Academic Researchers: Utility Tokens are Securities Under EU Law

On February 3^rd, 2020, a group of academic researchers revealed their findings concerning the distinction between utility tokens and other forms of digital assets. Ultimately, their research suggests the majority of utility tokens constitute ‘tradable securities’ under existing European Union (EU) law.

What’s the Legal Classification of Utility Tokens in Europe?

A group of academic researchers have recently collaborated to explore the distinction between utility tokens, security tokens, and other forms of digital assets. The researchers include Dmitri Boreiko, assistant professor of corporate finance at the Free University of Bolzano-Bozen, Paolo Giudici, professor of business law also at the Free University of Bolzano-Bozen, and Guido Ferrarini, emeritus professor of business law at the University of Genoa.

The group published a paper titled “Blockchain Startups and Prospectus Regulation”, in the European Business Organization Law Review. They took to a blog post however, through the Oxford University Faculty of Law, to explain their findings.

Utility tokens, they say, “are the means of payment for services or products that [a] team wants to create”. In turn, they acknowledge that utility tokens are provided as a means to access a platform and can be spent within its corresponding ecosystem.

A closer examination reveals a high degree of ambiguity, however. In a large ecosystem, the researchers say so-called utility tokens can actually act more like a currency. This is because users can utilize their utility tokens as a means of payment for particular services.

To take things a step further, utility tokens are tradable. Based on a market exchange rate, utility tokens can often be traded for bitcoins, ether, or sometimes even fiat currency.

What this means then, is that utility tokens “can be conceptualized both as a mini-currency and as an investment in a platform”. They combine a payment aspect, a utility component, and an investment all into one instrument. As the research points out, such a combination is not seen in the world of traditional finance, where clear boundaries are seen between currencies, financial assets, and consumption goods.

Utility Tokens as ‘Tradable Securities’ Under EU Law

The research then dives into the use of digital assets to raise capital, particularly through the Initial Coin Offering (ICO) and the Initial Exchange Offering (IEO). The IEO has garnered some popularity, even from certain regulatory jurisdictions, such as Malaysia. In the United States however, the Securities and Exchange Commission (SEC) has issued a formal warning of IEOs constituting securities offerings.

Regardless of the offering used to initially sell utility tokens, research shows notably high trading activity throughout the first six months after an initial sale. Due to this, the researchers say it’s very difficult to justify an investor’s sole intention of purchasing a utility token for use in one specific ecosystem. Instead, such activity “offers a clear indication” that tokens traded on exchanges are viewed by their purchasers as investment instruments.

Further, the research touched on financial risk — a component they say is inherent to digital assets. When looking at how European law defines “tradable securities”, there are a few criteria: such securities are issued in classes by for-profit-organizations, they are negotiable on the capital market, they have an investment component, and subsequently expose investors to financial risk. Utility tokens sold through both ICOs and IEOs, they say, “have all these features”.

In this sense, utility tokens would be subject to existing regulation, such as MiFID II and the Prospectus Regulation (PR), regardless of their utility in a given ecosystem. The blog post reads,

“Finally, we believe that in any event the key concepts are those of negotiability on capital markets and financial risk involved in the investment component of the asset. When tokens, whatever their nature, are negotiable on capital markets and present an investment component and a financial risk, they are tradable securities in accordance with EU financial markets regulation.”

What do you think about the research concerning the regulatory status of utility tokens? Should new laws be established to account for utility tokens, or should utility tokens be subject to securities regulations? We’d like to know what you think in the comments section below.

 Image courtesy of Scholarship Positions.