Are Crypto Tokens Securities?

on Thursday, February 17, 2022

In episode #3 of our ongoing deep dive into web3 and crypto, we explore the nature of financial products known as 'securities', their relation to crypto tokens, and the regulatory framework that exists around these structures.

Episode Notes


There is currently debate about how crypto investments fall under the existing securities regulatory framework. In this conversation, Stephen Diehl and Rufus Pollock dig into this debate, exploring what securities are and how they relate to crypto tokens.

Rufus and Stephen then consider the question, should crypto tokens be subject to the same regulation as securities? They 'steel man' the position that crypto investments should not be regulated as securities, outlining 3 key claims:

  1. Unregulated crypto investment is a liberatory and egalitarian force that democratizes company formation, lowers barriers, and allows all types of common enterprises that were previously prohibited by law.
  2. The ability to raise capital outside of the rule of law is a human right that is a safeguard against tyranny.
  3. Equity markets are ripe for disruption - it is time for the start of a new era that will reconfigure the entire global economy.

Rufus and Stephen end their conversation with an analysis of this position and the associated claims.

What Are Securities?

  • A security is a collective legal fiction that pools money and mediates income-cashflows between people according to an agreed-upon framework.
  • “A joint-stock company is a business entity in which shares of the company's stock can be bought and sold by shareholders. Each shareholder owns company stock in proportion, evidenced by their shares (certificates of ownership). Shareholders are able to transfer their shares to others without any effects to the continued existence of the company.”
  • An idea that goes all the way back to the 12th century, where medieval peasants would buy shares in a common enterprise of mills that would grind wheat.
  • Gave rise to a modern framework of laws that cover financial products from debt instruments, bonds, equities, and derivatives. The legal foundation on which all of market capitalism is built.
  • Because of their centrality to markets, securities have strict registration, ownership and transfer regulation.

The Debate Surrounding Crypto Investments

  • There is currently debate about how crypto investments fall under the existing securities regulatory framework. This is being debated inside the government regulatory agencies, on the floor of the Senate, and in the courts.
  • The outcome of the final ruling will potentially impact trillions of notional value in “scofflaw” investments of potentially unregistered securities.
  • Landmark case from 1946, SEC vs W. J. Howey Co. set the Howey Test precedent for determining what is a securities contract.
    • (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit and (4) to be derived from the efforts of others.
    • Many things can be sold as securities. (stocks, chinchillas, whiskey barrels, orange trees). It’s very context dependent.
    • If we accept the premise that crypto tokens aren’t currencies, then tokens are clearly investments made with the expectation of profit. Are crypto assets unregistered securities?
  • Crypto tokens currently exist partially outside the US securities framework.
    • The SEC has taken action against some Initial Coin Offerings, selling debt instruments to retail, against outright Ponzi schemes, and firms acting as bank-like entities.
    • District courts have set precedent in many investment fraud cases that have consistently indicated that token sales to US persons meet Howey Test and Dodd-Frank criteria of securities sales, even if done internationally (i.e. from Switzerland). If you sell to US persons it becomes a security under US law.
    • A federal case or executive order that sets precedent nationally has yet not been heard in the courts.
    • Thousands of companies' and projects' success or failure rests on token sales not being regulated as securities. If they are regulated as securities it is quite possible the entire market implodes.
  • Sale of securities depends on who you are selling to, and what kind of risk and return are presented in the prospectus.
    • Selling to the general public is highly regulated, with lots of disclosures, auditing of financials by PWC, Deloitte, etc., and transparency in ownership and inside stock sales.
    • Selling securities to institutions and high net worth individuals is not as highly regulated. SEC defines “accredited investor” as:
      • A company you are a director of.
      • A limited liability company or family office with over $5 million.
      • Individual with income greater than $200,000.
    • Case example: Theranos raised $724 million from private accredited investors including Henry Kissinger and Betsy Devos. The people in the blast radius of the fraud were all fabulously wealthy and invested capital they already allocated to high-risk investments anyways.
    • Many policymakers on both sides of the aisle debate whether or not the accreditation laws are too restrictive and shut the public out of high-risk-high-return investments that only wealthy people have access to.
      • On the right, then individual choice is a paramount, the government shouldn’t dictate risk-taking in markets. Just “evolution” and the natural state of being.
      • On the left, Pikkety’s analysis that wealth generated from capital grows faster than economic output and that patrimonial capitalism leads to distortions of markets and inequality.

