Token Launches From Ethereum to Telegram: Where Do We Go From Here?

Categorizing the sale of a digital token as a securities transaction would have an outsized impact on how the token can be offered, who can purchase it, how it is traded, its tax implications and beyond.

On the one hand, if a token can be sold without the transaction implicating federal securities laws, it is just like any other asset we are familiar with - a pair of sneakers, say - and it can be traded between any two users privately at any time and in any amount without any particular securities law compliance required, albeit subject to commercial and common law norms and expectations and statutory fraud laws.

In some cases, applying securities laws to transactions within a token could potentially crush the blockchain project altogether.

When an asset that initially has little or no functional use is being sold not to persons who have a genuine reason to use the token for its stated purpose following launch but, rather, to those who expect to hold the tokens for a period of time in order to profit from price appreciation resulting from efforts of the developers of the token promoting the benefits of the network, the scheme will likely satisfy the Howey test and would generally be considered an "Investment contract" and thus a type of securities transaction.

One way we know that the securities laws likely apply to most blockchain network launches is that even Commissioner Peirce feels that a "Safe harbor" is needed for these initial token sales to avoid the securities laws otherwise applying to these transactions.

Many blockchain projects raise just that question, though: Should resales of the relevant asset - the blockchain token - without a transfer of any promises made by the development team to the initial purchaser also be treated as securities transactions? If the underlying asset was any of those involved in the many post-Howey "Investment contract" cases on record, we doubt that the question would even arise, much less be answered in the affirmative.

In the Telegram litigation as well as in numerous other enforcement actions by the SEC, papers filed in court make clear that the enforcement staff believe that not only are these transactions "Securities transactions", but also that the blockchain tokens themselves are "Securities" and that the development teams are the "Issuers" of these securities.

The SEC's distinction between a security and a non-security So how does the SEC reconcile this distinction? Through a novel and, to date, untested theory - that at some point a blockchain token can "Morph" from being a "Security" and become a traditional "Non-security" asset based on factors extrinsic to the token.

Although the commissioners and staff of the SEC have worked hard to elucidate these concepts through the Token Framework and other written statements, various enforcement actions, many public appearances, and countless private meetings with market participants, the standards put forward by the SEC for distinguishing token sale transactions that should properly be considered securities transactions from those that should not are still unclear.

Is it all about the timing? So where did things go wrong for Telegram? Why is it that the SEC considered Grams securities and Ether not - at least by the time director Hinman gave his speech? The key difference could appear to be timing.