Therefore, the market once rumored that Ethereum seems to have the possibility of being supervised.

The SEC's characterization of Ethereum not only affects the hearts of Ethereum investors and participants in the ecology, but also affects the interests of other project parties and investors.

Because once Ethereum is defined as a securities, it will face strict regulatory requirements in many aspects such as registration, disclosure, and investor certification. Selling unregistered securities will not only allow Ethereum participants to go to jail and impose fines on Ethereum. The entire ecology and chain participants (including exchanges, investors and miners, etc.) will also be severely hit, and the Ethereum will also depreciate significantly. Moreover, Ethereum is one of the best in terms of market value. The recognition of Ethereum's former car will shake everyone's confidence in cryptocurrency, which is a disaster-level blow to the entire currency.

Fortunately, on June 14, 2018, William Hinman, head of the SEC corporate finance department, said in a speech entitled "Digital Asset Trading: When Howey Meets Gary Plastic", "From In view of the extremely decentralized decentralized structure, the current transactions and sales of Ethereum are not securities transactions, and also the factors that should be considered when evaluating whether a digital asset is a security."

In the speech, William Hinman proposed what factors should be considered when evaluating whether a digital asset is a security. The screenshot is from BiaNews.

In his speech, William Hinman mentioned “what factors should be considered when evaluating whether a digital asset is a security”, and last week’s “Guidelines”, on this basis, once again made it clear for blockchain entrepreneurs. The scope of application of the Securities Law.

It should be noted that the “Guidelines” merely repeat the view that the SEC has repeatedly emphasized over the past, that is, whether to identify an item as an “investment contract” based on the “Howey Test” and the corresponding judicial case. If it is an investment contract, it must be regulated in accordance with the securities laws.


Howey Test

To understand the Guidance Document, you need to understand the concept of "Howey Test" first.

Let's start with a simple science popularization under the US securities law.

In the United States, if the product being invested is a security, it must be regulated by law. The legal basis for determining whether it is a "securities" is mainly derived from two laws, the Securities Act of 1933 and the Securities Exchange Act of 1934.

According to these two laws, if an investment product meets the following three criteria, it is considered to be a security:

1) Investment products that are generally considered to be “securities”, such as company stocks, corporate bonds, etc. 2) Other investment products designated as “securities”, such as “revenues of oil, natural gas and other mineral investments”. 3) All other "investment contracts" that are recognized by the relevant government departments as having the nature of "securities"

The first two categories of standards are well understood, but the third category is a "bottom clause." This means that regardless of whether an investment product has the name "securities", it is considered a "securities" as long as it meets certain conditions and must be regulated by two US securities laws.

However, this "bottom clause" only identifies the investment contract as a kind of securities, and does not clearly define what constitutes an "investment contract."

This “unsure” regulatory standard was changed in 1946. This year, the US Supreme Court heard a dispute between the SEC and WJ Howey, and made a clear definition of the “investment contract”.

At the time, Howey had a large orange estate in Florida. In cooperation with some local resorts, they launched a “Orange Tree Farm Day Tour” project. After the tour, Howey will sell an “Orange Tree Farm Contract” to the tourists.

The contract consists of two parts, one is the land sale contract and the other is the land development contract. In other words, if you buy the land of an orchard, you can not directly participate in the business, but the contract will be authorized to Howey company to plant and operate in the form of a contract, earning dividends after earning money.

The US SEC believes that this model of Howey is essentially a “issuance of bonds” and “raised funds”, in violation of federal securities laws. But Howey believes that this is simply to provide a “land service contract” while selling the land, not to issue bonds. The case was finally appealed to the US Supreme Court.

The US Supreme Court finally ruled that this is indeed a bond issue, essentially using land as the distribution medium for bonds. The court held that it is not important for you to use any carrier to raise funds, because the carrier can be edited casually. As long as this process of raising funds satisfies the conditions of securities, it is securities.

The SEC and Howey cases have become classic precedents. After that, the SEC abstracted four conditions for satisfying the “investment contract” from this case:

1) Funding, that is, many investors invest all their own funds; 2) investing in common projects, that is, many investors put funds into the same project; 3) expecting profit, that is, the purpose of investment by many investors Is to make a profit; 4) Profit from the efforts or management of others. That is, the investor does not directly participate in the operation, but expects the promoter or operator of the project to work hard and manage to make profits.

As long as these four conditions are met, then it is considered to be an investment contract, which is a securities issue and belongs to the SEC jurisdiction. These four conditions are the famous "Howey Test".


Considerations behind the cryptocurrency compliance framework

It is not enough to know only the "Howey Test". Before reading the cryptocurrency framework "Guidelines", it is necessary to understand the essence behind the cryptocurrency compliance considerations.

The most influential crypto fund, the Anderson-Horowitz Fund (A16z), in the article "Analogies, the Big Picture, and Considerations for Regulating Crypto", tells the essence of cryptocurrency compliance considerations.

A16z believes that cryptocurrency projects are life-cycled and consist of three phases: the pre-release phase, the functional launch phase, and the final complete decentralization phase. Therefore, when conducting compliance considerations, specific issues should be analyzed in stages rather than across the board.

