Silicon Valley-based venture capital firm a16z Crypto, the crypto arm of Andreessen Horowitz, issued a stern warning on April 25 to startup founders considering token sales in the United States.
The advisory comes amidst growing regulatory scrutiny and enforcement actions by the US Securities and Exchange Commission (SEC).
“The SEC argues that nearly every token should be registered under US securities laws,” commented a16z Crypto’s general counsel Miles Jennings.
Selling Token In The US Carries Significant Legal Risks
Launching a token can be as easy as sending an email.
Unlocking their potential as a new digital primitive and bringing them to market is much harder.
I’ve worked with dozens of founders tackling this challenge and am now releasing a 3-part playbook written for everyone. 🧵 pic.twitter.com/egTp16QAWg
— miles jennings (@milesjennings) April 25, 2024
a16z Crypto’s general counsel, Miles Jennings, emphasized that publicly selling tokens in the US could expose startups to significant legal risks. Jennings highlighted the SEC’s application of the Howey Test, a benchmark for determining whether an asset qualifies as a security.
“Nowhere is the application of the Howey test easier than with respect to primary transactions (i.e., token sales to investors by token issuers),” wrote Jennings. “In many ICOs, token issuers made clear representations and promises to investors that they were going to fund their operations with the proceeds from the token sale and deliver a future return to investors.”
Jennings highlighted the consequences of a token being classified as a security, citing the lengthy registration processes, extensive disclosures, and stringent financial requirements that issuers must contend with.
“Those cases were securities transactions, regardless of whether the instruments being sold were digital assets or shares of stock,” said Jennings. “Case closed.”
He cautioned that noncompliance with securities laws often results in severe penalties.
“The SEC argues that nearly every token should be registered under US securities laws,” he reiterated.
Ensuring Compliance in Token Launches
Tensions between builders and regulatory bodies like the US SEC are a constant. While the SEC emphasizes the need for tokens to adhere to securities laws, builders argue for a more decentralized approach. Despite these differing perspectives, both parties ultimately seek to foster a fair and transparent environment for investors and participants.
Securities laws traditionally level the playing field among investors by ensuring transparent disclosures, while blockchain systems strive for decentralization to empower a wider range of participants.
This fundamental difference often leads to skepticism from regulators, who need help reconciling decentralized models with existing legal frameworks.
To address these challenges, Web3 builders must demonstrate the efficacy of their decentralized approach while following regulatory requirements, as recommended by a16z. Despite the SEC’s sometimes unclear guidance, projects can take proactive steps to ensure compliance and mitigate legal risks.
The first rule outlined by a16z Crypto advises against publicly selling tokens in the US for fundraising purposes. This caution stems from the SEC’s stringent application of the Howey Test, which deems many token sales as securities transactions subject to registration requirements.
By avoiding public sales in the US, projects can circumvent these legal complexities and pursue compliant fundraising strategies.
#CFTC classifies #Ethereum as a commodity while SEC insists that it is a security.
It doesn’t check all boxes of Howey Test to make this a security.
It’s about time, this clarification is given to the wider world!
Happy to see this. pic.twitter.com/kUEqJtpMls
— Abhi (@abhilasharaj001) April 25, 2024
Additionally, the emphasis on decentralization is a core guiding principle for token launches. Decentralization not only aligns with the ethos of blockchain technology but also serves as a key strategy for mitigating regulatory risks.
Projects can minimize reliance on managerial efforts and reduce information asymmetries, thus bolstering their compliance efforts through decentralization.
Communication also plays an important role in ensuring regulatory compliance throughout the token launch process. Projects must carefully craft their messaging to align with their chosen launch strategy, whether it involves decentralization, launching outside the US, or implementing token transfer restrictions. Clear and transparent communication helps mitigate the risk of inadvertently implicating securities laws.
a16z is still one of the key players in the industry, recently announcing an allocation of $30M funding for gaming startups, positioning them as a thought leader and the best to state those warning rules.
