When Does a Consumptive Token Become a Security? Understanding Securities Laws

When Does a Consumptive Token Become a Security? A Brief Securities Primer Confidential

What Is a Security? Securities, as defined by U.S. law, are "investment contracts" where an investor expects profits primarily from the efforts of a promoter or a third party. This profit realization can occur through the sale of the security or via collecting dividends or interest payments. Confidential

Application of The Howey Test Securities regulators often rely on the Howey Test, which was born from a 1946 U.S. Supreme Court case involving citrus groves, to help determine whether transactions are investment contracts and thus subject to securities laws. Confidential

Investment Contracts The Howey Test defines sales of securities as "investment contracts." An investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others, according to the SEC. Confidential

Consumptive Token Case Study Securities and Exchange Commission v. LBRY, Inc., Case No, 21-cv-260-PB (D.N.H. filed March 29, 2021) Court Rules in Favor of SEC in LBRY Enforcement action that consumptive tokens are deemed to be securities. July 11, 2023 Confidential

SEC vs. LBRY, Inc. LBRY is self-described as the first decentralized, open-source, fully encrypted content distribution service built using the same blockchain technology that underlies Bitcoin. In 2016,the company launched the LBRY Network as a decentralized platform for publishing and consuming content. As part of the launch, LBRY issued LBC tokens, which could be spent on the LBRY Network to (1) publish content, (2) create channels, (3) tip content creators, (4) purchase access to content, (5) boost content or channels in searches, (6) edit published content and (7)pay miners. Confidential

SEC vs. LBRY, Inc. On March 29, 2021, the SEC brought an enforcement action against LBRY alleging violations of Section 5 of the Securities Act. The SEC alleged that LBC tokens were offered as an investment contract and, therefore, were required to be offered and sold pursuant to a registration statement or subject to an available exemption from registration. Confidential

SEC vs. LBRY Ruling The court only briefly addressed LBRY s argument that LBC was purchased by many as a utility token for consumptive use rather than to invest. In rejecting this argument, the court stated that [n]othing in the case law suggests that a token with both consumptive and speculative uses cannot be sold as an investment contract. The court also found limited relevance instatements from some purchasers indicating they purchased LBC for consumptive use on the LBRY Network. The court concluded that even if some tokens were purchased with consumptive intent, that did not mean that LBC was not offered as a security. Confidential

In Conclusion There may be circumstances where a consumptive token would be considered a security. This would need to be determined on a case-by-case basis by examining the specific situation, scenario or characteristics of the cryptocurrency. Because technology and regulation in this area is evolving, if you are uncertain if securities laws apply to a cryptocurrency you are considering, contact the Commission s Division of Securities and Retail Franchsing. Confidential