One of the biggest myths surrounding cryptocurrencies is that they are out of the reach of securities regulators.
Promoters help perpetuate that myth by describing cryptocurrencies as “utilities” as a way of skirting regional regulations.
A utility token is a cryptocurrency that can be traded for products or services and is not structured as a security or debt instrument. However, to try to attract investors, companies are referring to their security tokens – which are held in hopes of speculative gain and are treated like any other security – as utility tokens without any regulatory authority approving the classification.
“What’s happening in the initial coin offering [ICO] world right now is people have virtually no background with securities, and they’re offering tokens that they’re calling utilities,” said Matthew Unger, founder and CEO of iComply Investor Services Inc. “In reality there’s nothing from a regulator that says it’s a utility. It’s just them hoping to get away with being called a utility.”
Unger points to Vancouver-based Vanbex Group and its FUEL cryptocurrency as a local example of a company that is referring to its cryptocurrency as a utility in the hopes that regulators will agree with its classification.
FUEL tokens are not considered a utility by any Canadian regulator, but Vanbex says they are working with the B.C. Securities Commission (BCSC) in the regulatory sandbox to try to develop a utility designation for cryptocurrencies.
Other ICOs, including offerings by Impak Finance and TokenFunder, have been granted temporary exemptions from security laws to give them time to comply. However, Unger warns that if the companies don’t comply with security laws or receive a different classification from a regulator by the end of the exemption, their coin offerings will be deemed illegal.
Only two jurisdictions – Switzerland and Gibraltar – have a utility token classification. B.C., however, has become the only North American jurisdiction to exempt cryptocurrency tokens from classification as a security. While the BCSC has not created an official classification for utility tokens, they decide on a case by case basis whether a certain token falls under their jurisdiction or not.
The B.C. regulator’s decision came late last year, when Vancouver-based innovation studio Axiom Zen released its CryptoKitties blockchain product, a game designed to teach people how to use blockchain. (Blockchain, the underlying technology behind cryptocurrency trading, acts as a public ledger comprising large numbers of decentralized transactions.)
CryptoKitties allows users to participate in blockchain transactions and create digitally facilitated “smart contracts” by trading digital cartoon cats.
CryptoKitties can be bought, sold or traded like a traditional collectible, while blockchain keeps track of ownership. Each CryptoKitty is a token that acts like any other cryptocurrency. Like bitcoins, CryptoKitties can be bought, sold or held for speculative gains. The only difference is that each token also represents the rights of ownership of a specific digital cat.
Programmed digital scarcity gives each cat a value. The company releases a controlled number of CryptoKitties, which are “bred” with each other to create new, unique CryptoKitty tokens. When two people agree to breed their CryptoKitties, a blockchain smart contract is created.
CryptoKitties’ 250,000 users have spent approximately US$26.3 million on the digital felines. The highest price paid thus far for a single CryptoKitty is US$176,600.
While the idea of cartoon cats on the internet might seem silly, it has unprecedented regulatory implications for the North American cryptocurrency market.
Regulators around the world are still figuring out how to adapt to a tokenized world.
B.C. has set a precedent for the exemption of cryptocurrencies from securities regulations and has created an opportunity for other companies.
“B.C. is starting to get a reputation as a good place for innovation,” Unger said. “I expect, especially in 2018, we’re going to see hundreds of ICOs coming to B.C. because of things like the regulator making a decision to say CryptoKitties is not a security.”
The BCSC has not designated CryptoKitties a security for two key reasons, according to Unger, who consulted on the compliance aspect of the project.
First, Axiom Zen approached its ICO differently than most companies in its sector. Most ICOs are used as a fundraising tool to support an idea. Axiom Zen, however, built a finished product and then released it to the public.
“If you’re selling a token, but the system isn’t developed yet, then it’s definitely a security,” said Axiom Zen co-founder Roham Gharegozlou. “If you’re selling a token and it can be used today, then it’s quite likely a utility.”
Unger said the second reason Axiom Zen was considered a utility is that it advanced the state of cryptocurrency technology by creating a new type of Ethereum token in the blockchain-based computing platform that was non-fungible and indivisible.
Note: A previous version of this article incorrectly stated that FUEL tokens were not considered a utility by any regulator. This has been updated to say that FUEL tokes are not considered a utility by any Canadian regulator.