Offering rewards tokens to residents of the United States of America may add legal risks to a cryptocurrency project from a securities regulation perspective. Fortunately there should be nothing wrong with taking the financial rewards that would have been allocated to token holders and using them purchase tokens for burning instead. Theoretically, the token holder may see the price of the token increase according to the laws of supply and demand. This might stimulate token sales without violating the definition of an investment contract according to the Howey Test.
The Howey Test
Thanks to the Supreme Court’s decision in a case brought against the W. J. Howey Company by the US Securities and Exchange Commission, it is clear that the purchase of a rewards token can be classified as an investment contract. An investment contract is “a contract, transaction, or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party...”
Essentially, a transaction is an investment contract if:
- There is an investment of assets (money, real estate, etc.)
- The investor anticipates some financial reward from the investment
- The investment is in a common enterprise
- The investor has no control over the financial reward anticipated
Pseudo Beneficial Burning
With psuedo beneficial burning, dividend like rewards are not offered. Consequently, the purchase of tokens might not be considered an equity like investment. From an equities perspective, there will be no more anticipation of financial reward from holding the token.
The investor may still anticipate a financial reward. However, it will not be through a dividend-like mechanism. In the token burning case, the anticipation of a reward comes from an expectation of a price increase. Given a fixed supply of tokens, purchasing the token now resembles purchasing a collectable from a financial asset perspective.
Considering the Howey Test’s common enterprise verbiage, where the fortunes of the investor would depend on the efforts and success of cryptocurrency project, it is clear that the market demand for the token is beyond the control of the cryptocurrency project’s leaders. For example, burning tokens cannot control demand for tokens. To truly control the fortunes of the token holder, the cryptocurrency project would need to be able to manipulate both supply and demand.
While the cryptocurrency project’s success may have some impact on the price of the token through influencing supply, there is no certainty that its efforts and financial success control the fortunes of the token holder. Indeed there may be other players in the market with far more influence on the price of the token.
Burning tokens is the process of reducing the supply of tokens. When a token is burnt it is sent to an address on the blockchain to which there is no usable private key. That means that it will be impossible for that token to be transferred again because all blockchain transactions need to be digitally signed with a private key to be valid transactions.
The process of burning tokens is verifiable as there is a public record on the blockchain. After the burning of a token there may be an impact to the market value of the token. Assuming no changes in demand, that impact will be determined by how much of the total supply the project can purchase in the marketplace once the token is listed on a cryptocurrency exchange.
From a regulatory perspective, this pseudo beneficial burning should be a safer footing for conducting a token sale. The US Securities and Exchange Commission may see no issue with a collectable token.
Disclaimer: I am not a lawyer or investment specialist. I just know a little about marketing strategy and have a fascination with cryptocurrencies. Please do your own research, question widely, and comment on my thoughts above. In the cryptocurrency world there is much to learn about law, economics, and technology. I am certain that I don’t have all the information to be an authoritative source of knowledge. That is where you can help. Please give me feedback. Feel free to email me at email@example.com to discuss anything cryptocurrency related or even to just inform me of spelling or grammatical errors. Thank you.