Steel Manning the Position that Crypto Investments Should Not Be Brought Within The Securities Regulation Framework

  • It is very easy to create an equity crowdfunding and cap table structure on top of crypto platforms like ethereum.
    • Individuals can do it anonymously and raise billions of dollar equivalents in seed capital for ventures that are very early. Don’t need to involve the SEC, government or lawyers at all.
    • Previously this kind of access was gated to US persons with connections and access to funds, connections and access to capital.
    • This is a liberatory and egalitarian force that democratizes company formation that lowers barriers and allows all types of common enterprises that were previously prohibited by law.
  • Ability to raise capital outside of the rule of law is not only a good thing, it is an outright human right that is a safeguard against tyranny.
    • Edward Snowden, SciHub, Wikileaks, etc
  • Equity markets are ripe for disruption and it is time for the twilight of the Securities Act and the start of a new era that will reconfigure the entire global economy.
    • Hypothesis: What happens on the other side of that financial reconfiguration can only be better than we currently have.


  • We tried the complete laissez-faire caveat emptor securities model in the 1920s. It ended very badly.
    • The kind of fly-by-night “There Will Be Blood” type of charlatans ran wild selling securities to the public.
    • Most US states created Blue Sky Laws to "to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other fraudulent exploitations."
    • History is repeating itself exactly like it did then. Shibu Inu and Dogecoin were the blue sky securities of the 1920s. People were attracted to get-rich-quick schemes back then just as much as they are today. Human psychology is remarkably invariant across time.
  • As part of the New Deal, the United States signs into law the Securities Act of 1933, Glass-Steagall Act of 1933, Securities Exchange Act of 1934. These largely clean up the fraud. The US framework is the blueprint for many industrialized nations to do the same.
    • The Great Depression ends and the US is victorious in WWII.
    • A long peace in financial markets.
    • Bank runs are entirely eliminated.
    • US capital markets become extremely large, robust and a new era of unrivalled growth and private innovation.
    • Centrist Hypothesis: Regulated capital markets, taken on the whole arc of human history, produce relative prosperity.
  • According to the SEC, crypto tokens meet the Howey Test and thus are securities contracts.
    • This fits with our general intuition about the intent and purpose retail day traders are buying them. They’re investing in common ventures with the expectation of profit from the sale of tokens the same as equity.
    • The enterprises possibly now exist as anonymous internet entities and Discord servers now instead of law firms and board rooms.
    • Some DAO governance tokens quite literally are designed to imitate voting shares as seen in existing equity structures.
    • How do we bring the great mass of scofflaw unregistered securities within the regulatory perimeter to protect the public? Is this even possible?
  • The smartphone era gives retail investors access to the public equities market with unparalleled levels of simplicity unseen in markets. There’s also a genuine interest in giving retail investors access to private equity investments.
    • Is such a structure even possible?
      • Horizon and liquidity concerns of private investment vehicles (like VC funds) are challenging for writers of small checks.
      • As an entrepreneur do we really want a cap table with 200,000 retired janitors from Idaho writing $500 checks into early companies. What is the legal overhead of this under the Securities Act?
    • Is it desirable?
      • High risk, high return. But with a 95% failure rate is it even appropriate for retail? Venture is not a great asset class compared to index funds in terms of brute returns.
      • If we lower the barriers to entry, the ICO bubble is a case study in even higher failure rates. Unprecedented levels of fraud unseen in developed markets since the 1920s.
      • ICOs are like a public stock offering before the company even exists or has a product.
      • Giving seed-stage ventures billions of seed capital detached from revenue, traction, or product market fit is a recipe for disaster.
      • There’s a perverse incentive to simply abscond with seed money rather than actually build anything.
      • There’s a perverse incentive to build technical Potemkin villages that focus on “token value go up” without building anything. Many crypto companies are here.
        • Can read the whitepapers of these companies and even people with PhDs in econ and software engineering can’t parse what they’re doing. How is the lay public going to do due-diligence on claims of financial perpetual motion machines?
  • Is there a legal investment vehicle structure that balances the risks of retail investors with their desire for access to high-risk early ventures?
    • Or should we simply bracket these kinds of securities sales to the already-wealthy? Because the check-size to risk ratio just empirically fits in the “Goldilocks zone” of the practical regulatory/legal/public-interest concerns.
    • Where should the accredited investor red line be?
    • Can the courts scale to handle millions of new investment fraud cases every year?
    • Is extreme levels of fraud simply the price we pay for a more dynamic economy or does this all lead to ruin like it has in the past?
      • Evolution and capitalism metaphor: extremophiles.
    • What is the right interplay between investment risk and the rule of law? Is creative destruction by any extra-legal means a positive force in the world?

