SEC Staff Says Tokens to Be Used for Video Games Are Not Securities
Commentary by Steven Lofchie
On July 25, 2019, the SEC Division of Corporation Finance granted no-action relief to a tech company that developed, and sought to distribute, a blockchain-based token (the "Quarter") for use on online gaming platforms. The company, Pocketful of Quarters, Inc. ("PoQ") developed tokens that allow users to pay for upgrades and other items in video games and to participate in game competition events.
According to the letter, 15% of the proceeds from the sales of the Quarters will go to the owners of the system. A portion of the remaining 85% of the revenue would be spent by holders of Quarters paying owners of games for access to game features. The game owners, not PoQ, will determine the value of the Quarters in each individual game. Game owners would be able to convert the Quarters they received into Ether, and presumably from Ether into dollars. PoQ also could use a portion of the 85% of revenue that did not go to the system's owners for the purpose of marketing the Quarters by payments to game owners, developers and influencers. In addition, these recipients of marketing payments would be able to convert their Quarters into Ether, and then into dollars.
The SEC staff highlighted that the Quarter was fully developed without the use of any proceeds from the sale of the Quarters. Ownership interests in the Quarter system, or at least parts of the system, are represented by a security that is evidenced on the blockchain. No relief from the securities laws was sought with regard to the token representing an ownership interest in the Quarters system.
Ordinary game players who purchased Quarters would not be able to transfer their Quarters to other persons or game players, and they would not be able to redeem them for Ether. The only permitted use of a Quarter by an ordinary holder would be to spend it in connection with the playing of video games.
Commentary
Not every initial coin offering is a "security" under the Howey Test. This is the most significant SEC action treating a product as a "utility token" and not as a security. That said, while there are lessons that can be drawn from the letter, the letter does not establish anything resembling a clear "rules of the road" that can be readily replicated by another technology developer. See also SEC Corp Fin Director Concludes That Bitcoin and Ether Are Not Securities.
The absence of any clear statement of law in this letter has given rise to what may turn out to be the most significant regtech development of 2020: SEC Commissioner Peirce's Proposal for a conditional token safe harbor from securities regulation.
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The SEC Division of Corporation Finance granted no-action relief from provisions of the Securities Act in order to simplify the usage of purchased units of value on online gaming platforms.