The Stockholm Syndrome of token hodlers regarding unregistered securities


As the SEC started to publish settlements with more known ICO offerors regarding the sale of unregistered securities, the cryptosphere is ripe with speculation regarding the security nature of several high-profile ICOs.

Before I go on, let me clearly state that all of what I write is personal opinion and not investment or legal advice. Also, I am not a lawyer and not qualified to give any such advice. I am writing, solely using common sense and for entertainment purposes. My definitions of legal terminology may well be completely wrong.

Security angst

What is puzzling to me is how vehemently hodlers (investors) in the respective token fight the notion that “their” token might be classified as a security.

Crypto twitter is awash with posts by the “Ripple army”, that may or may not be bots, attacking anyone who claims that in their opinion Ripple might be a security. The same goes for EOS, Cardano or even IOTA and generally any token you can think of.

It seems that everyone is afraid that their token could be seen as a security. I doubt that many of the people writing about it actually know what it would mean if their token were classified as a security.

When is a token a security

Before we look at what it would mean if a certain token were deemed to be a security, let’s try to understand what likely makes a token (or literally anything you sell) a security. Again, let me repeat, I am not a lawyer and all I am doing is writing down my own opinion, using common sense. Also, I am looking at this from the standpoint of US regulations, simply because US regulators have been most active/visible in the English speaking world. I am not a US citizen, but I do believe that over time global regulators will come to similar conclusions, so this is not the worst jurisdiction to look at.

In the US, as far as I understand (this is likely to be too simple from a legal point of view), the regulators involved would be the Fed (when it comes to the US Dollar and by extension Tether), the CFTC (when it comes to commodities, hence bitcoin and ethereum) as well as the SEC (when it comes to securities, hence what we are trying to look at in this article).

The SEC has a reasonably straight-forward way to determine whether a given token might be a security or not. It is called the Howey test (taken from SEC v Howey). Broadly speaking, a token would likely be seen as a security if it fulfills the following four criteria:

  1. It is an investment of money (note that according to, this has been expanded to the use of “assets” rather than just money in later cases)
  2. There is an expectation of profit from the investment
  3. The investment of money is made into a “common enterprise” (this is not completely defined, but has generally been taken to mean investors pooling their money investing in a project according to Specifically: “ If an investment opportunity is open to many people, and if investors have little to no control or management of investment money or assets, then that investment is probably a security. If, on the other hand, an investment is made available only to a few close friends or associates, and if these investors have significant influence over how the investment is managed, then it is probably not a security.”)
  4. Any profits stem from the efforts of a promoter or third party (this is generally taken to mean that the profits are likely to be mostly outside the investor’s own control; ie dependent on the actions of a third party, like a start-up company)

This test is derived from the landmark case SEC v Howey and as with anything in case law, it is never 100% sure how future cases will be treated and definitions may well be varying.

However, most judges or juries will look at precedent first and then use common sense for completely new situations.

Let’s use any ICO that happened in 2017 as an example to go through this test. Basically, if there is a centralized party (the group of developers, the start-up or the large organization involved) that received the proceeds from the ICO and people can be assumed to have invested mostly in expectation of future profits (ie to sell the token at an exchange for a profit), then the token in question is likely to pass the Howey test and to be deemed a security. It is as simple as that. Of course, the larger the “warchest” (money) of the centralized authority behind the offering, the more they are going to be able to fight each little detail of the definition in court when and if the SEC brings a case. It should also be noted that there will be several instances and it could take years — some lower courts might be more open to the arguments of an ICO promoter because the SEC is sloppy in its argumentation or because they are simply being outspent in terms of legal advice. However, using common sense and not trying to deliberately take a side here, almost 99% of ICOs in 2017 fit the above definition.

Very brief detour here: I have heard retorts such as “but then a football ticket to an important match that can be re-sold on ebay for a higher Price is a security“. Not sure if I really have to explain it, but whoever thinks that should be able to see that the promoter of this ticket (the football club) is promoting the game and not the ticket. Far from making exchange listings and trying to ensure people can trade the tickets for higher prices, clubs take active steps to ensure tickets are sold at the same price on authorized venues in many cases and if you cannot see that the main motivation for 90% of buyers is to watch the game then you are kidding yourself. Even if some buyers only buy to re-sell, clubs usually limit the number of tickets one person can buy and they do not promote it as an investment. If anything they take active steps to prevent it becoming one, as mentioned above. So no, the above does not mean that anything you personally think you can re-sell at a higher price is a security.

