US court finds crypto tokens are securities

A US court has held in a 7 November 2022 decision that a blockchain token called LBRY, offered and sold by the defendant, LBRY, Inc., was a “security” under US securities laws. The case is important because LBRY was positioned at least in part as a “utility token” designed for use on the LBRY blockchain, rather than wholly as an investment. The case was brought by the Securities and Exchange Commission, the US securities regulator. Under the US Securities Act of 1933, securities cannot be offered or sold without filing a registration statement, which LBRY, Inc. did not do. One of the forms of a security under the Securities Act is an “investment contract”. The standard test applied to decide if something is an investment contract was set out in the Howey case (SEC v. W. J. Howey Co., 328 U.S. 293 (1946)), where it was held that there must be (i) an investment of money, (ii) in a common enterprise, (iii) with an expectation of profits to be derived sole from the efforts of the promoter or a third party. In the LBRY case, only the third of these elements was in dispute. The judge found that LBRY, Inc. was “pitching a speculative value proposition” for LBRY, and the fact that it informed some potential purchasers that it was not offering LBRY as an investment did not matter: “a disclaimer cannot undo the objective economic realities of a transaction.”

In Australia, different criteria apply when determining whether a crypto asset may be regulated as a security or other form of financial product. ASIC has provided some guidance in its information sheet 225 (INFO 225), where it lays out how a crypto asset could potentially be a security or an interest in a managed investment scheme (“MIS”). When considering if tokens offered in an initial coin offering or “ICO” are securities, ASIC looks at the bundle of rights included with the token. If those rights are similar to rights commonly attached to a company share, such as voting rights and a right to participate in profits, then it is likely that it will be regarded as a security. A crypto asset could also be an interest in a MIS if there is a contribution of money or assets by the investor to obtain an interest in a scheme, and any of the contributions are pooled or used in a common enterprise to produce financial benefits or interests in property, and where the investors do not have day-to-day control over the operation of the scheme (although they may have voting or similar rights).

The recent case launched by ASIC against Qoin shows that the Australian regulator is taking a more assertive approach in the crypto space, and we can expect that it will look closely at the LBRY decision. It can’t be assumed that a “utility token” crypto asset will not be regulated by securities laws.