In a public statement in the Matter of Wireline, Inc., SEC Commissioner Hester M. Peirce makes an excellent point in her Concurrence by cautioning that Commission and courts have made the mistake of “treating the pre-sale and public distribution of tokens as one event.”
In fact, it is better to focus on the distinction between issuance and distribution instead of pre-sale and public distribution. Pre-sale is private distribution. Distribution therefore conceptually includes both “pre-sale” (private distribution) and public distribution. But in addition to distribution, there is firstly the matter of issuance.
Therefore, there are two distinct events/acts with respect to a token: issuance and distribution. They are not the same. The Howey Test can be and should be applied at any stage of these events/acts, to define the underlying asset within a potentially metamorphic action context, rather than treat the asset as an independent existence in an unchanging abstract world, as Commissioner Peirce warned. Especially, because distribution is an ongoing process during which the nature of a token could be transformed, the Howey Test is an ongoing test.
In traditional securities, there has been little need to emphasize on such distinctions, primarily because the involved parties and events all follow a common and straightforward pattern: a company that is a bearer of the security is the issuer, and an agent/brokerage does the distribution. Seldom would the nature of an asset change through issuance and distribution.
But with cryptocurrencies, many creative scenarios are present.
Take bitcoin for example, contrary to what many people believe, all 21 million bitcoins were issued at the creation of Bitcoin blockchain (with the Block 0). What makes bitcoin unique is that all coins were issued not to an identifiable human entity such as a shareholder, nor even to an issuer company’s corporate treasury, but to a “crypto box” safeguarded by software and a predetermined protocol.
Further, by design, the issued tokens are to be gradually released to miners who build and maintain blocks, also based on a predetermined protocol.
Technically you might argue that every act of releasing coins to a miner is an actual “issuance” of the coins. But there is no identifiable “issuer” in the case of bitcoin. The original issuer, Satoshi Nakamoto, does not have any direct control over the releasing of the coins to the miners, as everything is pre-set in the coding.
One might then argue that it’s the bitcoin core developers who are collectively the issuer. But the developers do not have any ownership to the unreleased coins, nor are they supposed to change the coin-releasing mechanism set by Satoshi the original issuer. (However, the core developers could change the codes, in violation of the original protocol and potentially rendering the underlying asset a suspect of a security. In fact, in the case of BTC, the core developers did make such changes to the original bitcoin protocol, numerous times, and have shown intention to continue to do so in the future.)
There was no private distribution of bitcoin. Satoshi, the creator of the Bitcoin, did not receive any bitcoin tokens at the Genesis event of issuance. He was of course the first miner who mined some of the first blocks to be awarded certain number of bitcoins, but because bitcoin blockchain was publicly released without any pre-mining, theoretically everyone in the world could do mining on an equal competitive basis with Satoshi himself, and many did in fact.
Miners subsequently sold bitcoins they received, either peer to peer or through an exchange. And this form of bitcoin distribution is still an ongoing process.
Therefore, in the case of bitcoin, the tokens were not securities when they were issued (meaning they did not meet the Howey test at the time of issuance). And further there is no private distribution such as a pre-sale to make these tokens securities (meaning there were no such transformative private distribution activities that changed the coins to a security that met the Howey test).
The only remaining suspect is therefore the public distribution. SEC has so far concluded that due to the sufficiently decentralized nature of bitcoin network, bitcoin distribution does not violate securities law, meaning that when examined at the time, place and manner of bitcoin distributions, these bitcoins still do not meet Howey test to become securities.
However, because the distribution is not a single static act, but a dynamically evolving one, one should not be confidently assuming the SEC’s conclusion is permanent with regard to bitcoin. In addition, it’s arguable that the SEC may have not taken into full consideration of the involvement of crypto exchanges in their inquiry, and may revisit this issue in the future.
Furthermore, just because an underlying asset is not a security does not mean that all activities related to the asset cannot be a security. For example, gold is a commodity not a security, but an ETF for gold is a security. There should be plenty caution for individuals or companies who raise funds to purchase bitcoin, especially if the actor is a publicly listed company which is under close scrutiny of SEC.
In contrast, most other tokens are done in a very different way compared to bitcoin. They are suspect in issuance. They are suspect in private distribution (often accompanied by pre-mining by the issuer). And they are suspect in public distribution. Any one of these junctures can put an enterprise which acts behind the token in violation of the securities law.
In fact, an argument can be made that most crypto tokens are illegal securities, unless the law is changed.