DeFi Governance Tokens Tread Carefully as the SEC's Invisible Hand Looms

Published on by Cointele | Published on

Governance tokens in decentralized finance, or DeFi, have suddenly jumped into prominence following the success story of Compound's COMP token, whose price action and liquidity mining program resulted in increased public interest.

Unlike previous iterations of "Utility tokens" during the initial coin offering mania, DeFi governance tokens lend themselves to a more fundamentals-based analysis.

As Michael Anderson, co-founder of Framework Ventures, told Cointelegraph earlier in 2020, the DeFi investment thesis hinges on token economics that would "Capture the value" generated by the protocol.

Spurred by the COMP distribution, Anderson spoke once again with Cointelegraph on a variety of topics, including the legal standing of DeFi tokens.

While the governance aspect of DeFi protocol tokens is self-explanatory, some of the token economics approaches can be compared to dividends as well.

Maker uses a "Buyback and burn" mechanism to capture value with the MKR governance token.

Proceeds from the interest paid by borrowers are used to buy MKR tokens through an auction, and are then burned.

Given the clear analogies with company stocks, there is an intervention risk from the Securities and Exchange Commission, which might deem these tokens as securities.

Philip Moustakis, counsel at Seward & Kissel and former SEC senior counsel, told Cointelegraph that a securities classification "Depends on the facts and circumstances of each token." As he explained, voting rights by themselves do not define if a token is a security, citing the example of the SEC's investigation into The DAO and its issues with the decentralization of the system, rather than voting rights.

Summarizing, he included a set of "Critical questions for DeFi tokens," including whether they represent a capital raise, if the network is truly decentralized, capital gains and losses implications for transacting with the tokens, how many of the tokens were offered and how much they resemble shares in a network.