Are ICO Tokens Securities? Why It Matters

Investors often ask if you purchase a token through an ICO, is it a security? Under U.S. law, securities must follow disclosure requirements and specific registration.

To date, the U.S. Securities and Exchange Commission (SEC) has not done a great job of providing clarity on this matter. It announced last year that different circumstances need to be taken into account when determining whether a token is a security or not.

The SEC, however, did provide investors more detailed guidelines. Let's take a look.

The Benefits Of The Howey Test

Thankfully, The Howey Test helps in determining if a digital token is, in fact, a security. The test was created on the heels of a U.S. Supreme Court case in 1946.

The test states that a token qualifies as a security when it is a "contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party."

In simple terms, a person must invest in a common enterprise with the intention of making a profit from the work of others.

The DAO Impact

The SEC credited the Howey Test with playing a key role in the DAO investigation. The DAO was a digital distributed organization that sold tokens to its investors, and in return offered them a say on the development of projects on its platform.

According to Bitcoin Magazine, in 2016 The DAO raised over $100 million. However, their site was compromised when a hacker stole up to one-third of the company's assets. To get their investor's millions of dollars back, the Ethereum community had to perform a hard fork.

The SEC came to the conclusion that the tokens sold by DAO were securities that fell under federal securities laws. The government did not, however, press charges against those involved in the attack.

What About Utility Tokens?

It remains to be seen whether so-called utility tokens are securities. Utility tokens can be bought as services and are used to raise funds for projects. These tokens appear to fall into a somewhat gray area.

Blockchain lawyer Marco Santori, and Protocol Labs' Juan Benet and Jesse Clayburgh co-authored a whitepaper which gave the following assertion:

1)Tokens issued before their respective platform is completed are likely securities.

2)Tokens distributed after their platform is ready to go are probably not securities.

What To Take Away

As with any investing, there are risks when it comes to buying tokens through an ICO. You are essentially investing in a startup.

Just like regular startups, a lot of these ICOs fail. So it is important to make sure you conduct extensive research on the tokens and the market before investing. To start off strong, read Bitcoin Market Journal and learn to invest like a pro!