The latest state to confront the utility token issue, Colorado, recently enacted the Digital Token Act (the Act). The Act amends the provisions of the Colorado Securities Act that require the registration of all securities offerings in the state unless an exemption is available. Specifically, the Act provides a conditional exemption from registration for certain utility tokens qualifying as “digital tokens” that have a “consumptive purpose.” It also provides limited relief from broker-dealer registration for intermediaries effecting transactions in such digital tokens.
The Act defines a “digital token” as a digital unit that is: (1) created (a) in response to the verification or collection of a specified number of transactions relating to a digital ledger or database; (b) by deploying computer code to a blockchain network that allows for the creation of digital tokens or other units; or (c) using any combination of the methods specified in (a) or (b); (2) recorded in a digital ledger or database that is chronological, consensus-based, decentralized, and mathematically verified in nature, especially relating to the supply of units and their distribution; and (3) capable of being traded or transferred between persons without an intermediary or custodian of value. Having a “consumptive purpose” means “to provide or receive goods, services, or content, including access to goods, services, or content.”
Offerings of digital tokens are only exempt from the registration provisions of the Colorado Securities Act if the issuer of the tokens:
(1) (a) effects or attempts to effect the purchase, sale or transfer after the Colorado Securities Commissioner initially promulgates implementing rules; and (b) complies with all of the requirements of the Act and those contained in the rules promulgated the by the Securities Commissioner;
(2) the issuer files an online notice of intent with the Securities Commissioner;
(3) the primary purpose of the digital token is a consumptive purpose;
(4) the issuer of the digital token markets the digital token to be used for a consumptive purpose and does not market the digital token to be used for a speculative or investment purpose; and
(5) either the consumptive purpose of the digital token is available at the time of sale or all of the following conditions are met: (a) the consumptive purpose of the digital token is available within one hundred eighty days after the time of sale or transfer of the digital token; (b) the initial buyer is prohibited from reselling or transferring the digital token until the consumptive purpose of the digital token is available; and (c) the initial buyer provides a knowing and clear acknowledgment that the initial buyer is purchasing the digital token with the primary intent to use the digital token for a consumptive purpose and not for a speculative or investment purpose.
The Act also includes a limited exemption from broker-dealer registration in Colorado for persons effecting transactions in digital tokens that have a consumptive purposes at the time of sale.
The new law becomes effective in August 2019, but it would seem the Colorado Securities Commissioner must first adopt enabling regulations before issuers can rely on the registration exemption. While it is encouraging that Colorado has confronted the utility token issue in a creative way, the compliance system it sets up is not much different from the one applicable to other private placements of traditional securities. Those in the crypto community seeking a full-bodied exemption from securities regulation will not find it under the Act, and the practical relief for issuers of utility tokens under the Act is therefore limited.
Moreover, in addition to ensuring a good exemption under the federal securities laws, issuers and intermediaries effecting transactions in utility tokens must also perfect an exemption under the laws of other states in which the tokens are made available for sale. At this time, few other states have adopted a regulatory regime on par with the Act. Thus, as a matter of logistics (and with a certain irony), it may be easier and more efficient for an issuer of a utility token to treat the token as a traditional security and perfect an offering exemption under federal Regulation D, which provides a measure of preemption of state law that would supersede the various conditions imposed under the new Act.