This also echoes the SEC Chairman Jay Clayton's mention that the analysis of whether digital assets are offered or sold as a security is not static and is not strictly defined.

Below we will interpret these three phases one by one.

When a cryptocurrency project was just started, it was a pre-release phase.

At this stage, it is similar to the angel wheel of the startup. The founder/founder can get financing with a simple business plan, while the encryption project raises funds through a white paper.

In the pre-release phase, the Howey test framework can be applied directly to determine if a project is a security:

1) Is it money invested? Obviously, all crypto-investment investors at this stage are invested with money; 2) Is the investment in order to obtain the expected profit? Obviously, investors want to appreciate the value of the token at a certain point in time after the project network is effective, and thus obtain a profit return. 3) Does the expectation of such profit depend on the efforts of others? Obviously, in order for investors to make a profit, “others” (that is, project founders) need to build and develop networks.

Therefore, we can make the next judgment: In the pre-release stage, before the function of the project goes online, the investor provides funds to the sponsor and obtains a contract, which is expected to accept Token at some point in the future. According to the current securities law framework, this contract is likely to be an investment contract and belongs to securities.

The second life cycle of a cryptocurrency item is a functional online phase, or a functional network phase.

At this stage, determining whether Token is a security depends on whether the project sponsor has implemented the features and goals that the white paper claims to achieve.

The situation at this stage is a bit more complicated, because after the function is online, there are many different roles in the entire encryption network ecosystem.

The first one is the real user.

For example, those who buy storage space on the network, or who want to access a particular application. This group generally uses money to purchase Token (in accordance with the first article), but the purpose of the purchase is to use a certain function in the network, rather than expecting to make a profit, and therefore does not meet the expected profit return in the Howey test.

The second is the miners and verifiers in the network.

In the POW Consensus, miners verify the transactions in the network by providing hardware and computing power. In POS, you need to buy and pledge a certain number of tokens in order to become a verifier of the transaction.

Technically, POW miners don't directly invest in Token, but they need to spend money to buy mining machines, investment time and operating expenses. In a POS network, a certifier needs to buy an equity to qualify as a verifier.

So, for these people, is it money to invest?

In the SEC's view, “money investment” has a broader definition, as long as there is some degree of value exchange, such as investing through other assets or services, and also satisfying Howey's “money investment”.

At this stage, do miners and verifiers have profit expectations?

Obviously, miners and verifiers will not provide verification services for the network for no reason, they will pay a high sunk cost and definitely expect to make money. But their role is more like a UPS that provides express delivery services to Amazon. They focus on providing services and need to generate cash flow instead of speculating on future prices (although some of them are not excluded for speculative prices).

Are the expected profits of these two roles dependent on the efforts of others?

After the function is online, if the project is truly recognized by the market, has potential market demand, and thus adds value to the investor's assets, then we can say that the success of the project is no longer dependent on the project sponsor or founder. Effort, but because the promised function really works, there are real user needs.

In this case, Token does not depend on “the efforts of others” to obtain income, and it is not a security.

There is also a special role to consider, those who get tokens through airdrops. Tokens are obtained through the project's airdrops, generally without any capital investment, and do not seem to meet the test.

However, in the SEC's view, the project's airdrops are aimed at expanding word of mouth and brand marketing, and expanding the community's network. Although there is no money on the surface, it constitutes a certain exchange of value by the SEC.

Therefore, in essence, an airdrop may also belong to a securities sale or distribution.

The SEC believes that airdrops are a value exchange

To sum up, in the second phase, after the function is online, the network function user uses money to purchase the token, but does not expect a profit return. This token is not a security, that is, if it can only be used in the ecosystem. The functional Token is not a security.

It should be noted that in the second phase, that is, after the function is launched, we can re-evaluate the investment contract in the first stage, that is, the pre-sale phase, because the standard for evaluating whether the token is a security has changed.

For the reassessment, the Guidance Document gives the following criteria:

According to the Howey test, even if the investment contract is signed in the pre-sale phase (investment contract means securities), after the function is online, if the investor's profit forecast for Token is not dependent on other people (here mainly refers to the project) The efforts of the founder's promoters, etc., then, the Token at this time is likely to be not a security.

Last summer, William Hinman also published a similar view: "The digital assets that were originally sold as investment contracts may have non-securities attributes as the network evolves and technology changes."

It should be noted here that under the current US securities legal framework, “investment contracts” and “objects of investment contracts” can be attributed to different natures. Therefore, determining whether a particular Token is a security depends on the nature of the Token itself, not the previous Token sales agreement.

In fact, Token's investment contract is a security, and Token itself is not a security, it is the protection of investors in the US securities law.

Because after a cryptocurrency item is launched, if the project party fails to honor the promise, the investor can completely sue the project party according to the securities law, because the investor's investment contract purchased in the early stage belongs to the securities category and is protected by the securities law.

Finally, the third phase of the cryptocurrency project is the complete decentralization phase.

At this stage, the expected function of the project not only works, but the project's sponsors no longer control the network. Because the code and data are open source, the project can be forked, so the project can move in different directions, there may be versions running under different rules, and even multiple different governance models and voting mechanisms.

