Continuing on our journey of securities law and cryptocurrency, it’s time to start pulling apart the Howey test. In an academic paper following the Howey Test’s 64th anniversary, the test was equated to that house that the home owners have continued building new additions that are clearly additions, sometimes awkward, and “the consensus of neighbors with taste is that the house should be torn down and rebuilt from scratch.”
What better way to start than by contemplating what is an “investment of money”? In my previous post, “investment of money” is presumably an investment of anything of value. An investment is the commitment of the item of value with the expectation of receiving some additional profit. This prong seems simple enough, is rarely litigated, and not of much concern; however, of more concern to the crypto community is the concept of airdrops.
An airdrop is when a token project distributes tokens into the token recipient’s cryptocurrency wallet for no monetary contribution in exchange. Most of the time, the airdrop is for the Ethereum blockchain; however, airdrops have occurred on Stellar, NEO, Waves, and EOS (to name a few) and bitcoin holders have received airdrops via Bitcoin hard forks. Airdrops continue to be a source of token distributions for a number of reasons. For the token issuer, it is an easy way to gain a broad network of token holders. Once listed on an exchange, the token holders are free to trade thereby creating a “liquid” market and market cap for the token project as well as a source of income for the token project as an airdrop usually constitutes some minority percentage of the token supply. I say “usually” because an $8M airdrop earlier this month ran out of tokens and has since announced a token buy-back program. Airdrops, as a token generation event, appear to be a way to create demand for your token and to skirt the uncertainty around ICOs and securities laws. Unfortunately, this is not the case.
No Investments of Money and Securities Law
Like everything in cryptocurrency right now, it’s all new and there is nothing like it that regulators can compare it to. Well, you can continue thinking that; however, where airdrops, or free distributions of securities are concerned, the SEC has seen this movie before. On July 21, 1999, the SEC issued four cease-and-desist proceedings relating to the issuance of “free” stock. The SEC claimed in its press release, “Free stock is really a misnomer in these cases. While cash did not change hands, the companies that issued the stock received valuable benefits. Under these circumstances, the securities laws entitle investors to full and fair disclosure, which they did not receive in these cases.” The valuable benefits for these companies were “a fledgling public market for their shares, increasing their business, creating publicity, increasing traffic to their websites, and, in two cases, generating possible interest in projected public offerings.” The reason the valuable benefits to the company are mentioned is because Section 2(a)(3) of the Securities Act defines a “sale” to “include every contract of sale or disposition of a security or interest in a security, for value.” Therefore, these companies were selling unregistered securities to the public.
Given that tokens are airdropped into your cryptocurrency wallet and it is then your choice to trade them or use them as the network prescribes, is subjecting the token distribution to securities laws necessary? Yes, airdrop scams do exist taking the form of impersonating real airdrops, fake profiles and project name confusion, marketing gimmicks, requesting private keys. The SEC’s role is to protect the integrity of markets through full and fair to disclosure to prevent fraud. So, is subjecting airdrops to securities laws using the above history of free stocks necessary to achieve the SEC’s purpose or is another regulatory body like the FTC more equipped to handle such an issue?
However, as of now, when contemplating an airdrop as a token distribution model, securities law still applies. While the SEC is warming up to the notion that utility tokens can exist. However, the economic realities of the transaction must still be contemplated. An SEC review is substance over form. Unfortunately, giving away things for “free” is not so free.
Commentary by Stan Sater & Jeffrey Bekiares, Esq. Jeff is a securities lawyer with over 8+ years of experience, and is co-founder at both Founders Legal and SparkMarket. He can be reached at [email protected]