Concepts Covered


  1. Bindseil, Ulrich, Patrick Papsdorf, and Jürgen Schaaf. 2022. ‘The Encrypted Threat: Bitcoin’s Social Cost and Regulatory Responses’. 7 January 2022.
  2. Bank of International Settlements. 2018. ‘Cryptocurrencies: Looking beyond the Hype’. In . Bank for International Settlements Basel.
  3. Boreiko, Dmitri, Guido Ferrarini, and Paolo Giudici. 2019. ‘Blockchain Startups and Prospectus Regulation’. European Business Organization Law Review 20 (4): 665–94.
  4. Brownsword, Roger. 2020. Law 3.0: Rules, Regulation, and Technology. Routledge.
  5. Burilov, Vlad. 2019. ‘Regulation of Crypto Tokens and Initial Coin Offerings in the EU: De Lege Lata and de Lege Ferenda’. European Journal of Comparative Law and Governance 6 (2): 146–86.
  6. Butler, Simon. 2021. ‘Cyber 9/11 Will Not Take Place: A User Perspective of Bitcoin and Cryptocurrencies from Underground and Dark Net Forums’. In Lecture Notes in Computer Science (Including Subseries Lecture Notes in Artificial Intelligence and Lecture Notes in Bioinformatics), 12812 LNCS:135–53. Springer.
  7. Cumming, Douglas J., Sofia Johan, and Anshum Pant. 2019. ‘Regulation of the Crypto-Economy: Managing Risks, Challenges, and Regulatory Uncertainty’. Journal of Risk and Financial Management 12 (3): 126.
  8. Ferrari, Valeria. 2020. ‘The Regulation of Crypto-Assets in the EU – Investment and Payment Tokens under the Radar’. Maastricht Journal of European and Comparative Law 27 (3): 325–42.
  9. Finck, Michèle. 2018. Blockchain Regulation and Governance in Europe. Blockchain Regulation and Governance in Europe. Cambridge University Press.
  10. Goforth, Carol R. 2021. ‘Regulation of Crypto: Who Is the Securities and Exchange Commission Protecting?’ American Business Law Journal 58 (3): 643–705.
  11. Guadamuz, Andres, and Chris Marsden. 2015. ‘Blockchains and Bitcoin: Regulatory Responses to Cryptocurrencies’. First Monday 20 (12).
  12. Hacker, Philipp, Ioannis Lianos, Georgios Dimitropoulos, and Stefan Eich. 2019. Regulating Blockchain: : Techno-Social and Legal Challenges.
  13. Hofman, Darra, Quinn DuPont, Angela Walch, and Ivan Beschastnikh. 2021. ‘Blockchain Governance: De Facto (x) or Designed?’ In Building Decentralized Trust, 21–33. Springer.
  14. Kapsis, Ilias. 2021. ‘Should We Trade Market Stability for More Financial Inclusion? The Case of Crypto-Assets Regulation in EU’. FinTech, Artificial Intelligence and the Law: Regulation and Crime Prevention, 85–104.
  15. Kraus, Daniel, Thierry Obrist, and Olivier Hari. 2019. Blockchains, Smart Contracts, Decentralised Autonomous Organisations and the Law. Edward Elgar Publishing.
  16. Lee, Joseph. 2022. Crypto-Finance, Law and Regulation: Governing an Emerging Ecosystem. Routledge.
  17. Liaw, K. Thomas. 2021. ‘Trading and Regulation of Cryptocurrencies, Stablecoins and Other Cryptoassets’.
  18. Maia, Guilherme, and João Vieira dos Santos. 2021. ‘MiCA and DeFi (“Proposal for a Regulation on Market in Crypto-Assets” and ’Decentralised Finance’)’. SSRN Electronic Journal.
  19. Rae, Shaela W, and Lorraine Mastersmith. 2019. ‘Crypto Asset Trading in Canada: Entering a New Era of Regulation’. Banking & Finance Law Review 35 (1): 153–85.
  20. Reiners, Lee. 2020. ‘Cryptocurrency and the State: An Unholy Alliance’. S. Cal. Interdisc. LJ 30: 695.
  21. Walch, Angela. 2015a. ‘The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk’. NYUJ Legis. & Pub. Pol’y 18: 837.
  22. ———. 2015b. ‘The Bitcoin Blockchain as Financial Market Infrastructure: A Consideration of Operational Risk’. NYUJ Legis. & Pub. Pol’y 18: 837.
  23. ———. 2019a. ‘Deconstructing ‘Decentralization’: Exploring the Core Claim of Crypto Systems’. C. Brummer (Ed.), Crypto Assets: Legal and Monetary Perspectives, 1–36.
  24. ———. 2019b. ‘In Code (Rs) We Trust: Software Developers as Fiduciaries in Public Blockchains’.
  25. ———. 2019c. ‘Software Developers as Fiduciaries in Public Blockchains’. Regulating Blockchain. Techno-Social and Legal Challenges, Ed. by Philipp Hacker, Ioannis Lianos, Georgios Dimitropoulos & Stefan Eich, Oxford University Press, 2019.