Risky and rational.
That about sums up the state of U.S. token sales in the wake of new dialogue on whether the mechanism, by which startups are issuing custom cryptocurrencies to raise funds, is compliant with the law. Lost in the dialogue, however, has been that there are many more specific types of token sales.
In fact, when developers have an idea for a distributed project, they often raise money with what’s come to be called a “simple agreement for future tokens” or a “SAFT.” (A method that’s often synonymous with initial coin offerings, in which tokens are minted and sold directly to the public).
More broadly, the SAFT is an idea that a company that wants to build a service platform that runs on tokens can raise money by selling contracts to receive those tokens once it has been built. The contract is a security, everyone agrees, but the thinking is that the token wouldn’t be once the platform is live.
Of course, crypto startups could also raise money by selling equity to venture firms, but that takes away some of their upside, and that’s how the SAFT has perhaps pulled away from other competing standards.
Mark Radcliffe, a partner at the law firm DLA Piper, told CoinDesk:
“If you want non-dilutive financing, your choices are a SAFT or try to stay outside of the US.”
Still, a lot of SAFTs have been showing up in legal filings in the U.S. of late. Intangible Labs raised $133 million in a SAFT. Privacy protocol Orchid has stated its intention to sell $125 million in SAFTs.
There have been others, too, and that’s notable given the current climate.
Aaron Wright of Cardozo Law School, for example, has made a detailed case arguing that the SAFT is itself a security, from contract to token, an argument that looked prescient when earlier this year rumors began to swirl that the Securities and Exchange Commission (SEC) was going after lots of initial coin offering (ICO) projects.
In fact, many people believed the SAFT was the common thread across the cases regulators were building.
This perception that the SAFT continues to linger, even though those close to the creation of the idea have denied it. And it seemed somewhat like the token space had started to go quiet thereafter, a trend that might have boosted perception that something was amiss
Material changes did take place. Public sales to U.S. investors dwindled, for example. Even giving tokens away to regular people turns out to be a pain. The funds raised these days in pre-sales come from accredited investors only. In fact, many limit their efforts to veteran investors and funds.
But the SAFT?
“I don’t think the SAFT ever went away,” Radcliffe said.
And key to that realization is that despite the tone of many mocking media articles, U.S. regulators have not yet publicly rendered judgement on the SAFT yet.
There’s been no guidances. There’s been no cases filed. There have certainly been no cases brought to trial. All we know for sure is the chairman of the SEC has expressed concerns several times in public remarks.
“Can you convert something that’s a Reg D offering into something that’s not a security? It’s an untested theory,” Radcliffe said.
Like a farmer who buys a futures contract for corn. The contract is a security but the corn itself isn’t when the farmer takes delivery. Can that work for tokens? Courts haven’t said.
Former Commodities Futures Trading Commission Chair Gary Gensler confirmed the same this week, stating clearly that this matter remains undecided:
“Can you put a packaging around a token, and so the package is a security and so the token later on is not. Is that alright? The SEC has not yet spoken on that, and there’s controversy around it.”
So, the short answer is the industry doesn’t know. Some number of ICO projects may be in negotiations with regulators now over their past offerings, but the facts and circumstances have yet to emerge.
And as we previously reported, even if that’s underway it’s going to take a long time to sort cases out. But considering the fact that most of these projects are served by the same relatively small group of large law firms, it is telling that SAFTs keep moving forward.
So, where does this leave aspiring entrepreneurs? The first place to start in talking about the risk of SAFTs is to discuss the risks of not doing it.
Industry veteran Caitlin Long spent much of this year working to get legislation passed in Wyoming that recognized the legitimacy of utility tokens at the state level. In the course of working that campaign, she talked to companies that left the U.S. because they couldn’t stomach the regulatory uncertainty here.
“They are leaving out the entire U.S. market and that’s the deepest capital market,” she said.
Raising money just gets much harder elsewhere, Long said, never mind the other benefits of having the oldest and most entrenched tech sector in the world.
One very new startup with plans for a modest $5 million token sale to develop a more affordable type of mining chip has announced its intention to operate from Wyoming following the new laws.
Founder Charles Dusek told CoinDesk he had considered locating offshore, but he decided to try remaining here after seeing one state endorse the business model.
“We are betting there’s going to be a movement to open it up,” he said.
So, what’s the risk if the SEC does come down on this funding approach? Radcliffe and Long both agreed that criminal action was very unlikely for companies operating in good faith.
“The nightmare scenario would be a categorical classification from the SEC that all tokens are, in fact, securities,” long-time crypto startup entrepreneur Ryan Selkis wrote on the Messari blogrecently, after news came out that major investors had met with the SEC about this new industry.
In that case, the SEC might require companies to return all the money raised. This might be an extreme analysis, though.
“I think that the risk of the SAFT is not in the SAFT contract, but rather that the tokens upon issuance are securities which would dramatically limit their value in running a network,” Radcliffe said.
Long added that lawsuits by investors following such a finding might be the larger risk than any specific punishment regulators might impose, but she also argued that the SEC still has some important thinking to do.
Because the ICO market has started to look like venture capital and initial public offerings’ kid sister going through a growth spurt, Long argued that it’s very unlikely that the SEC will make a move that would stifle this entire new industry.
Assuming a project is well-intentioned making a good faith effort to be compliant with the law, she said:
“I think those who are taking a little bit of regulatory risk are going to be fine.”