Where SAFT Falls Short

Limiting ICOs to accredited investors almost feels like a retreat from the goal of democratizing capital markets, columnist Michael J. Casey writes.

AccessTimeIconOct 4, 2017 at 11:01 a.m. UTC
Updated Sep 13, 2021 at 7:00 a.m. UTC
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Michael J. Casey is the chairman of CoinDesk's advisory board and a senior advisor for blockchain research at MIT's Digital Currency Initiative. 

In this opinion piece, his latest in a weekly series of columns, Casey offers qualified praise for the recently released SAFT framework and makes the case that legislative reforms are needed to deliver on the true promise of tokenization.


Who says only software developers can hack?

The team from Cooley LLC and Protocol Labs, which released the SAFT project white paper on Monday, makes a fine group of "legal hackers."

The SAFT (Special Agreement for Future Tokens) concept offers a clear-headed bridge solution to the real risk of legal action by the U.S. Securities and Exchange Commission (SEC), a risk that threatens to disrupt the booming industry of crypto-token sales. The idea offers a compliant path for developers of token-based decentralized applications to responsibly raise the funds they need build out their platforms.

Still, for those of us who believe utility tokens have the potential to change economic paradigms, spur collaboration and innovation and incentivize people to develop and protect public goods and resources, there's something inherently disappointing about the SAFT concept.

First, a SAFT is deliberately set up as a security, which means that without going through the cumbersome, expensive and restrictive process of SEC registration, issuers can sell them only to "accredited investors."

This limits potential participants to those earning more than $200,000 annually or who have non-residential assets worth more than $1 million. Its arrival almost feels like an admission of failure, a step back from the goal of democratizing capital markets.

Ethics issue

Any crypto person worth their salt wants to empower the little guy.

They want to beat the Old Boys clubs of Wall Street and Silicon Valley, and boost the pool of reachable investors that developers of open-source protocols can tap to build self-perpetuating decentralized networks and forge the peer-to-peer economy of the future.

None other than Protocol Labs founder Juan Benet has put voice to this frustration.

In a July blog post announcing the SAFT-based sale of filecoin, a token intended to bootstrap the development of his Interplanetary File System, Benet said he wanted to "personally say 'I'm sorry' to all of the people frustrated by the accreditation requirements."

He lamented:

"We wish we could make our upcoming token sale as broad as we possibly can."

The problem is not the SAFT, of course, which is a sound compromise for letting founders fund development work without fear of being shut down, while protecting investors from fraudsters who would run off with their money. The problem is the law itself.

And that's where the SAFT Project may be most helpful. It could spur debate, not only about how to stay within existing regulations, but also on how to reform legislation to create a much broader, fairer and robust environment for funding innovation.

If that doesn’t happen, token issuers will find underground ways to raise money and set up shop in friendlier jurisdictions, limiting U.S. engagement in this industry and curtailing its potentially positive impact on the world.

Letter of the law

Founders who launch token sales – frequently described as initial coin offerings, or ICOs – tend to argue that their tokens provide functional "utility," exempting them from securities registration. Since users need the tokens to access their platforms' services (or so they assert), their ICO offering documents often describe them as product akin to a negotiable membership ticket.

But the SAFT Project team makes the solid conclusion that in the pre-sale period – before a platform's network is developed and before users are actively exchanging tokens for services – many, if not all, ICOs would pass the SEC's benchmark Howey test for defining securities, especially its "expectation of profit" provision.

"Purchasers in these direct presales tend to expect profit predominantly from the seller's efforts to create functionality in the token," the SAFT Project's white paper reads. "As such, these sellers may unintentionally be selling securities, and may have failed to comply with several U.S. laws."

The SAFT, defined as an investment contract, acts a legal bridge to solve this dilemma.

Once the platform has reached a point of functionality, the issuer delivers tokens to the SAFT investors, who can then sell them freely to the general public since they are, at that point, no longer considered securities. The structure may have the additional benefit of holding developers to account regarding their promise to build a platform, since they must wait until the second phase to sell their own tokens.

But there's no getting around the fact that, under a SAFT, it's wealthy investors that gain ground-floor entrance to the startups that may become the Googles, Facebooks and Amazons of the future, not regular Joes in flyover states.

Level playing field

This is why legislative reform is needed.

It's not to say some protections for investors aren't needed. As compelling as the libertarian "caveat emptor" case can be, securities laws have evolved as they have because, after centuries of scams and exploitations dating back to the South Sea Bubble, societies have demanded them.

The problem is they've gone too far. After a decade of near-zero interest rates while hedge fund managers and venture capitalists made a killing, small investors are right to demand that they be allowed to invest in projects they believe in.

We also have an existing framework to improve upon: the JOBS Act.

As the name suggests, the Jumpstart Our Business Startups Act of 2012 was initiated to spur growth during the sluggish recovery from the 2009 recession by giving startups access to a wider pool of funds. It required the SEC to write new rules that, among other things, allowed startups to tap crowdfunding mechanisms in equity financing rounds.

But once the crowdfunding rules came into effect in 2016, they included heavy restrictions. They capped the fundraising opportunities at $1 million per year per startup, limited individual investors earning less than $100,000 to a total investment of just $2,000 per year and imposed burdensome disclosure requirements on startups using the facility.

As a result, few have availed themselves of it.

Right direction

Given that the JOBS Act followed the biggest financial crisis in 80 years, the hesitation of lawmakers to go further wasn't surprising.

But the rules were developed before most people had any idea of blockchain technology, which offers new opportunities for transparency and accountability. Features such as proofs of reserves, multi-signatory escrow arrangements and open-source software development should, if properly used, bring new protections for investors, regardless of how rich they are, and mitigate the need for external restrictions.

People in the crypto community have an opportunity, in other words, to show just how much more secure capital raising could be under a fully auditable blockchain system that no centralized institution can undermine.

It will need a stronger self-regulatory approach in which best principles for token issuance are fostered by an ecosystem of analytics, ratings, founder registries, software audits and probing journalism.

If the SAFT idea takes off, we'll be best served if it ends up being more than just a way to stay compliant.

We should see it as a framework with which to promote a ICO model that's robust and secure yet open and fair, to ensure that the token economy evolves with the kind of wide public access that's needed if it is to fulfill its sweeping potential.

Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Protocol Labs.

Building a bridge image via Shutterstock


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