Marco Santori is a fintech law firm primarily based in New York Town in which he potential customers the blockchain technological know-how workforce at Cooley LLP.
In this opinion piece, part of an ongoing series on the state of U.S. regulation as it applies to initial coin choices and token sales, he points out the importance (and limits) of the lately announced SAFT task.
Approximately a calendar year back, I gave a generalized clarification of how some token sales could violate federal securities legal guidelines in the U.S. I also gave some tips on how to make a token and network that would stay clear of stability status.
Sadly, quite a few token sellers have continued promoting tokens to the general public prior to developing the network’s true functionality in what I have taken to contacting a “immediate presale.” Many commentators, myself integrated, have discovered the “immediate presale” design to be a blunt and risky method. I warned towards it at the finish of my October 2016 op-ed.
In this Section 2, I propose an substitute: a thorough transaction framework that could appreciably lower the danger of the token vendor functioning afoul of the securities legal guidelines. We have been functioning on developing this composition with a couple unique contributors in the industry, including buyers, issuers and developers. A couple of our clients are by now tests it in the wild.
It is named the SAFT: Easy Agreement for Long run Tokens. Of course, it is really a play on the Y Combinator Secure (Easy Agreement for Long run Fairness). The SAFT is a agreement involving developers and buyers. The SAFT framework is a transaction flow with this agreement at its heart.
We didn’t invent the SAFT. It was remaining utilized in an unexamined way by token sellers prior to we started suggesting it. It is significant time an individual looked beneath the hood, although, and examined regardless of whether it actually, you know, performs.
At a significant amount, the SAFT seems like this:
- The developer of a token-primarily based decentralized network enters into a published agreement, named a SAFT, with accredited buyers. The SAFT phone calls for buyers to pay out revenue to the developer in exchange for a appropriate to tokens as soon as the network is concluded. The buyers commonly get a lower price. The developers will not situation any pre-useful tokens at this phase, but they do file the required sorts with the SEC.
- The developer uses the revenue to build the network. This could take months or decades. Nevertheless no pre-useful tokens are issued.
- After the network’s simple functionality exists, the developer creates the tokens and delivers them to the buyers, who can market tokens to the general public on the open marketplace to know their financial gain.
- The developers them selves can also market tokens to the general public if they so drive.
The SAFT difference
Assess this two-action system to the immediate presale, in which developers market a pre-useful token right to the general public for speedy supply or for supply at some date in the potential.
The developers increase tens of millions of general public dollars, and use that revenue to build the network protocol to functionality. The general public will take on all the danger that the task fails, and does so with out the profit of typical disclosure concepts, fiduciary responsibilities, heightened antifraud expectations or accreditation needs.
I remain a supporter of the token sale in standard, but the immediate presale is troubling for at least a couple causes. To maintain with the theme of Section 1 of this series, I will concentrate on a single cause: a immediate presale could be regarded the sale of a stability to the general public with out a registration assertion or exemption in position. That is unlawful in the U.S.
I feel the SAFT framework addresses this worry elegantly. The SAFT is a published document (obtainable as an exhibit to this white paper below) that seems like a Secure, and, like a Secure, the SAFT is a stability. At least we feel it has a incredibly great likelihood of remaining regarded a stability – and the events totally intend for it to be a single.
We are not seeking to stay clear of the securities legal guidelines below. We’re seeking to use them.
Investors buy the SAFT not since they intend to use the tokens on the network as soon as it is designed, but since they find to market the tokens on the open marketplace and know the financial gain from their lower price. There is no (or pretty much no) consumptive intent below. The buyers count on to financial gain from the attempts of the developer.
Since the SAFT is a stability, the developers take care of it like a single. That is to say, they stick to the securities legal guidelines when they market it: they file the requisite type with the SEC, they accredit their buyers (if required) and they could even flow into a non-public placement memorandum.
The buyers send out their buy revenue (in dollars, ether, bitcoin, and so forth.) to the developers. In exchange, the developers indication a SAFT and get the job done around the subsequent couple months or decades to build the network into a thing genuinely useful.
After it is useful, the developers generate the tokens and produce them to the buyers. After any lockup period in the SAFT has expired, the buyers can then market the tokens on the open marketplace. The developers can market them publicly as nicely.
The most prevalent criticism to this technique goes a thing like this: “Okay, the SAFT is a stability. You have followed the securities legal guidelines there. But as soon as the developers market the tokens to the general public, a great deal of purchasers will obtain them just to speculate by buying and selling on an exchange! Isn’t that a stability as nicely?”
Very well, likely not. Try to remember, just obtaining a thing to resell it for a financial gain on a secondary marketplace would not make the matter a stability – not even if all of the other prongs of the Howey test are satisfied. The concern is: Wherever can the customer moderately count on that secondary marketplace benefit appreciation to occur from?
