Are DAO tokens securities according to the SEC?

A plain English definition of what a security is, using the Howey test, and the 1st DAO as an example.

Are DAO tokens securities according to the SEC?

TLDR: If you sell someone an instrument or a contract that promises future returns because of the work you’ll do with their money, you are selling a security. An investment DAO’s “governance token” would be a security if the DAO promised or implied that the token’s price would increase because of that DAO’s investments. Majority of governance, utility, and membership tokens are securities.

The story to date

The first DAO on Ethereum was formed by a German company to “build projects”. It sold tokens to investors to fund them, and promised to share future profits. Investors were allowed to and had ability to re-sell their tokens on trading platforms. Before the DAO could work on any projects, it was hacked, and 1/3 of its funds were stolen. The DAO found a way to get them back.

The SEC investigated the DAO to discern if its tokens were securities and found that they were, under both the 1933 Securities and 1934 Securities Exchange acts.

The definition of a security

A security includes an “investment contract”. That means an investment of money in a company, org, venture, or a project, with the expectation of profiting from the investment that you get because of work others perform through their entrepreneurial or managerial efforts. The definition is laid out in sections Section 2(a)(1) of the Securities Act and 3(a)(10) of the Exchange Act and is popularly known as the Howey test.

The definition is meant to be flexible rather than formulaic. How the token is used is more important than what it's called. A "utility token" is not exempt from being defined as a security because it has "utility" in the protocol, such as governance. If the company used it to raise money and gave investors expected of future profits, it's a security.

Where modern DAOs stand on the regulatory landscape

The act of “investing” in something can take on the form of “investing goods and services” and not money. When a group of people or firms jointly pursue shared (i.e. common) goals, they become responsible for success or failure of that enterprise. Any contract they sell and promise others future profits is a security.

Yes, a lot of DAO tokens are securities by definition.

What about DAOs that mint tokens but the members perform the work themselves?

The token would be a security if:

  1. Members (who buy the token to get access to the DAO) own so few tokens that they can't influence its direction through a vote

  2. Members are so inexperienced in the business operations that they are incapable of exercising their partnership powers

  3. Members are dependent on unique entrepreneurial or managerial abilities of DAO's founders, leaders, and promoters that they cannot replace them or otherwise exercise meaningful partnership or membership powers.

Is it bad for the token to be called a security?

No, it just has to be registered to afford its issuers and investors adequate legal protection.

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