Bilzin Sumberg

Developers of digital tokens can find themselves in an existential crisis.  Security or not a security? Commodity or not a commodity?  To register or not to register?  Bitcoin, Ethereum, Aave, and the like are cryptocurrencies available on a decentralized network and are generally viewed as commodities not necessarily subject to the heavily regulated environment of securities.  However, navigating the regulatory environment to determine whether your digital token should be classified as a security or a commodity is not always a straight road.  Take XRP, for example, which was once one of the most valuable digital tokens after Bitcoin and Ethereum.  After the Securities and Exchange Commission filed a lawsuit against Ripple Labs, accusing it of selling unregistered securities, XRP’s value tumbled.    Ripple Labs has taken the position that its digital token, XRP, is a commodity, similar to some other popular digital tokens and that it, therefore, did not need to register with the SEC.  The final determination in the Ripple Labs case will be a turning point in the regulatory road for developers and their counsel.

Affectionately nicknamed the “Crypto Mom” by the crypto community, SEC Commissioner Hester Pierce recently published an updated safe harbor proposal.  The safe harbor would give token developers a three-year grace period to develop a decentralized or functional network[1]  without having to register with the SEC.  The intention is to allow developers, during the grace period, to develop their tokens in a decentralized network.  The developer would be able to sell tokens during the grace period without having to register with the SEC.  During the grace period, developers would have to submit mandatory semi-annual updates.

At the end of the grace period and with the assistance of outside counsel, the developer would either have to register the tokens as securities or seek an exemption from registration.  In an exit report, outside counsel would provide an analysis on why the network that has been developed is decentralized or functional or state that the tokens will be registered under the Securities Exchange Act of 1934. The exit report requirements will provide guidelines for outside counsel to make such a determination in the report.

Please check back for more updates on the safe harbor proposal and the cryptocurrency regulatory space.


1 “Decentralized” or “functional” network is relevant to the “Network Maturity” analysis under the safe harbor proposal.  When a token transaction has reached Network Maturity, it is no longer considered a security transaction.  Network Maturity is achieved when the network is either: (i) not economically or operationally controlled and is not reasonably likely to be economically or operationally controlled or unilaterally changed by any single person, entity, or group of persons or entities under common control, except that networks for which the “Initial Development Team” owns more than 20% of tokens or owns more than 20% of the means of determining network consensus cannot satisfy this condition; or (ii) functional, as demonstrated by the holders’ use of tokens for the transmission and storage of value on the network, the participation in an application running on the network, or otherwise in a manner consistent with the utility of the network.