Part of the Hopefully Helpful series.

In my previous article, I wrote about ICOs and how past events in the cryptospace have built up to result in a breakdown in the ICO ecosystem. In this article, I continue to follow updates on ICOs this year and show why regulatory bodies classify products as security tokens.

But first, a tl;dr to bring everyone up to speed:

  • The ICO is currently the main fundraising model for most crypto companies.
  • Companies using the ICO model self-declared their tokens as ones that served the purpose of ‘utility, not security’, thus sidestepping around laws for securities.
  • Initially, most regulatory bodies took a ‘do-no-harm’ approach, likely because the technology and market were new and foreign.
  • The new market was unsaturated and companies that started ICOs reaped returns, drawing even more investors, which invited more ICOs…
  • Eventually, the market became saturated and competition increased, and there was less profits to be made.
  • ICOs started going bust, and frauds were reported by the media.
  • Investors, who were unprotected by the nature of the barrier-less market, suffered the losses acutely.
  • Regulatory bodies started investigating and traced the cause to ICOs.
  • Regulatory bodies started taking action, with the SEC issuing cease-and-desists to unauthorised ICOs with tokens they deemed to be ‘securities’.
  • Companies are shifting gears and seeking legal clarity, going to regulatory bodies to approve their token offerings and tokens by declaring that their tokens are indeed securities.

Earlier this year…

“I believe every ICO I’ve seen is a security”.

Following the events of the space, the US SEC has been clamping down on crypto companies. In February this year (2018), Securities and Exchange Commission chairman Jay Clayton famously declared: “I believe every ICO I’ve seen is a security”. This put majority of the crypto companies in the grey area. The ICO model could no longer dance around the securities laws. And with the tightening regulations, were all ICOs in danger of a cease-and-desist? What about Ethereum, the ICO that empowered entrepreneurs to harness blockchain technology for their own innovative projects?

Thankfully, an olive branch was extended in June this year at the Yahoo Finance All Markets Summit: Crypto. The SEC Director of the Division of Corporation Finance, William Hinman, specifically declared that ‘current offers and sales of Ether are not securities transactions’.

In his speech, he also mentioned that the nature of a truly (or sufficiently) decentralised network would not benefit from regulation, suggesting that a decentralised project may satisfy SEC regulations. The speech, coupled with a few investigation reports, also gave the crypto community some structure of what the SEC terms as a ‘security’.

So the big question is this: Is the token I’m holding classified as a security?

Here’s a (hopefully) helpful guideline:

If the project did not run an ICO, it is safe. Example: Bitcoin.

If the project ran an ICO, it’s in the grey area. Taking direction from Hinman’s speech, if the project in question began with an ICO, but is (1) now decentralized, and (2) has ‘utility’ as its dominant use case, regulating it as a security would not benefit the network, and therefore it should not be subject to securities laws. Example: Ethereum.

If the project ran an ICO, and (1) Passes the Howey test, or the Family Resemblance Test, (2) is marketed as an investment, (3) does not have ‘utility’ as its dominant use case, or (4) is not decentralized/ has a central power then it is likely to be classified as a security that has violated SEC laws.

Note that the way the public treats a token (i.e. as an investment vehicle or otherwise) would also be factored in the investigation as well.

These points were further evidenced by the DAO investigation report, which ultimately ruled DAO tokens to be securities. The points below corroborate with Hinman’s speech:

1. The DAO began as an effort to create a crowdfunding contract to raise funds to grow a company in the crypto space.



2. The DAO’s ‘curators’ had considerable power in the system. (In their whitepaper, a curator could also reduce the voting quorum requirement by 50% every other week.)


= Centralized

3. Secondary Market Trading: DAO token holders could monetize their investment in DAO tokens by reselling the tokens they were holding on various platforms that supported secondary trading in DAO tokens.


= Marketed and used as an investment vehicle

4. In addition, evidence was given for the prerequisites of the Howey Test, which are:

a. Investment of money or other assets

b. Reasonable expectation of profits

c. Derived from the managerial efforts of others (third party)


= Passed the Howey Test

The resulting remedial actions taken by companies found to have offered securities are listed below:

  1. Refund investors
  2. Pay a penalty to the SEC
  3. Comply with laws by registering the token as a security

Alas, for ICOs who run the risk of offering an unregistered security, what recourse is there? Since the tightening of regulations, some offerings have closed their sales off to American investors, while others have started marketing themselves as ‘SEC-compliant’ and launching STOs. Of course, to date (at time of writing), the SEC has yet to approve of any crypto offerings, be it ICOs or STOs.

So what exactly are STOs? Stay tuned to the next article of this Hopefully Helpful series to find out more about Security Token Offerings.



Cheryl Lim