The crypto community is highly divided on whether tokens issued during ICOs are securities or not. The argument tends to center the Howey Test and the legal definition of what a security is when compared to the purported “utility” of the token being sold. As a refresher, a transaction is an investment if:

1. It is an investment of money

2. There is an expectation of profits from the investment

3. The investment of money is in a common enterprise

4. Any profit comes from the efforts of a promoter or third party*

The pro-securities side says that if the token can be bought with the expectation of selling at a higher price, it will be treated like a security. Those on the other side say that ICOs are conceptually identical to crowdfunding, where people purchase early access to a platform. The fact that the price increases on the open market is merely a byproduct of supply and demand economics.

The rest of this article is devoted to how dangerous the thinking of the second camp is.

ICO ≠ Crowdfunding

The strongest argument for ICOs being spiritual opposites from crowdfunding is the fact that ICOs are designed to create value through scarcity. This is the reason crowdfunding campaigns set minimum levels while ICOs set maximums.

To illustrate: when you are supporting a drone company via crowdfunding, you can rightly expect to receive one of their products in the future as reward for your contribution. But you are paying for them to increase their output and sell more drones which are identical to yours. In this way, your money actually devalues the individual asset. But ICO investment… ahem… “contribution” is a zero sum game. For every token you **don’t **get, someone else does. If it is truly a utility for everyone to use, it begs the question of why companies would want a limit on coins.

The Howey Test asserts that “courts look at the economic realities behind an investment scheme, rather than at its name or form,*” which brings me to my next point:

Why would you ignore the worst case scenario?

Only time will tell how the courts are going to rule. But from a community that is largely rooted in agile software development, there seems to be a notable lack of assumptions testing. Buildings have earthquake resistance, cars have seatbelts, and people have health insurance not because they expect to experience earthquakes or crashes or accidents every day, but just in case. What is the point in charging ahead insisting the black swan of regulation could not happen?

Now for the most dangerous part: all the arguments I have seen assume that regulators are completely neutral parties. In reality, regulators have more skin in this game than most of the crypto community combined. It represents reputation for them: each and every scam where honest people lose money is because of their inaction. More importantly, it represents revenue: a regulated asset is a taxable one, and the growing $500b crypto market is looking like a lot of assets. Never underestimate the power of regulators — they have done things from coercing Apple to hand over encryption keys to making Mark Zuckerberg testify in front of Congress.

We are at a pivotal moment in crypto, let’s make sure everyone gets through it with no jail time or evaporated wealth.

*Courtesy of findlaw.com

The crypto community is highly divided on whether tokens issued during ICOs are securities or not. The argument tends to center the Howey Test and the legal definition of what a security is when compared to the purported “utility” of the token being sold. As a refresher, a transaction is an investment if:

1. It is an investment of money

2. There is an expectation of profits from the investment

3. The investment of money is in a common enterprise

4. Any profit comes from the efforts of a promoter or third party*

The pro-securities side says that if the token can be bought with the expectation of selling at a higher price, it will be treated like a security. Those on the other side say that ICOs are conceptually identical to crowdfunding, where people purchase early access to a platform. The fact that the price increases on the open market is merely a byproduct of supply and demand economics.

The rest of this article is devoted to how dangerous the thinking of the second camp is.

ICO ≠ Crowdfunding

The strongest argument for ICOs being spiritual opposites from crowdfunding is the fact that ICOs are designed to create value through scarcity. This is the reason crowdfunding campaigns set minimum levels while ICOs set maximums.

To illustrate: when you are supporting a drone company via crowdfunding, you can rightly expect to receive one of their products in the future as reward for your contribution. But you are paying for them to increase their output and sell more drones which are identical to yours. In this way, your money actually devalues the individual asset. But ICO investment… ahem… “contribution” is a zero sum game. For every token you **don’t **get, someone else does. If it is truly a utility for everyone to use, it begs the question of why companies would want a limit on coins.

The Howey Test asserts that “courts look at the economic realities behind an investment scheme, rather than at its name or form,*” which brings me to my next point:

Why would you ignore the worst case scenario?

Only time will tell how the courts are going to rule. But from a community that is largely rooted in agile software development, there seems to be a notable lack of assumptions testing. Buildings have earthquake resistance, cars have seatbelts, and people have health insurance not because they expect to experience earthquakes or crashes or accidents every day, but just in case. What is the point in charging ahead insisting the black swan of regulation could not happen?

Now for the most dangerous part: all the arguments I have seen assume that regulators are completely neutral parties. In reality, regulators have more skin in this game than most of the crypto community combined. It represents reputation for them: each and every scam where honest people lose money is because of their inaction. More importantly, it represents revenue: a regulated asset is a taxable one, and the growing $500b crypto market is looking like a lot of assets. Never underestimate the power of regulators — they have done things from coercing Apple to hand over encryption keys to making Mark Zuckerberg testify in front of Congress.

We are at a pivotal moment in crypto, let’s make sure everyone gets through it with no jail time or evaporated wealth.

*Courtesy of findlaw.com