If you are thinking about launching a Token Generation Event (TGE)—which is also commonly referred to as an Initial Coin Offering (“ICO”)—and you are either based in the U.S. or plan to offer your token to U.S. citizens, you need to be aware of the“Howey Test,” which is used by the SEC to determine whether your token is a “security” (and here’s a hint—you do NOT want your token to be considered a security by the SEC unless is properly registered as such).
The Howey Test gets its name from a 1946 U.S. Supreme Court decision in which the court established that a security “involves an investment of money in a common enterprise with profits to come solely from the efforts of others.” Sec. & Exch. Comm’n v. W.J. Howey Co., 328 U.S. 293, 300 (1946).
As with most legal decisions, the exact definition of things like “common enterprise” are left open to interpretation, and ultimately vary depending on the nature of the enterprise in question. In the case of blockchain tokens, there are three main things you want to ask yourself before launching a TGE:
- Is my token an investment vehicle?If the SEC views your TGE as an investment vehicle, i.e., one that is being purchased primarily by investors to make money (or is at least being advertised that way), it will almost certainly be considered a security. As a result, you should NEVER suggest that investors can make money from your token. Furthermore, it is a good practice to avoid using the term “ICO” as it implies investments. Always use “TGE” instead.
- Does my token have utility? Or even better, does it have exclusiveutility?From the SEC’s perspective, a token without an actual use (a use that is separate and independent from being a funding mechanism) is closest to what a security is. In order to avoid being considered a security, a token must be used for something, e.g., the use of a product or access to a service (see point #1, above). When thinking of token utility, it is also important to think in terms of “exclusive” utility. For example, if your token is being used to access a platform and engage with its content, the token should be the only option given to users to access the platform. If, on the other hand, you allow users to access your platform via tokens as well as via other means like FIAT currencies, the utility is not exclusive, and the SEC may simply see it as a tactic to circumvent the requirements for issuing a traditional security (which is often the purpose of relying on TGEs/ICOs in the first place).
- Is my TGE being used to access something concrete?
Stated another way, is the TGE just being used to raise money for an idea, or is it being used to gain access to something that actually exists? If it is just an idea, your TGE is much more likely to be considered a security by the SEC. On the other hand, if your business is an actual platform with an Alpha version that users can sign up for and start using, a TGE that grants access to that platform is less likely to be considered a security by the SEC (note, however, that a simple demo version of the platform in question may not suffice, as there needs to be actual proof that the product is being used for its utility, which is covered in point #2, below).
Bottom line: If you feel that your token won’t pass these three points above, don’t risk it. Either pivot to a new token model or consider converting the token to a security or filing for Reg D, Reg A or Reg A+ instead.