In my personal opinion, the more of the below characteristics a token exhibits, the more likely it is that the SEC would allege it to be a security (aside from the very easy common sense read above):

  • The token was promoted via paid advertising by a central party or person
  • The advertisements noted or hinted at future profits
  • The advertisements put the token at the centre of their message; not a future product (ie the advertisement did not read something like: “You can now buy capacity on our distributed cloud solution for a discount” but rather said “Invest now into our token that will facilitate blockchain-driven distributed cloud-solutions”)
  • The whitepaper makes any kind of mentions of “token burning”, “payment of dividends/revenue shares/any other form of compensation depending on the business progress”, “future exchange listings” as all of these are promises that make the token scarcer and thereby allegedly more valuable, but have zero to no meaning in regards to any future product. Dividends and the like are extremely obvious incentives / promises of future profits. Noting in passing that a number of ICOs had that promise in their white papers at the start and some changed it later. That is unlikely to work in their favor…
  • The ICO was timed during the crypto gold rush (ie 2017). I know this is not very intuitive, after all — why should it matter when the ICO happened. Well firstly, before the SEC published their opinion on The DAO, you could always claim ignorance much easier. But mostly, it goes back to the Howey Test expectation of profit. Before 2017, there were hardly any large (volume-wise) “altcoin” exchanges. Before 2017, crypto was a niche segment that was a marketplace, but also the “fight” of token such as Litecoin, Bitcoin and yes, Ethereum, was about becoming the next platform for applications or a currency. I believe it is much easier to argue that investors did not have expectations of profit as their main motivation to invest prior to the gold rush. The first Ethereum buyers might very well have been coders that actually use Ethereum as a platform. Was there an expectation of profit? Yes. Was it the main driver behind buying the token? Questionable. Does it depend on the success of one single institution (and specifically, did it at the time of ICO)? I don’t think so. I am aware of the Ethereum Foundation, but I think a good point can be made that Ethereum, which is distributed in terms of mining and consensus would still exist without it. Anyways, we can disagree on this, but the SEC seems to agree with me.
  • The investment is very much structured like being a shareholder. You benefit if the promoter (the development team, the start-up, the company…) succeeds in selling their products and becomes successful as it would mean more buying demand for the token. This is also clearly the main motivation behind buying the token (ie the reddit forums are full of posts around how well the team is placed to take advantage of a market opportunity, how good the developers are (those that sold the token, NOT the decentralized open source ones)), next to “when Binance?”.
  • Your ICO promoter had a checkbox that made you confirm “you are not a US citizen” (come on, you have to get it: they knew exactly what they were doing). In my opinion, btw that simple checkbox will not save them. In a KYC world you have to verify that your client is a certain nationality. Not just ask them and accept any answer.
  • You can immediately point to one central party or group of people that did the ICO and got the proceeds of the ICO
  • In a side note: airdrops will likely need new landmark cases, but I personally believe that if a central agency made efforts or promised such efforts to list a token at an exchange (which we all know costs a lot of money), at some point in the future, the point 1) of the Howey test will not be important any longer OR could simply apply to those who bought the token in question from the promoters AFTER the airdrop, when they sold their stash on an exchange. But the future will tell.

I am therefore of the firm opinion that almost all ICOs in 2017 are securities. It makes sense that they are and I do believe history will prove I am right on this one, although it will take years to be sure AND I AM NOT A LAWYER. This is not legal advice.

Briefly, let me also tell you what makes it likely (in my personal opinion; I am not a lawyer, this is not legal advice) for a token to NOT be a security:

  • It has its own blockchain that is run in a decentralized fashion (miners are not concentrated with the same party that did the ICO or airdrop; POS nodes are not concentrated with that party, there is no central permissioning “council” or similar whose power lies with the promoter of the ICO)
  • It is not listed on any exchanges and most importantly a central party did not promise any such listings
  • You can immediately point to a product that is actively being sold by someone that (a) makes up the main actual USE of the token (ie Ripple having a SWIFT alternative that does not USE Ripple does not qualify and the use in such a network needs to be the bulk of the volume as opposed to exchange sales) and (b) that necessitates a token to work. In most cases you could easily incentivize with US Dollars or bitcoin if you look at the current token “use cases”.
  • There was no paid-for advertising
  • Development is entirely open source and based on decentralized consensus (not on permissioned consensus)

As an example, if Amazon were to introduce a centralized blockchain, they would not need a token for it, as it (Amazon) would be incentivized to run the verification process by other means than a token. They would quite simply have a USE for the blockchain.

Again, all of the above is just my opinion, but it was necessary to write this down so that we could proceed. Also, again note that legal clarity on this will take an enormous amount of time, but I think you should ignore common sense only at your peril.

The benefits of securities regulations to investors (hodlers!)

Now that we have cleared up the notion of what is likely to be a security (almost all ICOs and airdrops) and what not (bitcoin, ethereum,perhaps some small share of ICOs), let’s turn to what that would mean.