Try to remember from Section 1, for a token to be a stability, the Howey test necessitates that the purchaser count on his financial gain to consequence “from the attempts of other people.” If the purchaser expects financial gain, but it is really predominantly from a thing other than the attempts of other people, the matter he bought is not a stability beneath Howey.
For case in point, when an individual buys gold or sugar legal rights as an financial investment products (i.e. just to resell it on an open marketplace), that individual expects gains, but that financial gain is not from the effort and hard work of any individual third get together. It is from the terrific range of marketplace variables influencing provide and demand for gold or sugar.
The rate of a performing token is likewise determined. The benefit of a performing token remaining put to its meant use will be determined by a terrific range of worldwide provide-and-demand forces. For a pre-useful token, although, the customer should really count on a single force to predominate the other people: the attempts of the developer who has promised to imbue the token with functionality.
As a result, the “attempts of other people” prong of Howey can be satisfied reasonably quickly by a pre-useful token.
After useful, the attempts of the developers will no doubt even now determine into the benefit of the token on secondary markets, but it would be complicated to say that protocol upgrades could be the “undeniably important,” “vital attempts” (each Howey needs) that commonly cause the rate to shift.
The “vital” attempts of the developers have ordinarily been expended by now in building the useful network. Purchasers of tokens on that by now useful network no for a longer period want to rely on the developers to expend all those attempts.
Certainly, in most circumstances it could be complicated to say that the rate shift was brought about by any “attempts” at all. For useful tokens, rate moves can be brought about by any range of forces influencing provide and demand. To use examples from the SAFT Undertaking white paper: A token performing as a medium of exchange on a decentralized marketplace for graphics processing energy (I’m building this a single up) could fluctuate with the release of a strike online video recreation franchise or the availability of rare earth aspects utilized in graphics card processing.
A token performing as a simple coupon for a totally free box of razor blades (building this a single up, much too) could fluctuate with the rate of metal, or even the acceptance of beards in a target marketplace. To be positive, the token sellers’ managerial attempts in updating the network will aspect into the rate, but will it predominate all the other forces? For an by now-useful token, not often.
Striking a stability
In a SAFT transaction, the reasonably heavyweight securities legal guidelines implement at the early phases, when the complete task could are unsuccessful and they are most needed.
Recall that the SAFT is a stability, so anti-fraud provisions, accredited investor needs and the like implement to the transaction. The additional manageable consumer protection legal guidelines implement as soon as the network is useful and, at minimum, prospective buyers count on the network to functionality.
So, the SAFT framework phone calls for securities legal guidelines when the customer will take on enterprise danger, and phone calls for the consumer protection legal guidelines when the customer will take on products danger. That struck us, the authors of the white paper, as the appropriate state of affairs, and we feel the SAFT will get us there.
That claimed, there are a great deal of limits on the overall flexibility of the SAFT framework. For case in point, the SAFT:
- Isn’t essential for developers who can market a useful token right to the general public on working day a single. The SAFT bridges the treacherous regulatory waters involving accepting funds and delivering a useful token. If you’ve by now designed a useful token, the requirement of a SAFT is questionable.
- Won’t accomplish significantly for tokens that are them selves securities (e.g. limited partnership pursuits like the DAO token). Employing a SAFT will not likely make a securities token any considerably less of a stability. The SAFT only performs for “utility tokens.”
- Will not help even utility tokens in which purchasers remain reliant on the attempts of the token sellers (or other people) for their expectation of financial gain soon after the token is circulating. Examples incorporate predicaments in which the vendor depends on the issuer’s guarantees to obtain again the tokens to maximize the rate, or in which the vendor guarantees to build the certainly useful functionality at some level soon after the sale.
Even knowing the limits, the SAFT is not very all set to serve as a marketplace typical. For a single matter, the examination we’ve carried out is limited to U.S. regulation. A further cause is that the industrial conditions of the SAFT are bare-bones and simple.
For these and other causes, we’ve introduced the SAFT Undertaking. It is meant to be a discussion board for discussion and sharing suggestions about the SAFT framework. Our door is open for tips and criticisms.
In Section 3 of this series, I intend to talk about some SAFT greatest procedures, including tax management strategies and the varieties of tokens that are most suitable with the SAFT framework.
Have an concept for a industrial provision for the SAFT? A criticism of the regulatory arguments supporting it? Seen a policy consideration we missed? Believe this complete SAFT matter is doomed? We might like to know why! Lead to the SAFT task.
Clock parts image via Shutterstock
Disclaimer: This write-up should really not be taken as, and is not meant to supply, financial investment tips. Remember to conduct your individual complete research prior to investing in any cryptocurrency.