The End of Utility Tokens…?
Today, the vast majority of Initial Coin Offerings (ICOs) or Token Generating Events (TGEs) prefer the issuance of “Utility Tokens” to circumvent securities laws. However, as government regulation tightens towards protecting investor rights and classifying utility tokens as “Securities” — primarily in the US — it’s perhaps just a matter of time until other leading regulatory authorities such as the Swiss Financial Market Supervisory Authority (FINMA) and the Financial Conduct Authority (FCA) in the UK revise their current ICO guidelines. As the government regulators around the world continue to release pronouncements classifying the majority of ICOs as ‘Securities’, its inevitable that entrepreneurs will continue to manoeuvre into less restrictive jurisdictions (e.g. Switzerland, Singapore, Malta, and Cayman Islands, just to name a few).
Furthermore, most utility tokens fail to pass the so-called “Howey Test” — a legal test defined by the US Supreme Court in 1946 that determines whether an investment opportunity or asset would legally be considered a security or not. Applying this historical principle in the digital era of cryptocurrencies is debatable — whereby a transaction is deemed an investment agreement if it meets one of the following criteria, based upon the token characteristics as described in the Whitepaper.
a) It is an investment of money
b) There’s an expectation of profits
c) Investment is in a common enterprise
d) Profits come from efforts of a third-party
Investments in ICO projects — often legally termed as ‘contributions’ or even ‘donations’ by creative law firms — largely meet the definition of “Securities” under the aforementioned points a) and b) of the Howey Test. It is therefore plausible that current token trends are shifting towards the “Security Token Offering (STO)” as the future of fundraising, potentially replacing ICOs and Utility Tokens over the coming years. In this context, and according to various industry experts, STOs are expected to further stimulate market liquidity with access to $18 trillion of individual and institutional capital (so-called ‘smart money’) in comparison to the $12 billion available to ICOs today. However, with flawed token valuations, token wallet hacks, and an unclear regulatory environment, digital tokens remain a speculative and high-risk asset class.
In anticipation of STOs becoming the preferred investment token for investors around the world — enabled through an ingenious compromise that facilitates the automatic compliance with securities laws built into the blockchain smart contracts — many startups that aim to build genuine and profitable businesses may decide to raise capital through STOs, thus proactively mitigating against potential legal issues, regulatory interference in operational business, and the possibility of litigation further down the road.
Furthermore, the issuance of security tokens demonstrates higher credibility and trustworthiness in the underlying business model in comparison to ICOs, which have been tainted as scams and pump-and-dump schemes, resulting in many failed crypto investments. With that said, organisations need to remain conscious of the fact that governmental regulators will continue to lag behind the technological advancements in the crypto space — not due to their lack of effort in keeping up — but rather due to the extraordinary speed of technology evolution, powered by large global and vibrant open-source communities.
Adapting and keeping pace with this rapid evolving macro-environment is a major challenge and potential risk for any organisation. However, to achieve sustainable competitive advantage in a decentralised and tokenised economy, entrepreneurs and enterprises must learn to adapt and be disrupted to remain relevant. As the blockchain and distributed ledger technology expands deeper into every sector of the digital economy, the multi-dimensional characteristics and current classifications of cryptographic tokens based on their underlying economic function (e.g. Utility, Payment, Security, Asset, or Hybrid) will evolve in parallel — as token design frameworks introduce the new emerging concept of “Consumer Tokens”, arguably ending the current era of Utility Tokens…