Despite the fact that SAFT (Simple Agreement for Future Tokens) is extensively utilized in blockchain projects, many developers still do not understand the SAFT thoroughly. The majority of projects regard this as a pre-purchase contract for a future commodity. Is this, however, the best approach to comprehending SAFT? Let’s break down the legal aspects of SAFT with JNT through this article.
Why define the SAFT contract type?
The fact that SAFT is classified as an investment contract will lead the project to a series of legal consequences, one of which is the requirement to register with the competent authority for the sale of tokens. As a result, the attitude of “Just have something to record token sales” can lead to securities law violations.
How to determine the type of SAFT?
SAFT is basically just a tool for each contracting party to fulfill their obligations. Therefore, before mapping out the basic terms in SAFT, project developers should understand the following factors to understand and comply with the law.
1. Token Type
Tokens are the contract’s object, therefore knowing what type of token can aid the developers to figure out what type of SAFT it is. The Howey Test is one way to determine that token. Although the Howey Test refers to SEC v. W.J. Howey Co., which reached the Supreme Court in the US in 1946, it is still a widely used standard set in other countries these days.
The Supreme Court established four criteria to determine whether an investment contract exists. Under the Howey Test, an investment contract is:
- An investment of money
- In a common enterprise
- With the expectation of profit
- To be derived from the efforts of others
Read more: Howey Test
Howey Test is a flexible case-by-case test for securities. If a token provides equity (which includes shares, debentures and units in a business trust), or units in a collective investment scheme, that token is definitely security (often referred to as a Security token) because it fulfills both 4 criteria above. As a result, SAFT for this coin can be recognized as a legitimate investment contract.
If a token represents a right to a good or service, that token can be a utility token. Projects often mistakenly consider they are in a “safe zone” when advertising their token as a utility token. They believe that once the project runs and the pre-sell token will be a commodity when it is delivered in the future, that token is definitely not an investment and therefore does not pass the Howey Test. However, even if the token is used in such a way, the token may still be considered an investment if the purpose of the SAFT is an investment. Therefore, there is no bright-line test for which tokens are securities, and a token’s putative utility alone does not shield it from classification as a security.
Read more: NFT, Security token and Utility token
2. Country of establishment
Due to the internet and digital nature of blockchain projects, no single jurisdiction has sufficient regulatory hold over a specific project. However, to minimize regulatory risks, enhanced standards by the Financial Action Task Force (“FATF”) require virtual asset service providers (“VASPs”)(1) to be at least licensed or registered in the jurisdictions(s) where they are created, or if a natural person, they should be licensed or registered in the jurisdiction where their place of business is located. This can be broadly understood as the companies that own the project must at least comply with the laws of the country where they are established.
Each country may have different regulations on the type and the sale of tokens. Therefore, to determine whether SAFT is an investment contract and the sale of tokens requires registration, developers must rely on the laws of each country to have the most precise view.
In the US, in 2017, the US Securities and Exchange Commission (SEC) issued guidance determining when an initial coin offering (ICO) or token sale is considered a security sale. Howey Test is applied to solve the above problem. There are actually 2 lawsuits, SEC v. Kik Interactive Inc. (in 2020) and SEC v. Telegram Group Inc. (in 2019) identify issued tokens as security tokens even though companies claim to be utility tokens.
In addition, some projects may invoke rule 506(c) of Regulation D to exclude themselves from the obligation to register with the SEC by only allowing accredited investors to sign SAFT. However, in SEC v. Kik Interactive, although the private sale and public sale of Kin tokens are used for two different objects and currencies: the private sale uses USD for accredited investors through SAFT, while the public sale uses ETH for the public through various exchanges, the court still concluded that it was impossible to separate these transactions from each other and that they should be viewed as “part of a single plan” to launch Kin and its supporting digital ecosystem. Therefore, Kik violated regulations on registration with the SEC.
It can be seen that the US has quite strict regulations on buying and selling tokens as well as using SAFT. However, with its pioneering position in setting blockchain regulations, the US will likely be a model for other countries to build a legal framework.
Singapore does not yet have a separate regulation governing SAFT, however, in the Monetary Authority of Singapore (MAS)’s A Guide To Digital Token Offerings, there is an example related to SAFT as follows:
Company G is incorporated and has its principal place of business in the United States of America. Company G intends to offer digital tokens (“Token G”) to any person globally, including in Singapore. Token G is governed by a Simple Agreement for Future Tokens (“SAFT”) and is an “investment contract” (and therefore constitutes securities) under US laws (or the “Howey Test”). Token G will be tradeable in the secondary market on an over-the-counter basis or on third party cryptocurrency exchanges.
Application of securities laws administered by MAS in relation to an offer of Token G:
- The ability for a digital token to be traded on the secondary market alone does not result in a digital token being construed as capital markets products under the SFA.
- The treatment of a token under the Howey Test is not a consideration for deciding whether a token is a product regulated under the SFA.
- Company G must separately assess whether its offer of Token G in Singapore would comply with the securities laws administered by MAS despite its assessment of Token G under US laws.
As such, if a project’s token is considered a security and SAFT is identified as an investment contract, the company will have to comply with the securities laws in Singapore if the token is offered in Singapore. Under Article 240 of the SFA, a company is required to make a report when it offers “securities” to persons in Singapore, except in exempted cases. One of those exemptions is an offer to sell to “institutional investors” (almost like accredited investors in the US) if certain conditions are met such as advertising and restrictions on resale.
Some countries like Panama, and Cayman adopt the FATF definition of Virtual Assets (VA) which stipulates that a VA is defined by FATF as a digital representation of value that can be digitally traded, or transferred, and can be used for payment or investment purposes. At the same time, these virtual asset providers must register when buying, selling or exchanging. Therefore, for tokens that are considered an investment, the use of SAFT to sell tokens must definitely register with the competent authority.
3. Any solution for SAFT?
So is SAFT an investment contract or a pre-purchase contract for a future commodity? Considering the information shared by JNT above, Projects and investors may label “investment” for this type of contract. However, determining what type of contract SAFT is should be based on the token’s operating mechanism, legal regulations, as well as the content of the agreement between the parties. In the spirit of SAFT, the drafting of the terms of the contract needs to be careful not to violate the prohibitions of the law.
Let JNT protect your Project with our SAFT drafting and consulting service. Proud to be a pioneering professional legal and financial consulting unit in the blockchain, JNT has been helping hundreds of Clients achieve their business goals. Please contact JNT for the most comprehensive solution for your Project!
Auth. Zed Nguyen
(1) FATF has defined VASPs to include persons carrying on a business of conducting one or more of the following five activities: (i) exchange between virtual assets (“VA”) and fiat currencies; (ii) exchange between one or more forms of VA; (iii) transfer of VA; (iv) safekeeping and/or administration of VA or instruments enabling control over VA; and (v) participation in and provision of financial services related to an issuer’s offer and/or sale of a VA.
