This week’s EOS and Sia settlements with the SEC reinforce Coin Center’s 2016 policy recommendations.
Block.one has settled and is paying a fine for doing a pre-sale of EOS as ERC20 tokens, and Nebulous has settled and is paying a fine for selling Sianotes, a profit share in the returns from their network’s decentralized storage system. In both cases, the cryptocurrency on each project’s running network has not been deemed a security in their respective settlements: EOS (the tokens on the now functional EOS network) is not deemed a security, and Siacoin (the tokens on the now functional Siacoin network) is also not deemed a security in their settlement.
In our Framework for Securities Regulation of Cryptocurrencies we explained why this exact type of outcome strikes an ideal policy balance. Tokens providing some use-value from a decentralized network are not a good fit for securities regulation, while heavily marketed and pre-sold tokens (as in trading before the network is live) are a good fit for securities regulation.
In a 2018 update to our Framework we stressed that two separate inquiries should be performed regarding security classification if a network’s token was presold but later successfully launched and now provides functionality. First, an inquiry about the pre-sale agreement (and any tokens representing it, e.g. EOS’s original ERC20 token) will likely find them to be a security and investors could benefit from appropriate disclosures and controls. Second, a separate inquiry should look at the resultant decentralized token (once distributed) and if the network is powered by open source software and running with an open consensus mechanism the token is not a security, current purchasers have less need for a disclosure regime focused on the original issuer.
This division between pre-sold token and resultant token is sometimes referred to as a transmutation of a security into a non-security or commodity. We don’t like this framing. Nothing, in our opinion, ever transmutes. The agreement for future tokens was (and always will be) a security, and the tokens that get delivered are the fruits of that agreement. The resultant assets are not tainted by their being part of an earlier crowdfund any more than the Floridian land sold in the Howey case is tainted today. Yes the land and the tokens were involved in investment contracts that were rightly regulated as securities, but these assets are not securities when they trade on secondary markets amongst persons who did not participate in the prior investment schemes. With regard to functional and decentralized cryptocurrencies, there is no original sin and there is no transubstantiation.
While some may be vexed by the size of the fines involved, the policy here is sound. We are very gratified that the SEC continues to take a reasonable approach to providing investor protection in this space.