On July 25, 2017, the Securities and Exchange Commission (SEC) issued a statement on the regulatory significance of offers and sales of digital assets carried out using distributed ledger or blockchain technology. That statement followed the SEC's Report of Investigation into The DAO, an unincorporated organization designed to issue tokens administered on a distributed ledger that would allow the holder to share in the anticipated earnings of the organization. The DAO and its structure drew a great deal of attention after a hacker stole approximately 1/3 of its assets.
The SEC's investigation, as summarized in the Report of Investigation, was concerned at least in part with the character of the tokens issued by The DAO and whether they were securities that should be subject to SEC regulation.
The SEC's statement notes the caution in the Report of Investigation that "issuers of distributed ledger or blockchain technology-based securities must register offers and sales of such securities unless a valid exemption applies." Not only must issuers of such blockchain-based securities comply with securities laws, but so too must any securities exchanges providing for trading in such securities.
The SEC's level-headed position – that initial coin offerings (ICOs) or blockchain tokens "may" in some circumstances be subject to securities regulation – reflects the fact that not all digital tokens are created for the same purpose. This mirrors the position taken by the Ontario Securities Commission (OSC) in its March 8, 2017 bulletin, that "businesses that use distributed ledger technologies [...] such as blockchain, as part of their financial products or service offerings [...] may be subject to Ontario securities law requirements."
The SEC's position on both The DAO and on ICOs can hardly be surprising. Securities regulators in both the U.S. and Canada will scrutinize the substance of a product or transaction, rather than just its form or label in order to determine whether securities law applies. As the SEC observes in the Report of Investigation, "whether or not a particular transaction involves the offer and sale of a security – regardless of the terminology used – will depend on the facts and circumstances, including the economic realities of the transaction."
The ruling is a further signal of likely impending general acceptance of the practice of trading securities on the blockchain. It follows the passage the previous week of amendments to Delaware's General Corporation Law (which came into force on August 1, 2017) to permit Delaware corporations to use distributed ledgers or blockchains for the creation and maintenance of corporate records, including the company's stock ledger.
The ruling also raises the question of where the line between a true cryptocurrency and a share-adjacent blockchain token might be. We can expect a less obvious future case will prove to be more controversial as more firms move into the DLT space.
For more information on blockchains, distributed ledgers, smart contracts and cryptocurrencies, please visit Norton Rose Fulbright's suite of resources on FinTech law and regulation here. See also Unlocking the Blockchain, our global legal and regulatory guide to DLT.
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