What the Cardozo report gets right and wrong about SAFT’s approach to ICO self-regulation.
By: Pete Martin
Tags: ICO, Token Sale, Investing, Cryptocurrency, Blockchain

A new report has raised questions on, arguably, the first attempt at self-regulation in the ICO market.

Authored by the Cardozo Blockchain Project at Cardozo Law School in New York, the report highlights potential issues in the Initial Coin Offering (ICO) legal instrument called a Simple Agreement for Future Tokens, or SAFT, a new ICO transaction agreement aimed towards complying with known SEC rules and enforcement actions, for which they have yet to offer comprehensive rules or regulations on the ICO market.

We’d like to address some of the report’s core concerns, and explain why we still believe the agreement perfectly complements Votem’s one-of-a-kind ICO.

Among the largest legal challenges to the still-unregulated ICO market is the potential classification of tokens as securities. If any token is classified as such, the presiding company is open to securities regulatory action.

This core legal issue has led to the development of what’s called a SAFT — Simple Agreement for Future Tokens — an agreement between purchaser and seller that promises the future delivery of tokens once they’re developed which was created by leading law firms Cooley, LLP, Perkins Coie and others.

Counter-intuitively, SAFT is itself a security (but not equity — akin to a futures contract). It stays compliant with SEC regulations by following Regulation D of the Securities Act, which allows unregistered securities to be lawfully sold, so long as they’re sold exclusively to “accredited investors” — typically defined as high-income and high-net-worth individuals, in addition to many trusts and banks.

Below we address concerns highlighted by the Cardozo Report and our position on those same concerns.

Concern 1: SAFT’s alone may not provide sufficient legal cover for problematic ICOs.

Among the most salient and recurring critiques in the latest Cardozo report is the reputation of a SAFT as a one-size-fits-all legal solution.

The report states that SAFT, “Blurs the true test of how tokens will be analyzed under U.S. federal securities law, which is highly dependent on the relevant facts and circumstances.”

In this legal reading, SAFT’s overall focus on addressing one SEC guideline gives investors the impression that they’re entirely safe because the SEC is concerned with clear-cut rules when in reality, they’ll likely scrutinize the overall economic circumstances of the transaction on a case-by-case basis. This is fair. A project that would otherwise break securities laws isn’t inherently rendered safe due to any SAFT wrapping.

Additionally, soon after the whitepaper was published, one of its authors made public statements to the effect that SAFT alone can’t protect all tokens.

“There are plenty of limitations on the flexibility of the SAFT framework. For example, the SAFT…. doesn’t achieve much for tokens that are themselves securities (e.g. limited partnership interests like the DAO token). Using a SAFT won’t make a securities token any less of a security. The SAFT only works for “utility tokens.”

Which brings us to the author’s next criticism.

Concern 2: Many utility tokens may not prove useful enough to avoid security classification.

The SEC’s prior DAO report establishes that tokens themselves may be considered securities, depending on their composition.

However, clear rules for defining security tokens were not given, and the cryptocurrency community, in turn, has taken an educated guess: tokens that function as investments are likely securities, and those that function as a currency within a working infrastructure — utility tokens — probably aren’t.

So far, it’s thought that the majority of tokens are in fact securities, and for good reason. Cryptocurrencies’ immaturity and lack of clear oversight has lead to a proliferation of scammy or poorly-organized ICOs whose intentions are closer to taking advantage of high investor demand than developing fully-functional blockchain companies.

“The majority of ICOs that are happening now are in fact securities and should follow the standard process for securities offerings,” according to Rune Christensen, founder of MakerDAO. “They are fooling naive investors into believing that they are buying a piece of decentralized infrastructure when, in fact, they are only buying the promises of the management team.”

Utility tokens, meanwhile, are designed to be used within a functioning product ecosystem.

“If you think about it in terms of a video game arcade, at some arcades you can just put quarters in the machine,” said blockchain lawyer Joshua Ashley Klayman. “In others, you have to put tokens in the machine. So users have to buy the token to transact within the ecosystem. The idea is that people really want to use the product or service that the company is offering and that the token is the only way to access it.”

Cardozo authors argue that many of these utility tokens still might qualify as securities, for two reasons:

- The economic reality of tokens seems to benefit investors at the cost of others.

- The “profit-seeking” nature of the SAFT agreement may qualify tokens as securities.

Concern 3: SAFT’s ‘Profit-seeking’ nature may raise regulatory red flags.

Chief among the report’s assumptions is that SAFT encourages organizers to construct their product, platform, and marketing to maximize investor “profit potential.”

This assumption is misleading, in our opinion. While SAFT may soon be independently adopted by purely investment profit-seeking ICO vehicles, the appeal of SAFT has been used by and was designed for, forward-thinking and transparency-minded ICO organizers.

So far, projects launched on CoinList — the SAFT-dependent ICO marketplace created by the agreement’s architects — feature user-first services, like Blockstack, FileCoin, and the upcoming PROPS ICO. These experienced development teams are a far cry from the hucksters who populate the Ethereum Scam Database.

These utility tokens are particularly well suited to the SEC’s case-by-case method, as stated by the researchers since each token is structured differently.

It’s important to not let optimism override marketplace incentives though: we could see dishonest actors in the ICO space adopt SAFT as a legal shield.

When that happens, SAFT likely won’t prove safe.

Concern 4: ICOs tend to favor wealthy investors over their future users.

Adding to their “relevant facts and circumstances” argument, The Cardozo Blockchain Report’s authors successfully argue that the SEC may rule unfavorably on ICOs because they appear to favor investors over consumers.

They write:

“With traditional equity investments, investors are generally aligned to support the long-term growth of a company and its valuation and are subject to robust transfer restrictions. Under the SAFT Approach, however, SAFT purchasers are incentivized to profit from a short-term token sale event. That single sale event may be all that a SAFT purchaser needs (depending on the discount rate they receive under the SAFT) to recoup their initial investment and make a substantial profit.”

It’s important to note that SAFT-based ICOs aren’t necessarily more likely to favor wealthy investors than non-SAFT ICOs. Still, the authors make a highly constructive and necessary criticism here. Investor speculation drives higher token valuations, which makes them less accessible to users.

Stay Conservative My Friend

We’re confident that 2018 will be the “year of oversight” — and we think that’s a very good thing. Although we’ve received excellent counsel from our attorneys at Cooley, we know we are taking a risk because none of this has been adjudicated through the courts enough to create a precedent. However, we think our approach is in good company with the high integrity teams at Filecoin and others and frankly, doing business always involve calculated risk.

We’ve implemented a few key differentiators in our ICO to address the investor/consumer imbalance:

First, we’re holding a reserve of our VAST exchange tokens to avoid their value from increasing to the point that they’re no longer accessible for consumers.

Second, our token marketplace (“VASTEX”) will reduce short-term speculation by allowing investors to rent out tokens (we’ll publish a more detailed post on this mechanism shortly) to users — at a predetermined price and timeline.

Third, our SAFT is being conducted as a securities-grade offering and following strict compliance laws globally; Reg D in the U.S.

We believe these precautions create a better offering for all VAST Token Holders regardless of whether they want to leverage the utility value or hold for a long-term investment.

Our recommendation to others launching their Token Sale is to spend the time, money and effort to be as cautious and conservative as you can and provide your token holders with as much transparency as possible. The more legitimate ICO’s that happen, the more opportunity there will be for innovators and entrepreneurs who want to take advantage of this crowdfunding method.