TLDR On 3rd April 2019, the US Securities Regulator, SEC, issued a public response to TKJ (TurnKey Jet Inc) that stated unequivocally that the Tokens issued by TKJ are not securities. This may offer regulatory clarity for Utility Tokens, but the devil is as always in the details. This post is one entrepreneur’s attempt to parse these details to understand the legal landscape around Tokens.
Here is the original SEC announcement.
IANAL Disclaimer. I Am Not A Lawyer. Get proper legal advice. This is just one entrepreneur talking to other entrepreneurs.
This update to The Blockchain Economy digital book covers:
- Takeaways from each of the points in the SEC notice
- Case Law is different from Civil/Code Law
- Choose your playing field – Regulated or Unregulated
Takeaways from each of the points in the SEC notice.
Our takeaways in italics
- TKJ will not use any funds from Token sales to develop the TKJ Platform, Network, or App, and each of these will be fully developed and operational at the time any Tokens are sold;
Don’t use Utility Tokens to raise capital. For that, use Security Tokens. TKJ was not raising capital. In venture terms, you need to at least have working code ie MVP (Minimum Viable Product).
- the Tokens will be immediately usable for their intended functionality (purchasing air charter services) at the time they are sold;
In short, use Utility Tokens for marketing, not for capital raising. PrePaid Tokens work when supply is limited. This is clearly true for air charter services (which is what TKJ offers) and most analog physical world services. If supply is limited, customers are motivated to order ahead. This is very different from most digital services which are defined by being unlimited supply (because of almost zero cost to copy). Smart entrepreneurs will figure out how to create premium digital services with limited supply but with digital efficiency. An example might be a physical artefact with some special branding for fans.
- TKJ will restrict transfers of Tokens to TKJ Wallets only, and not to wallets external to the Platform;
The term wallet is confusing here. The SEC definition seems to assumes open source crypto wallets that anybody can use. No problem, plenty of choice here. This is not like physical wallets where we can have multiple tokens (cash, loyalty cards, credit/debit cards) in a single wallet. In the digital realm, the equivalent to that physical wallet is our mobile phone. The term wallet as used by SEC is more like a combination of loyalty card with pre-paid card.
- TKJ will sell Tokens at a price of one USD per Token throughout the life of the Program, and each Token will represent a TKJ obligation to supply air charter services at a value of one USD per Token;
SEC jurisdiction is America where USD is the currency, so their reference currency is USD. For other jurisdictions the token will need to be priced in other currencies. The more fundamental point is that these tokens are non-fungible. You can ONLY use them to buy air charter services.
- If TKJ offers to repurchase Tokens, it will only do so at a discount to the face value of the Tokens (one USD per Token) that the holder seeks to resell to TKJ, unless a court within the United States orders TKJ to liquidate the Tokens
This is a sensible precaution against ponzi schemes, where the issuer gives early buyers a guaranteed profit. Note the words “unless a court within the United States”. Our mantra at Daily Fintech is “bits don’t stop at borders but money has to show its passport”; financial regulation is jurisdiction dependent.
- The Token is marketed in a manner that emphasizes the functionality of the Token, and not the potential for the increase in the market value of the Token.
Note that TKJ is NOT a cryptocurrency business; they are a business in the physical world that is using cryptocurrency technology to grow their business. This would be like selling Taxi Medallions as Tokens. The Medallion/Token buyer aims to offer a taxi service and may or may not be able to sell the Token/Medallion for a profit later. Utility Tokens are about marketing not capital raising. For a brief moment in 2017, entrepreneurs got a two for one deal in ICOs that enabled both marketing AND capital raising. Those days are over. Although the new rules seem like a limitation, the biggest issue for most ventures is marketing, not capital raising. So using Utility Tokens to reduce Customer Acquisition Cost (as we explore in this related chapter) is a big deal.
Case Law is different from Civil/Code Law
The SEC letter is no guarantee and the SEC staff reserves the right to change positions.
This is just how case law works.
The law in the USA & UK and many countries is case law (aka common law), where the law is established by the outcome of former cases (aka precedent). This is very different from what is sometimes called civil law (which I call Code Law for reasons explained below) in countries such as China, Japan, Germany, France
For more background on Case Law vs Civil/Code Law please read this.
Civil/Code law originated in the code of laws compiled by the Roman Emperor Justinian. Civil law has codified statutes. I prefer the term Code Law to Civil Law as this style of law is what developers/coders prefer and instinctively assume. You can turn Civil/Code law into computer code in Smart Contracts. It is much harder to do this with case law where you will often be told “well, it depends” or “it will be judged on a case by case basis”. This is why you must consult a lawyer and why the SEC announcement has this boilerplate language:
”This position is based on the representations made to the Division in your letter. Any different facts or conditions might require the Division to reach a different conclusion. Further, this response expresses the Division’s position on enforcement action only and does not express any legal conclusion on the question presented.”
Choose your playing field – Regulated or Unregulated
Fintech Entrepreneurs have 3 basic regulatory strategies to choose from:
- A. Full stack regulated. You ask for permission upfront. Budget for big legal and compliance bills. Compete directly with banks. Do this in every jurisdiction you want to do business in (state by state in America and country by country in Europe).
- B. Full stack unregulated. This is what Uber, AirBnB and Skype did. You act boldly without upfront permission and either seek forgiveness or fight (depending on how powerful the regulator is). Banking is far more protected/regulated than taxis, lodging or telecoms, so this is a dangerous strategy in Fintech, but can work for some types of user for Bitcoin related services.
- C. Lower in stack unregulated. Provide services to regulated companies north of you in the stack.
Bitcoin is C. Companies northward in the stack provide the user facing functionality and can choose either A or B.
Context & References
Investing in Utility Tokens.
Entrepreneurs who use Utility Tokens to reduce CAC (Customer Acquisition Cost) will create the most valuable Security Tokens
Bernard Lunn is a Fintech deal-maker, investor, entrepreneur and advisor. He is CEO of Daily Fintech and author of The Blockchain Economy.
I have no positions or commercial relationships with the companies or people mentioned. I am not receiving compensation for this post.
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