CSA Provides Further Guidance on the Securities Law Implications of Token Offerings
June 30, 2018
On June 11, 2018, the Canadian Securities Administrators (CSA) published CSA Staff Notice 46-308 – Securities Law Implications for Offerings of Tokens (Staff Notice). The Staff Notice supplements the previously released CSA Staff Notice 46-207 - Cryptocurrency Offerings and provides additional guidance regarding the securities law implications of initial coin offerings and initial token offerings (in this blog post, token offerings).
The Staff Notice makes it clear that the CSA view is that most token offerings will be subject to Canadian securities laws and that regulators will continue to take enforcement action against projects and businesses that engage in token offerings without complying with applicable securities laws.
There does not appear to be any new regulatory framework being contemplated to address token offerings. Accordingly, those who are undertaking projects involving tokens should engage with counsel and regulators early in the process to ensure compliance with the existing framework.
Application of Canadian Securities Laws to Token Offerings
While each token offering must be analyzed on its own facts and none of the below factors is determinative as to whether an offering involves an "investment contract" (and therefore, a "security") subject to securities laws, the Staff Notice identifies certain factors that may be considered. Ultimately, emphasis should be placed on substance over form when making the determination.
Factors Suggesting Canadian Securities Laws May Apply
The Staff Notice identifies certain factors that may indicate that a token offering involves an “investment contract” , including:
The proposed function of the token is still under development (i.e. the proposed function is to use software but the software does not yet exist)
The token is not immediately delivered to purchasers
The stated purpose of the offering is to raise capital to develop the platform or support the value of the token
The issuer offers free tokens or other benefits to promoters of the offering
Management of the issuer retains a significant number of unsold tokens as compensation
The issuer suggests the tokens will be used as a currency or have broad utility, but there is no evidence of widespread adoption
Management of the issuers represents that they have special expertise that will increase the value of the token
There is a finite supply of tokens or access to tokens will be limited in some fashion
The issuer permits purchases of tokens for an amount that does not align with the purported utility of the token
Marketing of the offering targets purchasers who would not reasonably be expected to use the platform or product
Management states that the tokens will increase in value, or encourages others to make such statements
There is a reasonable expectation that the tokens will trade on a cryptoasset trading platform or will otherwise be freely tradeable
Factors Suggesting Canadian Securities Laws May Not Apply
The Staff Notice also identifies certain factors that may indicate that a token offering does not involve an “investment contract”:
Tokens are distributed for free (although a distribution of free tokens as part of an overall sale of an ancillary product or service may involve an investment of money and be characterized as a security)
Tokens have a fixed value that does not change with time or changes based on non-commercial factors
Tokens are not fungible and have unique characteristics
A continuous or unlimited supply of tokens exists
We note that a token may fit within other branches of the definition of “security” under securities legislation, not just the “investment contract” branch cited above.
In general, securities laws will not apply to the sale of what is commonly called a "utility token" i.e. a token which can be used only for a specific purpose, such as purchase of specific software, where the item being purchased exists as a finished product. However, the Staff Notice states that “most of the offerings of tokens purporting to be utility tokens that we have reviewed to date have involved the distribution of a security, namely an investment contract.” In short, a token may have utility and also be a security.
The Staff Notice also notes that tokens delivered at subsequent steps may be a security, even if they have “utility,” because they continue to have features of an investment contract or have other security-like attributes. The Staff Notice expressly states that the CSA “will have concerns where a multiple step transaction is used in an attempt to avoid securities legislation.”
You can view the Staff Notice here.