If you’ve spent anytime in the blockchain or cryptocurrency community, you’ve heard the debate rage on over whether a specific cryptoasset is a security or utility. In order to understand that all cryptoassets are utilities, it’s crucial to examine the functionality of blockchains, cryptoassets and decentralized technologies. Also, a look at secondary market behaviors is needed to question if these usage behaviors should influence our evaluation of utility vs. security. Lastly, separating platforms that exercise functions of a cryptoasset from the functionality itself, makes it obvious that all cryptoassets are utilities at their foundation.
Bitcoin, a peer to peer electronic cash system issues a small unit of divisible, transferable, digital scarcity called a bitcoin. There is no promise that a bitcoin will magically multiply or pay dividends, therefore there’s no intrinsic speculative reason to buy bitcoin. Not a security. Ethereum and smart contract tokens with added functionality make things more unclear where the line is. However, all smart contract functions must be triggered by an external account (human). It’s upon us to separate functionality from usage. When we do, it’s plain to see that cryptoassets are nothing more than digital storage containers with fancy locks. More on this later. First, let’s break down the broad functionality of all cryptoassets:
- Unit of account — valuable and scarce
- Medium of exchange — transferable
- Programmable — functional
These are not the definitions of money or currency, and there’s no store of value or price in this definition, because it’s not a requirement that a cryptoasset store any value at all. Value is what users ascribe to a money, currency or asset through it’s usage and trade. The focus is on intrinsic, programmed functionality of cryptoassets that can be embedded at inception. To be clear (and to date), there is no way to make a cryptoasset trade itself intelligently or pay a dividend autonomously. Platforms that claim this are often centralized and triggering functions of cryptoassets based on external factors, usage and behaviors.
So examining the 3 core features of a cryptoasset, are you convinced that this abstract digital unit will magically rise in value or multiply itself based on it’s code alone, without external input? Not likely.
The Howey Test states:
1. There is an investment of money
2. There is an expectation of profits
3. The investment of money is in a common enterprise
4. Any profit comes from the efforts of a promoter or third party
So far the SEC has only deemed that the DAO (decentralized autonomous organization) tokens issued on the Ethereum blockchain are securities. The intention of these tokens was to own a share of projects invested in by a decentralized community of token holders, where dividends from the success of the project would be paid back to these token holders. Great, that’s a security.
Separate for a second the DAO Token from it’s user base, which is subject to change at any time. Do the tokens themselves make investment decisions and pay dividends? These functions have to be triggered by external accounts (humans). What is the “common enterprise” if the DAO is an ever-changing composite of token holders? Is there any promoter or third party efforts intrinsic to the tokens? All DAO token holders are only voting on directing funds. We’d have to examine whether each project funded is in fact a security. What if all DAO holders for the rest of time decided to only make charitable donations… Is there any expectation of profit?
At their core, DAO tokens are nothing more than digital storage containers with fancy locks. Their usage and behavior is voted into existence by a composite of DAO token holders. Yes at any given time the behavior of the DAO as a whole could definitely be construed as security like behavior. At their core, all cryptoassets are simple utilities and usage by a common enterprise creates a security. Separate cryptoassets from their utilizing platforms or common enterprises.
We’re all aware that secondary markets exist for cryptoassets and prices are highly volatile. Clearly it’s not an intrinsic quality of cryptoassets to be tradable on exchange websites, they are made tradable by various exchanges and collective behavior of the crypto community.
If a cryptoasset was not transferable, there would be no way for anyone to own any unit of account and therefore access to the utility of said token. Additionally, transferable functionality alone is not enough to deem a cryptoasset a security. Therefore, restricting the transferability of cryptoassets, imposing limiting functionality is both hard (perhaps impossible in some cases) and absurd. This was recently suggested by a Canadian token issuer, Token Funder, to comply with the Ontario Securities Commission and clearly demonstrates a complete lack of education in the space on the part of the issuer and regulators.
Not to beat a dead horse… but we cannot condemn a functional unit of digital scarcity by labeling it a security, simply because random hodlers want to trade units around. The cryptoasset doesn’t trade itself and multiply it’s value. People do that.
Separating functionality from usage leaves some clearly unimaginative cryptoassets without platforms to execute their functions. Perhaps not even assets at all. So where does all the fervor to own these digital units come from?
I argue that platforms utilizing functions of cryptoassets in a security like manner should be held accountable to securities law. These include platforms for the investment of cryptoassets and triggering functionality in order to pay dividends based on external factors and usage. This definition is vague and unclear, because I haven’t see the right discourse on cryptoassets that separates their core functionality from usage and behavior. Besides native cryptos that form the incentive mechanism of a specific blockchain, all utility coins and tokens to date have combined their utility and usage by claiming to be both the issuer of the cryptoasset and the one and only platform where it can be used for any intended utility.
Within my role at Vanbex Group, evaluating clients and new investment opportunities, I see the “all in one” blockchain solution time and time again. It’s the classic VC play spun for blockchain.
Listen, we’re going to issue this crypto right? Then we’re going to build the one and only platform for it’s usage, forever linking ourselves with the success of this cryptoasset and all of the legal and securities scrutiny. But get this… we’re going to own the entire industry vertical. Isn’t that awesome?
No, it’s not awesome. It’s a terrible idea. These people fundamentally misunderstand the third pillar of the blockchain, cryptoasset and decentralization movement. Decentralization.
The value is not in owning an entire industry vertical like Facebook with social data or Amazon with shopping data. The value is in the cryptoasset utility that enables the exchange of value without intermediaries for a given industry vertical.
Learn to let go… develop an open source protocol around a cryptoasset with a focused basket of utility functions and let anyone build platforms on top of it. Let them deal with the scrutiny of securities commissions around the world.
An Olive Branch to Securities Wannabes
Yes there are native coins that pay dividends. Securities. Yes there are cryptoassets tied to real world appreciating assets like stocks and other equities. Securities. Yes there are securities token platforms. Securities. Why work so hard for all the scrutiny though? Why not work one technology level lower and develop the cryptoasset that powers the securitization of all assets and all securities platforms?
Decentralize and conquer.
Separation of concerns (SoC) is a design principle of computer programming. Separating a computer program into sections that deal with one concern, a set of information, at a time.
I argue that we should approach our regulation and evaluation of cryptoassets with the same separation of concerns. Cryptoassets without external triggers are nothing more than digital units of account with programmable locks. The behavior of users, markets and platforms are what bring a cryptoasset to life, and also where the conversation regarding securities and investments should be. If more blockchain and cryptoasset projects understood the values and ethos of decentralization, the debate wouldn’t be raging and it would be plain to see that all cryptoassets are utilities.
Part of understanding these assets and how we should regulate them comes from examining their foundations and value. Here are some resources: