Blockstack’s token offering is historic, but its dance with the SEC is far from over

By Guillermo Jimenez

Make no mistake. Blockstack receiving the SEC’s approval to sell its blockchain-based tokens to mom and pop investors is a big deal.

But the crypto startup’s journey to achieving regulatory compliance, creating a “sufficiently decentralized” network in the eyes of the SEC, or even proving that a market exists for regulated tokens remains long and arduous, legal experts say. And companies throughout cryptoland will have a vested interest in every twist and turn.

Yesterday, Blockstack announced that it had become the first blockchain company to receive the SEC’s blessing to conduct a public, ICO-like offering to anyone in the world. The company aims to raise $28 million through the sale of its Stack tokens (STX), which launches today.

While several other crypto startups have applied for the SEC’s approval, Blockstack is the first to get clearance under the Regulation A+ framework—one of many exemptions to federal securities laws that allows companies to sell securities to investors, under certain conditions, without facing the same arduous reporting requirements of public companies, such as Apple or Facebook. Approval under Regulation A+ means non-accredited investors—those that don’t meet the SEC’s requirements of a $1 million net worth or $200,000 annual income—may also participate in Blockstack’s sale.

But more than that, this is also the first time that a crypto company has taken a digital asset that would otherwise be known as a “utility token”—a critical piece of software upon which the success of the Blockstack network depends—and registered that token as a security in a sale to the general public.

And while the freewheeling, unregulated ICOs of the last several years may have carried considerable legal risk for the startups that raised millions shilling tokens, Blockstack's approach carries its own set of hazards for both its business and its investors.

"In some ways, this approach carries additional risk for token investors as compared to an unregulated token sale," said Gabriel Shapiro, an attorney and co-founder of ZeroLaw Tech. After all, "no one has yet created a blockchain that relies on a protocol token that also happens to be a security."

In doing so, Blockstack is carving out a path that will have significant implications for others looking to do the same, and the impact of its token offering is already being felt throughout the industry.

Just securing the SEC's approval is a “huge step forward for the crypto industry,” said former securities litigator and Compound Finance General Counsel Jake Chervinsky. “After years of waiting and wondering about the SEC's approach to digital assets, it's refreshing and encouraging to see the regulator finally put its stamp of approval on a blockchain-based offering,” he said.

The move, in fact, clears the way for the long list of other crypto startups seeking a Regulation A+ exemption to be approved by adjusting their models to match that of Blockstack, said Drew Hinkes, an attorney at Carlton Fields and Athena Blockchain general counsel. 

Shapiro echoed the sentiment, suggesting that Blockstack’s offering provides “the missing piece of the puzzle for compliant sales of utility tokens that also are investment vehicles.”

And in approving Blockstack’s token sale, Shapiro said that the SEC now appears open to “permitting projects that pursue a compliance path to take flexible, functionalistic views of securities laws in order to make their decentralized technology work within a legal compliance framework,” he said.

But making that work won’t be so easy.

Blockstack intends to create “an independent, decentralized ecosystem, over which no one party, including Blockstack, will have control,” according to its circular. The company claims it has more than 160 decentralized applications on its network and plans on its native STX token to be used, for example, to “register digital assets like domain names, inscribe and enact smart contracts, and process transaction fees.”

But treating these tokens as securities, including the tokens that are later mined on the network, may make it difficult for Blockstack to achieve its decentralization goals, according to legal experts. 

“Blockstack's offering circular describes a complex scheme for distributing newly minted tokens to miners: each distribution will be registered separately with the SEC and delivered to a centralized wallet, where they'll remain until miners have complied with applicable anti-money laundering and securities law requirements,” said Chervinsky. “Since Blockstack is the first company to conduct a securities offering of this sort, it will have to navigate the complexities of the securities laws without any pre-existing models to guide the way.”

Shapiro likewise said that it remains unclear whether Blockstack’s approach will be consistent long term with the aims of decentralized technology. “As Blockstack itself notes in the most recent filing, there are uncertainties as to whether Blockstack can stand up as an independent blockchain secured by mining if in fact all the tokens issued by the protocol itself need to be pre-registered as securities,” he said.

The situation presents a uniquely crypto catch-22.

On the one hand, in order to sell its tokens to the public, Blockstack was compelled to register them as securities—specifically, investment contracts—with the explicit expectation for investors that the token may increase in value over time through the company’s efforts.

On the other hand, the eventual success of the Blockstack network largely depends on its tokens ultimately becoming non-securities—as the company notes in its circular—resulting from its network becoming “sufficiently decentralized” over time. 

But what that means, exactly, or what this process precisely entails, is still anybody’s guess.

“By treating its token as a security, Blockstack is drawn into an almost impossible metaphysical dilemma,” said Lewis Cohen, an attorney and founder of the New York-based firm DLx Law LLP. “When does its token morph into a non-security due to its network being ‘sufficiently decentralized?’”

Cohen said that while Blockstack’s token offering represents a “milestone” for the industry, and a demonstration of the “important role securities regulators can play in ensuring true transparency in decentralized systems,” it remains “critical to focus on the implications of Blockstack treating their tokens as ‘securities.’”

The situation is further complicated by the fact that Blockstack may need to eventually register as a full-blown public company, despite the cover it’s currently afforded under its Regulation A+ exemption, if it meets certain conditions. “This would be tough and is contrary to the goals of decentralization,” said Shapiro.

Since Blockstack is no longer explicitly taking the position that its Stack tokens are not “equity securities,” as its most recent circular indicates, it means that the firm runs the risk of being forced to become a public company if it raises more than $10 million in assets from more than 500 unaccredited investors or more than 2,000 investors in total, according to Shapiro. “That obviously really creates more impediments for this model,” he said.

“The idea is that you could do a Reg A+ offering, let the token breathe for a while, gin up enough interest so that the project essentially becomes decentralized, and then get a no-action letter to the effect that the token is not a security,” said Shapiro. “If you have to have to incur all the same reporting obligations as Apple to get to that point, it's going to become an even tougher path.”

Lingering questions as to what, precisely, Stack tokens represent for investors—debt, equity, or something else—are compounded by the fact that Blockstack’s token will, for the foreseeable future, lack the qualities and characteristics that have made its unregulated counterparts valuable—namely, tradability on crypto exchanges.

You won’t find STX listed on Coinbase, Gemini, or even Binance and other foreign exchanges. Indeed, as Blockstack itself notes in its circular, the registered securities exchanges or alternative trading systems on which the token could lawfully be traded don’t exist yet.

It appears then that whatever expectations Stack purchasers have for a return on their investment may be intertwined with the company’s ability to navigate the uncharted territory that lies ahead.

“It is clear that Blockstack hopes to get no-action relief from the SEC that its token has become 'sufficiently decentralized,' and thus is no longer a security, but timing that will be crucial and it won't be fully in Blockstack's control,” said Shapiro.

Indeed, even if Blockstack successfully manages to overcome the various regulatory hurdles that remain in its path, “there's no guarantee that its STX token will be a success,” said Chervinsky. “In the end, there's nothing magical about issuing a security on a blockchain—STX will succeed or fail based on its quality, just like any other asset.”

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