It’s been an extreme few months in the world of cryptocurrency.
If you’re looking to put more money to work in the token space, another thing that you’ve probably noticed is an explosion in the names used to define the different types: app tokens, utility tokens, security tokens…
What’s the difference and why does what a token is called matter so much?
The short answer – as with any investment – is that what you don’t know can cause you to lose money.
A new risk
In late July, the Securities and Exchange Commission (SEC) weighed in on a token issued by a Swiss-based foundation called The DAO. For those who weren’t following the decision closely, here’s what happened: the SEC found the project had run afoul of U.S. securities law.
A key point here: The DAO token collapsed before the SEC issued its guidance.
But what if it hadn’t? If the DAO token had still been freely trading at the time the SEC issued its guidance, it’s reasonable to wonder what the price impact might have been. Would the price of the token have tanked?
That’s a difficult question to answer precisely, because there’s been no precedent in the token space to date. (Though recent moves by China’s regulators may give us real-world insight).
From here, things get more complicated.
Since The DAO ruling was issued, participants in the token space have increasingly sought to find ways to distinguish between tokens that would qualify as securities and those that are not securities.
The legal view
Recently, terms like “app coin,” “app token,” “utility token” and “utility coin” have seemed to proliferate. But, what they all have in common is this: people use them interchangeably to mean “a token that is not a security.”
Joshua Ashley Klayman, who leads the Blockchain + Smart Contracts group at law firm Morrison & Foerster, said that there is no clear, bright-line guidance under the law on the distinction between the terms utility token, app token and security token.
According to Klayman, that leaves potential buyers and sellers of tokens in a tremendous gray area, since they are all effectively stuck in the position of trying to figure out how much any given token resembles a security.
“Most responsible securities lawyers would have said that The DAO token was highly likely to be a security,” she said. “When people ask about app tokens, it’s because they want to get out of the securities space. They don’t want to be constrained by securities requirements.”
Even though The DAO token was issued by a foundation in Switzerland, U.S. securities laws still apply because U.S. investors were purchasers of the token.
One way that people attempt to determine if something is a security token, according to Klayman, is based on whether the token has utility on day one.
“If you think about it in terms of a video game arcade, at some arcades you can just put quarters in the machine. In others, you have to put tokens in the machine. So users have to buy the token to transact within the ecosystem. The idea is that people really want to use the product or service that the company is offering, and that the token is the only way to access it.”
The VC view
Greg Murphy, a Toronto-based partner at the U.K. venture capital firm Outlier Ventures, which focuses on investing in blockchain and related technologies, also assists its portfolio companies with token issuance.
When asked to comment on the utility token/security token divide, Murphy acknowledged similar challenges.
“Everybody is struggling with the definition. And there really isn’t a good one,” he said.
Murphy went on to add that there is no direct jurisprudence on the matter and, hence, you’re at the mercy of your legal counsel’s view at the time you create the token – and that can alter as the regulations change.
Because of the shifting sands, Murphy said, “You have to ask yourself: Do you really want to take on potential liability if there is the chance of it being deemed a security in the future?”
The innovator view
And even those closest to the technology agree.
While Rune Christensen, founder of MakerDao – a decentralized autonomous organization working to build stable digital currencies – might be the first person you’d expect to have firm definitions, he doesn’t.
Yet, Christensen believes that ensuring solid distinctions between concepts like utility tokens and app tokens is critical for the success of the sector.
Asked to elaborate, Christensen was blunt about what he sees as the challenges now facing the space:
“The majority of ICOs that are happening now are in fact securities and should follow the standard process for securities offerings. They are fooling naive investors into believing that they are buying a piece of decentralized infrastructure when, in fact, they are only buying the promises of the management team.”
Christensen went on to explain that, from the perspective of token makers, it’s absolutely critical that the crackdown on token-based, unregulated securities offerings should not interfere with the kind of projects that are truly decentralized.
“It could be really destructive for innovation if the wrong tokens are deemed to be securities when they are not,” he stressed.
As for how investors will be able to tell which ones are which? If Christensen’s answers are any indication, that’s likely to be a question that challenges risk appetites for some time.
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