Part 4/5 - Currency Token: Utility Token are a kind of digital voucher which can be redeemed against a promised service of the issuer. “True” Utility Token are not (yet) regulated as financial instruments in Germany.
part 1 outlines general principles of Tokenization
part 2 assesses the features of Security Token
part 3 assesses the classification of Currency Token
more on Blockchain/DLT applications on our Blockchain In-Focus page.
After briefly entering into the technical structure of tokens and the legal classification of security tokens in the first, second and third part of this essay, the following parts are going to further examine utility tokens. In this regard, we are not discussing technical differences (if present at all).
Symbol for rights and obligations
To the extent that utility tokens are only accepted by the issuer but not by third parties and only the issuer carries out the promised service, the classification as e-money is ruled out.
The real utility token is also not subject to a capital market regulation. It is neither a security nor a capital investment. This is what BaFin also suggests in its advisory letter. With the suggestion that the mere description of a token as a "utility token" is not decisive for the legal classification, it explicitly clarifies that a token structured as a real utility token is not a security. The question of how a real utility token must be structured in order to be regarded as a security or a capital investment remains.
It is true that for some (or perhaps for most) purchasers, utility tokens have an investment component as they hope to (profitably) trade it on the secondary market. Yet, the purchaser's profit expectation is irrelevant for the assessment of whether a security is at hand. The requirements already explained in part 1 of this paper also apply in this case. The negotiability of utility tokens on the capital markets is also not sufficiently given.
Utility tokens as vouchers
Utility tokens as a type of voucher are not comparable to the securities listed by way of example in sec. 2 no. 1 WpPG or sec. 2 (1) WpHG. The incomparability with stocks and bonds is apparent. Moreover, the utility token does not reflect a claim for money against the issuer. It serves as a voucher that can be redeemed for goods or services. Therefore, its negotiability on the crypto exchanges corresponds to the trading with goods and not with a security. The Capital Market Law's disclosure guidelines serve the investment decision, but not the decision on usage or consumption. The example catalogue in sec. 2 (1) WpHG or sec. 2 no. 1 WpPG disclosed for the definition of securities serves the classification of financial innovations. It is supposed to make the law sustainable and provide a broader definition of securities, but it should not lead to the capital market regulation encroaching into the field of goods and services exchange or the general consumer protection.
It is also irrelevant whether tokens are already usable or whether the promised service will only be offered at a later time. This circumstance does not change its actual purpose, namely being exchanged for goods and services. An embodiment of a financial right under the law of obligations and/or a financial return on investment is not promised thereby. Accordingly, it deviates from an essential point of the example catalogue in sec. 2 (1) WpHG or sec. 2 no. 1 WpPG, serving the classification of financial innovations. Otherwise, the classification as a security would be subject to arbitrariness. Any form of electronically recorded advance payment could thus become a relevant transaction under the Capital Market Law when fungibility occurs.
Consumer protection and expectation of profit
With regard to consumer or "investor" protection, a utility token is not comparable to securities, either, and the classification as a security is therefore not necessary. After all, the purchaser does not invest in an instrument which is supposed to yield return on investment to be provided by the issuer, but in a voucher to be redeemed for goods or services. Any of the purchaser's expectations concerning return on investment refer to the hope for a secondary market but not to the features of the utility token. The purchasers' protection regarding their rights and claims of the use contract must provide guidelines subject to civil law and consumer protection law and the law regarding general terms and conditions.
An opinion can be found in literature, according to which the utility token should come under the securities regulation if profit expectation is the relevant motive of a responsible token purchaser or if the possibility of generating profit is indicated. The issuer of the utility token has a certain scope of structuring. If the white paper and the further advertising materials contained statements substantiating profit expectations, a security would be at hand. If no statements were made in that regard, a security would not be at hand. In some cases, a security is at hand if it is common knowledge that the purchasers are expecting profit.
This result is to be opposed. BaFin's publication series states that tokens are not regulated according to "marketing considerations". It might be the case that profit expectations are considered a criterion for securities by the US Securities and Exchange Commission's security regulations on the basis of the Howey test. Yet, this does not correspond to the German – and European – concept of securities. This concept is conclusively defined by the three criteria standardisation, negotiability on (capital) markets and transferability.
Another criterion is the comparability with traditional securities mentioned in the law by way of example, which is particularly important for the classification of financial innovations. These are: stocks, company bonds comparable to stocks and debt securities. If examined, none of these three types is subject to the purchaser's profit expectation solely substantiated by price increases. Stocks represent membership rights; company shares comparable to stocks put the purchaser in a similar economic position; debt securities grant monetary claims. Thus, return on investment in the form of regular payments by the issuer is anticipated.
Utility Token with expectation of profit
A utility token, having (advertised) profit expectations when sold on the secondary market is not comparable to these types. It does not grant a membership right or a similar economic situation and does not substantiate a monetary claim, it only grants a voucher-like right to non-monetary services. The expected profit does not come from the issuer, but can only be paid by third parties outside the issuer's area of accountability.
Unlike in the case of securities, it is therefore not the issuer's credit rating that is decisive, but the ability to provide the service or goods specified on the voucher and to pay a certain price for the utility token upon the will of previously uninvolved third parties. Thus, it is not a question of capital market regulation but, if any, a question of contractual law.
The utility token does particularly not include a direct participation in the company's success. It is therefore comparable to a commodity which does not come under the concept of securities. Further, the Bitcoin is also primarily traded on a speculative basis. However, BaFin has not classified it as a security. Other things are also traded on a secondary market without being qualified as a security.
A utility token that does not promise interests, profit sharing or other compensation, is therefore not considered an investment. As the catch-all elements of the VermAnlG do not include utility tokens, the latter is excluded from the prospectus law. A real utility token is structured in a way that it is not covered by the Capital Market Law.