By Byron Gilliam, Markets Strategist at Blockworks.
Tokens Are Not Stocks, Part One
My neighbor recently led a campaign against our Homeowners Association after discovering that it was over-funded by $1 million.
I immediately suggested turning his campaign into a hostile takeover so that we could, um, liberate the extra cash…but that’s unfortunately not how it works.
We could go full Gordon Gekko at our next HOA meeting, but my greed wouldn’t do us any good — even if we won control, the $1 million would still have to go towards, like, landscaping and stuff.
I was reminded of that while reading the SEC’s complaint against Ripple this weekend. (It was a slow weekend. And cold out.)
Because the complaint makes clear that the SEC wants DAOs to act more like HOAs and less like investment vehicles.
And for the most part, I think DAOs are in agreement.
Which led me to a realization that I think is important for crypto investors to internalize — so I'll need your full attention here…
Ready? OK, here it is:
DAOs are not companies, protocols are not businesses, and tokens are not stocks.
I may be getting out over my skis on the legal definitions (reminder: everything I know about the law I learned from Better Call Saul), but Gary Gensler says US securities law is “quite clear” on digital assets, so we have a lot to go on.
And even if I'm off base on the legal nuance, I’ll explain why I think tokens are not stocks is still a useful framework for crypto investing.
Because tokens, even abiding by SEC rules, can be investable without being securities.
Staking Your Claim
When you buy a stock you are 1) buying a claim on current assets and future cash flows and 2) trusting management to maximize those assets and cash flows.
Buying a governance token such as UNI feels exactly like buying a stock.
But that is misleading because DAOs are not intended to create assets and cash flows for investors — instead, they are meant to be de-centrally managed to the benefit of a protocol (not token holders).
Most DAOs, I think, are cognizant of that, as evidenced by the announcement of the UNI airdrop, which studiously avoided any hint that the protocol was designed for the economic benefit of token holders.
The purpose of an airdrop is to transfer management of a protocol to a decentralized community — and when you buy a token, you are buying a spot in that community.
It's not clear to me why that spot has a lot of value — protocols are not meant to benefit token holders, so it’s a bit like buying the right to manage my HOA.
Judging by the market capitalization many of these governance tokens get, however, people seem to think something else is happening.
The only thing I can take from Uniswap’s $9 billion market cap is that holders believe they have a claim on UNI’s treasury assets and cash flows.
But the SEC has given every indication that the token of a DAO that paid out assets and cash flows to token holders would be an unregistered security.
This, I suspect, is why DAOs like SushiSwap pay out the fees they earn only to those who have staked their tokens (instead of paying it to all token holders, like a stock would pay a dividend to all shareholders).
Paying fees to stakers can serve the protocol’s best interests by keeping the token price up — in the case of DEXes, for example, a higher token price enables a protocol to pay higher rewards to liquidity providers, which is essential for the protocol to function.
Paying fees to all tokens in the way a stock would pay a dividend to all shareholders would instead imply that SUSHI holders have a claim on SushiSwap’s earnings — which would make it an unregistered security.
Being deemed a security is why Ripple, once the second-largest crypto by market cap, has spent the last two years in court and is no longer listed on US exchanges.
Ripple invited SEC scrutiny and failed the Howey test in part because they led investors to “reasonably expect a profit from their investments."
I’m guessing that when you buy a crypto token you are reasonably expecting a profit…and that is totally fine if you expect that profit to come from staking rewards, as with SUSHI.
But if you think it will come from a claim on future cash flows, you are likely to be disappointed.
I suspect this may be why UNI has not yet turned on the fee switch that would pay earnings out to stakers.
UNI is doing just fine without it, so it would be a stretch to argue that turning the fee switch on is necessary for the good of the protocol — which is the argument they’d have to make in order to avoid being deemed a security by the SEC. Because:
DAOs are not companies — they are not managed for the benefit of investors.
Protocols are not businesses — they are not designed to generate profits.
And tokens are not stocks — they do not give holders a claim to assets or cash flows.
If any of those three things were true, they’d be an unregistered security.
Tokens Are Not Stocks, Part Deux
You may not care that the APY your token pays is called “staking rewards” instead of “dividends.”
But I think it’s a distinction that matters. And I’m going to tell you why…tomorrow, in Part Deux.
I asked for your attention at the start, and you’ve been great: You ignored at least three phone notifications (thank you) and you haven’t stopped to check Twitter even once (heroic).
But I sense I’m pushing my luck now, so let’s reconvene for tomorrow, when I’ll explain why I think tokens are not stocks is a useful framework for crypto investing — even if my understanding of legal nuance is not quite up to Saul Goodman standards.
Original Blockworks Article: https://blwk.omeclk.com/portal/public/ViewCommInBrowser.jsp?Sv4%2BeOSSu…
About the Author:
Byron Gilliam traded international equities for investment banks and brokers in Frankfurt, London, Paris and New York before becoming the Markets Strategist at Blockworks.
Now in Chapel Hill, NC, he writes a daily newsletter on crypto and markets. Byron has an undergraduate degree in history from Binghamton University and a master's degree in hard knocks from 20 years of trading.