On 25 July 2017 the United States Securities and Exchange Commission (‘US SEC’) issued a report of investigation in which it classified The Decentralized Autonomous Organization’s (‘The DAO’s’) Tokens as securities subject to federal securities laws.[1] This finding is significant, particularly for Initial Coin Offerings (‘ICOs’) like The DAO, which sell virtual coins or tokens to investors to create an asset pool to fund investments.


‘The holders of DAO Tokens stood to share in the anticipated earnings from these projects as a return on their investment in DAO Tokens. In addition, DAO Token holders could monetize their investments in DAO Tokens by re-selling DAO Tokens on a number of web-based platforms (“Platforms”) that supported secondary trading in the DAO Tokens.’

The US SEC applied the Howey Test. Because The DAO operated as an investor-directed investment fund, The DAO ICO had a speculative investment value. Thus, the US SEC classified The DAO tokens as securities as there was an investment contract, meaning ‘an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others’. It held that ‘money’ need not take the form of ‘cash’, and where ‘The DAO used ETH[2] to make their investments, and DAO Tokens were received in exchange for ETH…Such investment is the type of contribution of value that can create an investment contract.’ Because the ‘ETH was pooled and available to The DAO to fund projects [(contracts)]…depending on the terms of each particular contract DAO Token holders stood to share in potential profits from the contracts. Thus, a reasonable investor would have been motivated, at least in part, by the prospect of profits on their investment of ETH in The DAO.’ And, finally, ‘Investors’ profits were to be derived from the managerial efforts of others—specifically, Slock.it and its co-founders, and The DAO’s Curators’, and The DAO token holder voting rights were limited. Moreover, the investment of money was a common enterprise. Thus, the SEC found that The DAO – as issuers – must register offers and sales of securities under federal law. Because The DAO was compromised by a cyber attacker before it could commence funding, the SEC did not ‘analyze the question whether The DAO was an “investment company,” as defined under Section 3(a) of the Investment Company Act of 1940’ but instead cautioned companies to consider their obligations under the Act.

Importantly, the DAO ICO had a speculative investment value rather than an underlying utility.[3] Blockchain experts argue that the majority of ICOs have an underlying utility, as opposed to a speculative investment value. Most ICOs are either (1) ‘selling token with actual functions, similar to a virtual product [or] (2) Selling certificates for the receipt of a functional app coin in the future.’   For these types of ICOs it is not clear that the Howey Test would classify them as securities. This is because the generation of app tokens, for example, relies on the algorithms of the network, rather than on teams spending any effort in creating profit.[4]

The US SEC was less clear on the latter point, stating ‘Whether a particular investment transaction involves the offer or sale of a security – regardless of the terminology or technology used – will depend on the facts and circumstances, including the economic realities of the transaction.’

The SEC instead acknowledged that its intention was to ‘caution the industry and market participants: the federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology’. Yet, this finding is narrow and it may not apply to the majority of ICOs with an underlying utility, or as applied to a functional app coin.

Moving forward, there are signs that other regulators are looking to issue clarifications around ICOs and digital tokens. On 4 June 2017, it was reported that the People's Bank of China (‘PBOC’) was moving to regulate ICOs and is considering developing regulations to assist in the development of technology in this area.[5] Concurrent to this, the UK Financial Conduct Authority (‘FCA’) also published a discussion paper in which it states; ‘At this stage we do not see a clear need to consider changes to our regulatory framework for DLT solutions to be implemented. Instead we want to explore emerging business models, and how their potential risks and opportunities operate in the context of our regulatory framework.’ Thus, there appears to be somewhat of a consensus amongst the regulators that wherever possible, and as along as products do not contravene existing regulations, the sector should be allowed to develop regulations as it matures and evolves. Corroborating this view, on 1 August 2017, the Monetary Authority of Singapore (‘MAS’) also issued a clarification stating that under the Securities and Futures Act (Cap 289) (‘SFA’), ‘digital tokens may represent ownership or a security interest over an issuer’s assets or property. Such tokens may therefore be considered an offer of shares or units in a collective investment scheme under the SFA. Digital tokens may also represent a debt owed by an issuer and be considered a debenture under the SFA.’

As regulators in the major financial centres begin to develop frameworks for this fast growing sector, other countries are thus forced to react to ensure that their jurisdictions do not become safe havens for digital token enabled money laundering. On 17 August 2017, the Australian Ministry for Justice announced that it was moving to bring the regulation of digital tokens under the jurisdiction of the Australian Transactions and Reporting Analysis Centre (‘AUSTRAC’),[6] the aim of this being to increase oversight with respect to anti-money laundering purposes. This move comes after the Australian government previously moved in May 2017 to eliminate a double goods and services tax that was affecting the countries digital token economy, in the hopes of further spurring ‘fintech’ innovation.[7]

Whilst there are significant challenges, such as the need for a coherent legal framework for Smart Contracts and digital tokens across multiple jurisdictions, given the disruptive potential of this industry, many regulators are taking a progressive view towards regulation as they vie to position their cities as regional or global hubs for this industry. 

E. Joan, JD, MSt.(Law), MSL(Law), MBA(Finance), MPA, MSB is an University of Oxford alumni, and Peter Crane is an entrepreneur.


[1] See ‘Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO, available here.

[2] ETH stands for the platform ‘Ethereum’.

[3] See ‘Future of ICOs, SEC verdict, and the Howey Test’, available here.

[4] See ibid.

[5] See ‘PBOC Official: Research on ICO and Its Regulation’, full text translation available here.

[6] See ‘Government Anti Money Laundering Rules for Digital Tokens’, available here.

[7] See ‘Australian Government seeks to remove the double GST on bitcoin purchases (GST on buying bitcoin and then spending them)’, available here.