A Delaware-based blockchain company settled SEC charges for offering and selling digital tokens, in violation of securities registration requirements.
In an SEC administrative proceeding, the agency alleged that Blockchain of Things, Inc. ("BCOT") did not register its digital token, as required by federal securities laws. Prior to the offering, BCOT released a white paper explaining that the tokens could be converted into "credits" for services on a separate BCOT platform. This separate platform - known as Catenis - was designed to help app developers create new products by simulating an "ecosystem of third-party apps." The SEC determined that the token should have been registered as a security because the Catenis platform (i) was in a "beta" stage at the time of the offering, (ii) lacked restrictions on the conversion from tokens to Catenis credits, (iii) led purchasers to believe they could profit from the token if BCOT was successful, and (iv) did not clearly state the purchasers' rights to use of the technology. Between December 2017 and July 2018, BCOT generated over $12 million through the illicit offering.
In determining an appropriate penalty amount, the SEC took into consideration BCOT's remedial efforts and cooperation. To settle the charges, BCOT agreed to (i) cease and desist violations of SA Section 5(a) and (c) ("Prohibitions relating to interstate commerce and the mails") and (ii) pay a civil monetary penalty of $250,000. Pursuant to the settlement, the SEC Division of Corporate Finance waived the "bad actor" disqualification of BCOT.
In this case, the issuer was trying to benefit from the argument that the tokens it was selling were effectively "utility tokens" that would give purchasers the right to use the issuer's technology going forward and were not capital investments in the issuer itself. The SEC rejected this position, observing, among other things, that the issuer's technology was not yet in usable condition and thus the proceeds of the sale of the token were being used to build the issuer's product. (Put differently, the purchasers of the tokens were relying on the expertise of others to give value to the tokens which they purchased, or in which they invested.) Further, the SEC took the position that the tokens were "securities" because purchasers of the tokens were likely hoping to profit from the potential resale of their tokens to other futures users of the issuer's technology. (This point is significant because the SEC is asserting that a utility token that is sold on the basis of a suggestion that the utility token will increase in value is a "security" subject to registration, even if the token ultimately can only be "spent" by actually using the relevant issuer's product.)
It appears likely that the SEC was troubled because even the use value of the tokens was completely indeterminate, and up to the discretion of the issuer. If the issuer had determined that tokens purchased for a dollar were worth only a penny on the system, owners of the tokens would not have had any contractual recourse. If that would have been the case, the SEC might have reasonably believed that the token purchasers were fools in need of protection.
For a perhaps happier result, see SEC Staff Says Tokens to Be Used for Video Games Are Not Securities. In that case, the technology was said to be fully developed, and the seller of the tokens would not actually have any control over the ultimate value of the tokens, which were to be used in video games developed by third parties. While the terms of the video game letter appear too restrictive to allow for the distribution of utility tokens as a means by which most technology companies can jump start, it is the best guidance that the SEC has provided to date as to what constitutes a "utility token" rather than a digital security.