The key point here is that the true decentralized network is controlled by the network community to determine future functions and development direction.

This is similar to the Internet field. The Internet products we use today are all built on the Internet 1.0 protocol (such as HTTP, etc.). Until now, the upgrade and maintenance of these underlying protocols are still organized by some centralized standards organizations (such as W3C). The value of the products that are responsible, but built on these agreements, are not affected by the decisions of these centralized organizations.

Similarly, in a network of cryptocurrencies, there are many foundations, companies, and organizations that contribute to the development and improvement of infrastructure in the network, but the value of the applications or services built on these infrastructures is not It depends on the actions and decisions of these organizations.

It can be said that a truly decentralized encryption network, there are multiple organizations, not just an organization, they can provide different proposals and solutions for products; project development does not depend on a certain individual.

As the encryption project matures and evolves, Token holders' profit expectations no longer depend on the sponsor's efforts. In other words, the actions and decisions of these sponsors, founders, foundations, or standards organizations or other defenders no longer have an important impact on the value of the token.

Like futures, at this stage, the entire network should be affected by broader market forces. If the project meets market needs and provides users with valuable practical needs, then Token will appreciate based on free market pricing. Conversely, value may decline.

Therefore, in the final stage, Token is not in the securities category.


Four key points of the Guidance Document

It's much easier to understand the underlying nature of cryptocurrency compliance considerations and to understand the latest framework guidelines.

There are four main points in this 13-page framework Guidance Document, which are Howey test standards, whether they exist because of the founder's efforts, reassessing the criteria, and the attributes that have the potential to pass the Howey test. small.

Let's interpret one by one:

1) constitute investment contracts by Howey test to determine whether or not: (Note: The following Chinese Screenshot Source: Unitimes, compiler of: Jhonny; Original source: Theblockcrypto, original author: Steven Zheng)

2) Is there any expectation of profiting from the efforts of others? In the document, “others” are called “Active Participants” (APs), generally referring to the founder, evaluating whether a project depends on a certain Reference criteria for the efforts of active participants:

3) Reference criteria for reassessing the project:

4) The stronger the following attributes, the less likely it is to pass the Howey test:

There is no doubt that the SEC's cryptocurrency framework guidance is a positive sign, but there is also a consensus in the industry that there is a desire for clearer and clearer laws and provisions for encrypted digital assets.

Because for them, effective supervision is not only the sword of Damocles hanging over the head, but also a catalyst to purify the entire industry.


The first person to eat crab

Finally, let's take a look at the first Blockstack to eat crabs.

According to the latest news from Bloomberg, US blockchain company Blockstack has submitted an application for the issuance of tokens to the SEC, announcing the sale of tokens that comply with A+ regulations to raise $50 million for financing the development and construction of the platform.

The sale of the Token was in the name of Blockstack subsidiary Blockstack Token LLC, which issued 295 million tokens at US$0.3 in the US securities market. Compliance with A+ regulations means that token sales will be regulated by the US SEC, but it is more flexible and easier than IPO.

The A+ Regulations are a regulatory rule under the JOBS Act that allows uncertified investors and retail investors to participate directly in investment. This is one of the characteristics of cryptocurrencies, which can help mid-sized companies faster and easier. Fund raising. At present, in the United States to raise funds through the initial token distribution and sales model, basically the "A + regulations" as the main reference terms of compliance.

It is reported that Blockstack is a blockchain platform created by Princeton University researchers for security and privacy. At present, there are more than 80 applications on Blockstack, such as the decentralized version of Google Docs – Graphite, decentralized open source blog Sigle et al.

It is worth noting that Blockstack has received $50 million in financing from a number of well-known investment institutions including Union Square Ventures, Y Combinator, Lux Capital, and Naval Ravikant in the previous round.

In this Token financing, the Harvard University Endowment Fund has taken the lead in investing $5 million to $10 million to acquire the token, which means that the University Endowment Fund can hold the token directly.

Blocksetack co-founder and CEO Muneeb Ali said

“We have been working with professional securities attorneys to create a legal framework for compliance. Our framework is aligned with the latest SEC guidelines announced last week. This can create a precedent for practitioners across the industry, not just about The first token is issued and sold, and it provides a reference for setting up a new public chain and how to guide the construction of decentralized ecosystems."

This is a precedent for voluntary compliance. If the application is successful, this will be the first token financing project that meets US SEC regulatory standards. If approved, we will see how the cryptocurrency Token will be sold to the public.

Since cryptocurrency is a brand new thing, it is still being explored, evolved, and changed. How to achieve a regulatory balance between encouraging innovation and preventing risks is a problem for the SEC and even the world's regulatory agencies.

The SEC's regulatory path is still long, but at least, the latest "Guidelines" have released a positive signal and paved the way for the startup's first Token release.

Reference article:

1 "Analogies, the Big Picture, and Considerations for Regulating Crypto"


2 "Harvard Takes the Plunge Into Crypto With a Token Sale Investment"


3 Key Points | What are the SEC's “Analysis Framework for Digital Assets “Investment Contracts”?


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