cryptocurrency, bitcoin, ethereum, crypto
As we enter the age where Blockchain Rules The Nation, the Securities and Exchange Commission (SEC) has said it will treat Initial Coin Offerings ("ICOs") on a case-by-case basis.
In light of this uncertainty, some token issuers may choose to ignore securities laws and hope to Get Lucky when they get pre-ICO investments. But the SEC is likely to increase its scrutiny of tokens, so you should probably try Doin' It Right and use a Simple Agreement for Future Tokens ("SAFT").
Background: what is a security is and why does it matter? Read this (spoiler alert: more investments are considered securities than you probably think).
Harder, Better, SAFTer, Stronger: What Is A SAFT?
SAFTs are modeled after Y Combinator’s Simple Agreement for Future Equity ("SAFE"). A SAFT is an agreement between a utility token issuer and a token purchaser, and is often accompanied by an offering memorandum (which is a standard document used for marketing for VC and hedge fund offerings).
Two important features to note:
How Da Funk Does A SAFT Work?
The crux of a SAFT is the distinction between functional tokens and the right to those tokens once they become functional. It's akin to the difference between buying a house that's already built, and buying the right, before construction has begun, to own a house once it is built.
A SAFT is structured as follows:
The key is that the investors aren't buying tokens; they're buying the right to future tokens.
The SAFT itself (aka, the right to future tokens) is a security. But the tokens that the SAFT is converted into would most likely not be considered securities by the SEC.
The Technologic of Why Pre-Functional Tokens Are Likely Not Securities
The Howey test is used to determine if an investment is a security. The relevant requirement for SAFTs is that a security has a predominant expectation of profit that stems from the essential managerial efforts of others.
If an investor buys a utility token before it has reached functionality, it's likely a security. The purchasers of a pre-functional token "are, by and large, reliant on the efforts of the seller to develop functionality." The token's value would almost certainly be zero if its protocol is not developed to a functional point. Thus, the development team's managerial efforts are essential, and the utility token is likely a security.
If an investor buys the token after it has reached functionality, any managerial (aka, development) efforts by the dev team are likely not essential. Sure, the developers may play a role in any increase in token value. But so will supply and demand, broader blockchain trends, institutional investor sentiment, and so on. Courts have repeatedly held that mere increase in value on a secondary market does not constitute "efforts of others." Thus, a post-functional utility token is likely not a security.
Accredited Investors After All
Because the SAFT itself is a security, it must be registered with the SEC or fit into an exemption. As a result of this, most SAFT investments are generally limited to accredited investors so they can be exempt from registration.
Implications, Around The World
First, SAFTs are a sort of "pre-ICO," akin to angel investing.
Second, SAFTs are not for every day (aka, "retail") investors. SAFTs are typically restricted to the same accredited investors that traditional venture capital, private equity, and hedge funds are. This means SAFTs are more favorable to "centralized" investing, not crypto's promise of decentralization. This is not necessarily bad, though; more investment means more growth, regardless of source.