You Can’t Separate Utility from Security Tokens, Say EU Researchers

Published at: Feb. 3, 2020

European researchers writing for the Oxford University Faculty of Law blog argue that the distinction between utility and security tokens is less important than most assume when it comes to regulation.  

In a Feb. 3 blog post and their paper, “Blockchain Startups and Prospectus Regulation,” Dmitri Boreiko, Paolo Giudici and Guido Ferrarini claim that the conceptual difference between the two types of crypto-assets “should be at least partially abandoned.”

Dmitri Boreiko is an assistant professor of corporate finance and the Free University of Bolzano-Bozen, where Paolo Giudici is a professor of business law. Guido Ferrarini, for his part, is emeritus professor of business law at the University of Genoa, and chair in governance of financial institutions at Radboud University of Nijmegen.

Moving beyond the utility vs. security divide 

The researchers make two key points regarding digital tokens and regulation, which relate both to token taxonomy and to financing models such as initial coin offerings (ICOs) and initial exchange offerings (IEOs).

Token taxonomy — or classification — generally refers to the distinction drawn between utility tokens and security tokens

In the United States, for example, a token is considered to have the characteristics of a security — specifically an investment contract — where its purchase is held to be an investment in a common enterprise, in which investors are reasonably led to expect profits that others generate.

A utility token, by contrast, is more limited in that the given digital asset is held to be valid as a means of payment for the services or products that its issuers create. 

In their work, Boreiko, Guidici and Ferrarini argue that the absolute difference between utility and security token is not as clear as some regulators claim. 

For example, where a blockchain ecosystem is large and liquid, a utility token may take on the properties of a currency and can usually be converted to a major cryptocurrency such as Bitcoin (BTC) or Ethereum (ETH) by means of an exchange. It can also directly or indirectly be traded for fiat currency. The researchers write:

“The utility token can be conceptualized both as a mini-currency and as an investment in a platform. That is the reason why all tokens are briefly and broadly dubbed ‘cryptocurrencies’. Indeed, they aim at becoming a general currency or a recognized and easily exchangeable market-specific currency.”

What makes hard and fast boundaries hard to draw, they continue, is that utility tokens combine a customer payment mechanism (similar to currencies), a utility aspect (within an ecosystem or platform) and an investment component (as a tradable asset) — all in one instrument. 

From a regulatory perspective, the line between currencies, financial assets and consumption goods therefore becomes blurred, the researchers say.

Financing models and EU regulation

In the second part of their paper, the researchers look at ICO and IEO crypto financing models. 

Here, they point to the reasonably high trading volume of tokens issued via either route, well after the offering itself. This, they say, indicates that investors see these assets as tradable investments and not merely as utility tokens redeemable for services.

This character as an investment instrument exposes investors to common capital market and financial risks, the researchers note, and regulators should therefore treat these assets as tradable securities in accordance with EU financial markets regulation:

“Have all the characteristics of a capital market instrument. We therefore argue that they are subject to prospectus regulation independently from the utility that they offer to contributors.”

Currently, in a U.S. context, a security token classification can have major consequences for ICO operators and other crypto firms, as securities sales are subject to stringent requirements under federal law. If violated, the penalties can be significant.

In Europe, much attention has recently been focused on anti-money-laundering regulation and cryptocurrencies, while approaches to token taxonomy still remain largely fragmented across different countries.

Tags
Related Posts
It is time for the US to create a ‘Ripple test’ for crypto
Most crypto enthusiasts are less than pleased with the United States Securities and Exchange Commission’s past approach to crypto. This is not because legitimate businesses oppose regulation but because of the breadth, complexity and uncertainty associated with the current regulatory regime. Even in the context of general discontent, few actions by the SEC have engendered as much widespread criticism as the Dec. 22, 2020 complaint that initiated a civil enforcement action against Ripple Labs and two of its executives. Not everyone opposed the action. For example, Coin Center, a pro-crypto nonprofit advocacy and research group, declined to argue against the …
Technology / July 21, 2021
SEC vs. Kik Interactive: A status update on the Kin ecosystem and Kin tokens
Much has been written about the Sept. 30, 2020, decision by Judge Alvin Hellerstein of the Southern District of New York in the U.S. Securities and Exchange Commission vs. Kik Interactive. In that order, the judge ruled in favor of the SEC’s motion for summary judgement, applying the Howey Test in the course of determining that Kik Interactive had violated the federal securities laws by selling contractual rights to acquire Kin tokens and later by issuing and selling the Kin tokens themselves. Less has been said about the actual final judgement, entered by the court on Oct. 21, 2020, pursuant …
Technology / Jan. 24, 2021
Blockchain-Based Wireless IoT Network Helium Expands to Europe
Peer-to-peer, or P2P, crypto-powered wireless network Helium announced its expansion to Europe after launching in North America. According to a June 18 announcement shared with Cointelegraph, Helium will start shipping its network’s Hotspots to Europe in July. The announcement also notes that the firm just launched Helium Tabs. Helium Tabs are devices that leverage the decentralized network for tracking purposes. According to the official website, they have a battery duration of over 6 months. The hotspots are both low-power wireless access points accessible from up to 10 miles away and nodes on the Helium blockchain. Node operation is rewarded using …
Blockchain / June 19, 2020
German Security Token Platform to Develop a Custody Solution
German security token offering (STO) platform Black Manta Capital Partners partnered with local digital asset custody firm Finoa to develop institutional security token custody. According to an announcement shared with Cointelegraph on May 4, the cooperation aims to develop a regulated security token custody solution explicitly aimed at institutional investors, high net worth individuals and corporations. Black Manta and Finoa will first collaborate on securing the tokens of the Berlin STO that has tokenized $12 million worth of real estate announced last month. Per the announcement, Finoa is a Berlin-based digital asset custodian that holds a crypto custody license issued …
Regulation / May 4, 2020
US SEC Report Notes Trading Suspensions, Actions Against Crypto Firms in 2019
The United States Securities and Exchange Commission (SEC) suspended securities trading of 271 issuers this year, including some digital assets. The SEC released its annual report for the fiscal year of 2019 on Nov. 6, in which the regulator also noted that the number of suspensions is only slightly lower than last year’s 280. 31 court-ordered asset freezes in 2019 The report notes a Nevada company that falsely claimed to have partnered with an SEC-qualified custodian for its crypto transactions and to offer an SEC-regulated token offering as an example. In April, the SEC temporarily suspended trading in the securities …
United States / Nov. 6, 2019