I am mostly interested in what it means for investors and the effects should be massively positive in my view. If the token you hold is classified as a security that means that the promoter has certain obligations to regulatory bodies and to its investors. The benefits to investors are the following:

a) Regular regulatory disclosures such as Financial Statements, business progress and information about the company’s management (this is extremely relevant, given ICOs currently can choose what they disclose and what not. Investors are likely to be kept in the dark about anything adverse. As a registered security that is not the case)

b) Protection from fraudulent market activities such as insider trading, wash trading and pump & dump schemes to a certain degree (obviously we all know that this is not a perfect protection and YES, all financial markets are being manipulated to some degree, but it is much, much more difficult to do this in regulated markets with regulated participants and regulated instruments than it is for those instruments where it is not even clear if the activities are unlawful. It also has much more personal risk associated to it. Let’s not turn this down and say “oh, but we see manipulation in all markets all of the time”, but actually say “despite the difficulty in prosecuting this, let’s be the shining light and let’s try to make crypto better than the legacy system, not worse just because we can”)

c) Proper investor information and KYC (in other words, if your ICO promoter did not do a good job (or not at all for that matter) to educate you about the risks of the investment and give you all information you need to make an informed decision AND ensure you are properly fit to take such risks from a regulatory perspective, you are able to sue them on this basis and get compensated for your loss if you made one. How this is a negative for investors is just beyond me. Wake up people!)

There are further benefits, but those three stand out in my opinion. To me, they are extremely desirable features that crypto is missing at the moment. Yes, financial regulation is imperfect, but it is the current state of what democratic and autocratic societies alike have deemed fair protection for investors. We should welcome these in crypto and even IF some token and their promoters do not survive this, the long-term benefits of the above for all of crypto to me are hard to deny.

It would also pave the way for numerous ETFs by the way.

All of the above is of course besides the point that without actual assets to back your security (like equity participations or debt), I would still find it hard to say an ICO is worth anything. But as I said, that is beside the point. There are such things as “tracking stock” after all and even those are not worthless on public markets (no idea why).

The Stockholm Syndrome

So now let’s look at what token hodlers are hoping for. If you look at what is being published and written on crypto twitter, it appears that a vast majority of hodlers are doing everything they can to “defend” “their” token and argue for it not being a security (amongst other things; read the replies to my post clearly showing WCX was a scam before their ICO ended here; hilarious how far people go to defend those that harmed them).

To me this means that either they are unaware of the above benefits, are using the token for criminal activity (certainly the strong minority) or are simply aping the central promoters of their token in their statements.

The Stockholm Syndrome is a condition that causes hostages to develop a psychological alliance with their captors as a survival strategy during captivity.

It appears to me that this is a very accurate description of what is happening here. Holders (hostages) have been wronged by their ICO promoters (captors) and yet because they perceive that if the token is classified a security they will endure further losses (strategy for survival), they help the people who originally wronged them to argue that their token isn’t a security.

To be clear, if your token is trading below ICO value AND the centralized promoters still have large stacks of this token in their treasuries that they can sell, being classified a security and having to compensate investors for their losses as well as potentially being sued for damages might cause these central promoters to dump the token on an exchange and cause its price to fall further. So yes, there is a potential harm in this to current hodlers. However, if you file for damages and compensation, you should in theory be able to re-claim these losses and more importantly — there needs to be some sort of legal liability to these promoters IF they infringed on securities regulations. It can’t just be that they get to keep the money and go scot free (eat the cake and have it too).

The company in question could obviously go bankrupt and be unable to pay these obligations, but if you think of large firms such as Ripple or EOS, they have enough resources to (1) pay the fees, (2) compensate investors (hey, Ripple trades above ICO price I think, so why all the fuss?!?) and (3) provide the regulatory information investors are due. None of the token hodlers in these should fret their token being ruled a security in my personal opinion.

As always in crypto, “OGs” are not helping. Most of them are libertarians against any kind of regulations. Without going into the political arguments, just always remember that when a centralized promoter or an OG tells you what you should think, in a world of “every man for himself”, those people are likely to have subconscious or even conscious motives that might not align with what is best for you.

Don’t trust, verify ;-).

If you enjoyed reading this, please clap. Also, you can check out my other stories on Medium here and follow me on twitter.

Lastly, the all important disclaimer: this is my personal opinion, not my professional advice. Most of all this is not investment advice in any way, nor legal advice. Crypto assets can fluctuate widely in value and all of your capital can be lost. I have a 50/50 chance of being right. Any negative views expressed are solely aimed at the token in question, never at the development teams behind them for which I have utmost respect (if they are sincere). Any examples regarding securities law are simply examples to illustrate a point — they are opinion, not advice. I am not stipulating ANY of the mentioned token are securities.

Entrepreneur, Fund Manager, Ex-Consultant and Hobby Ice Hockey Player. Child of the Sun. Any opinions personal, never investment advice, sometimes parody

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