Issuing Blockchain-Based Cryptocurrency Tokens

AdobeStock_392233450-300x200Cryptocurrency has become a critical issue for many California business owners. These new forms of currency can be convenient, but they can also create legal obligations for the businesses that use them. It is important for all business owners to understand the legal implications of cryptocurrency offerings before engaging in any transactions. Some cryptocurrency transactions can fall under the SEC requirements, and business owners can face liability for failing to register their offerings or meeting other legal requirements.

Security Versus Utility

Cryptocurrency can be either a security or a utility, depending on how it is being used. A security is a fungible and negotiable financial instrument with some type of monetary value. When discussing securities, many investors immediately consider stock certificates. This is a classic example of a traditional security. They are not, however, the only item that can be used as a security. Cryptocurrency can also be used as a fungible, negotiable financial instrument, and often these instruments hold significant monetary value.

A utility, on the other hand, is a financial instrument that is used in exchange for goods or services. Many providers have their own cryptocurrencies that are used as payment methods. If the cryptocurrency is being used as an alternative form of payment, it could be classified as a utility and thus be exempted from the requirements of the Securities and Exchange Act of 1934. Unfortunately, it is not always clear whether cryptocurrency is being used as a security or a utility.

The Four Factor Test to Determine If Something Is a Security

You might be surprised to learn that this issue is controlled by a Supreme Court ruling from 1946. In SEC v. W.J. Howey Co., the Court had to determine whether interests that had been sold in a citrus grove constituted “investment contracts” (which are securities that must be registered with the SEC). A four-part test was created to identify securities:

  • An investment of money
  • In a common enterprise
  • With the expectation of profit
  • To be derived from the efforts of others.

So how does this apply to cryptocurrency? If a business accepts cryptocurrency as a form of payment, this does not represent an investment in the business. This limited use is likely to be considered a utility. But when a business issues cryptocurrency in exchange for an investment in the business, and the value of the cryptocurrency will be affected by the efforts of the business owners, this could be considered an investment contract under the Howey test. Cryptocurrency transactions that constitute investments are securities that must be registered with the SEC. Securities law also imposes either legal obligations on business owners.

Call Us Today to Speak to a California Securities Attorney

Before considering any type of cryptocurrency transaction, be sure that your business has dependable legal advice from an experienced California securities lawyer. The San Jose and Los Angeles securities attorneys at Structure Law Group know how new technologies are treated under existing securities law. Call (408) 441-7500 or contact us online to schedule a consultation. We help business owners avoid liability and design effective business plans that utilize cryptocurrency and other new technologies effectively.