Classification of Digital Assets

Whether a token is issued as a “utility” or a “security,” market participants around the world understand very well that the issuance of digital assets have become a growingly popular vehicle for capitalization across all industries, not just those related to blockchain. And while digital assets are still in their adolescent stages (in comparison to the history of new asset classes) they are nevertheless subject to the rules and regulations which govern traditional forms of raising capital, such as securities, stocks, and bonds.

It is important to note that over the last few years, the categorization of digital assets has taken on many forms. As governing bodies begin to find that each of the assets plays a different roles under different circumstances, there has been a divide in how to view assets such as cryptocurrencies. For example, the United States Commodities and Futures Trading Commission (CFTC) categorizes bitcoin as a commodity, while the Internal Revenue Service (IRS) treats that virtual currencies should be treated as property for tax purposes under the Internal Revenue Code.

While the Securities and Exchange Commission (SEC) have made it very clear that they will continually reserve their decisions on how to treat each digital asset on a case by case basis, treatment of bitcoin and ethereum have recently been held not to be securities under the infamous Howey Test. Yet, despite providing some form of clarity in this growing digital asset class, it remains unclear whether tokens issued by crypto-projects fall within the SEC’s purvue as either a security or not a security.

As part of our tokenomics auditing, we view all the characteristics that are necessary to determine how a particular token will be treated in the eyes of the law. The Petros Law Group provides thorough strategies to help clients bring their product to market proficiently and compliantly.

Our firm is dedicated to working closely with clients to ensure that they are provided a comprehensive legal breakdown of digital assets, including security tokens and utility tokens. Our goal is to create as much clarity to the unclear treatment of these virtual tokens and their respective use-cases.

Digital Asset Compliance

While the Securities Act offer several definitions, interpretations and an overly-generalized guideline for constitutes a “security,” the Securities and Exchange Commission (SEC) and the Courts rely mostly on case law precedent when applying the broad strokes of the Securities Act when ruling on whether or not these newly emerging digital assets fall within the purview of Federal regulators.

Is Your Digital Asset a Security?

The Howey test, a famous case decision ruled in 1943, has remained the standard framework used by regulators to determine whether or not a digital assets sold through a token generation event (e.g. ICO, STO, IEO) constitutes the sale of a “security.”

The United States justice system is well-known for its application of modern circumstances through archaic guidelines. However, until government regulators can design a universally applicable formula to define, regulate, and govern the purchase and sale of digital assets such as cryptocurrencies, utilities tokens, and security tokens, we much do the best with what we have.

For a comprehensive explanation of how the SEC applies its Howey test to determine whether a digital asset is or is not a security under the Securities Act, read our informative powerpoint presentation here.

When applied in a securities legal analysis, the SEC applies the Howey test by applying a three-prong test: (1) was there an investment money (later expanded to include digital stores of value), (2) in a “common enterprise,” (3) with a reasonable expectation of profits to be derived from the efforts of others.

File for an Exemption

Our firm provides STO Issuers with a bespoke strategic approach to formulating a well-structured security token offering that complies with the Securities Act under (1) Regulation D, (2) Regulation S, (3) Regulation A, (4) Regulation A+, or (5) Regulation CF.

“No Action Letter”

Additionally, if appropriate under the unique circumstances inherent in each Issuers token offering, a tokenized asset may be a good candidate for receiving approval form the SEC upon the filing of a “No Action Letter.” As defined by the SEC on their official government website, a No Action Letter is a formal request submitted on behalf of an individual or entity “who is not certain whether a particular product, service, or action would constitute a violation of the federal securities laws.”

The SEC will perform an analysis of the relief sought in the no action letter based on the specific facts and circumstances set forth in the request. If it is determined by the SEC’s staff that our client’s security token issuance is eligible for no action relief, the SEC will recommend that the Commission refrain from taking enforcement action against our client based on the facts and representations described in our No Action Letter. Click here for more information.