Regulatory Lessons from the EIGEN Launch

On non-transferability, geofencing, and the regulatory risk spectrum of token distributions.

The EIGEN token launch kicked off a discussion about two particular design decisions: (1) the token can’t be transferred and (2) can't be claimed by U.S. Eigenlayer users. These decisions reflect a very conservative approach to regulatory compliance.

We all know that current SEC leadership views every digital asset other than bitcoin as a security. This means every team thinking about launching a token has to wrestle with the fact that the SEC will almost certainly view that token as subject to the federal securities laws. Unfortunately, many lawyers begin and end the analysis there: if the regulator says it's illegal, you can't do it, full stop.

Lawyers are a risk-averse group in general, and compliance lawyers especially so. They're trained to check boxes to satisfy regulators and to say "no" until every box is checked. In the traditional securities context, this is uncomplicated. Compliance lawyers can check the box either by registering the security with the SEC (e.g., an IPO) or by satisfying all of the requirements for an exemption from registration (e.g., a Reg D private placement).

Yet, this approach doesn't work for crypto at all. The SEC has steadfastly refused to provide a workable pathway for the registration of digital assets, and the exemptions are all difficult to square with the decentralized nature of public blockchains.

So what is a risk-averse lawyer to do?

Enter non-transferability. In general, the securities laws only apply to assets that can be bought or sold. That's sort of the point: to protect investors who seek profit from the purchase and sale of assets that go up or down in value. In particular, the Howey test only applies to transactions (not assets), and only where the investor has a reasonable expectation of profit.

Thus, making an asset non-transferable creates a strong argument that the securities laws don't apply. If token holders can’t transact, then they can’t profit (barring some other mechanism like a right to income or dividends, which is rare in crypto), and so they shouldn’t need the protections of the securities laws. In theory, the SEC could still argue that a non-transferable asset is a security, but that would be a particularly silly view as a matter of policy, so even risk-averse lawyers are generally comfortable with non-transferable tokens.

What if a team doesn't want to make a token non-transferable? Enter geofencing. In general, the securities laws only apply to transactions that occur within the United States. This means if a transaction occurs sufficiently outside of U.S. borders, the SEC won't have jurisdiction over it in the first place.

The SEC does have some extraterritorial jurisdiction, but most lawyers believe the right geofencing approach provides a strong argument that the SEC lacks authority over the token distribution. This is why so many token distributions block U.S. persons. This is perverse and insane from a policy perspective since its main effect is to protect U.S. persons from receiving free tokens. But as a matter of satisfying risk-averse lawyers, it does the job.

Both of these options are on the conservative end of the regulatory-risk spectrum for token distributions. I call this a spectrum for a reason: given a lack of regulatory clarity, every team (with the advice of their counsel) has to decide how much risk to take on. For the risk-averse, choosing both options at once — distributing a non-transferable token solely to non-U.S. persons — is about as conservative as it gets within the crypto industry. The SEC itself might even agree that no securities offering has occurred within its jurisdiction.

But there are other points on the risk spectrum that are also defensible, even where the SEC might not agree. As I often find myself reminding people, the SEC doesn't make the law — it only decides its own views and enforcement strategy. It can be wrong and it can lose in court. The less conservative approach to token distribution is not to satisfy the SEC, but rather to get the law right.

For example, a different point on the risk spectrum is the view that free airdrops aren’t securities transactions, so airdropped tokens don’t need to be non-transferable or geofenced to comply with the securities laws. The SEC likely won’t agree with that view given its extraordinarily broad interpretation of the Howey test’s “investment of money” prong, and this issue is still being litigated in the courts. But it’s an approach that less conservative teams can consider with the advice of counsel.

To be clear, a less conservative approach isn’t for the faint of heart. It means taking on more risk of an SEC investigation, and even an enforcement action, with the good faith belief of prevailing in court. It also requires the fortitude and funding to fight all the way if necessary. But that posture reflects the strategy taken by the vast majority of the crypto industry, including its most reputable companies like Coinbase, which is locked in bet-the-industry litigation with the SEC right now.

Non-transferability and geofencing are both useful options when it comes to managing regulatory risk around token distributions. They just aren’t the only options, nor are they necessarily the right ones for every team and token.

*I am not your lawyer and nothing here is intended or should be taken as legal advice. If you're thinking about doing a token distribution, you'll need to hire your own counsel to advise you. I'm happy to make recommendations if you need assistance.

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