As we will see in case studies below, better classification is a prerequisite for better regulation and blockchain governance processes.

Recognizing the existence of (3) hybrid tokens, (4) hyperutility tokens, and (5) research tokens highlights the need for “sandbox” regulatory exemptions in order to optimize underlying market/tech processes, produce new types of social welfare gains, and unleash new modes of economic production.

Beyond the security v. utility binary, the case studies below also show the need for dynamic approaches to token classification, in contrast to the more static formal frameworks in use today.

Dynamic models are more flexible and responsive to shifting stakeholder expectations in the blockchain space. Hence, they promise greater legitimacy and security.

3. Formal Methodologies

As applied to blockchain, the Howey test now extends far beyond case law.

The jurisprudence around Howey now includes a long and rapidly growing line of progeny cases, as well as multiple instances of formal regulatory guidance from the SEC (e.g., first “no-action” letter in re: ICO; SEC 2019 Guidance on ICOs; SEC position on Ethereum; etc.).

There is also a growing body of SEC enforcement precedent in the blockchain space.

3.1 Beyond Howey

Separately from the SEC, other U.S. agencies that claim crypto oversight power include the Consumer Financial Protection Bureau (CFPB), U.S. Department of Treasury, Office of Foreign Assets Control (OFAC), as well as numerous state administrative and enforcement agencies. The proposed federal Token Taxonomy Act also seeks to extend IRS tax jurisdiction to token gains — retrospectively to January 1, 2017.

We also observe concurrent growth in global regulatory efforts (e.g., ECB analysis of crypto assets) at different stages of drafting and implementation.

Full surveys of crypto regulatory schemes must therefore include multiple sub-national and transnational efforts. To limit scope, however, the analysis below focuses on U.S. regulatory postures as representative of current and expected global trends.

3.2 Crypto Law & Policy

The formal sources of authority listed above are highly instructive. They become even more useful when juxtaposed against the aligned and competing policy aims that these laws and regulations actually effectuate.

This is a big reason we should adopt both legal realist as well as policy-oriented jurisprudence approaches to regulatory design. In the blockchain context, policy-oriented jurisprudence offers distinct advantages over more rigid positivistic logics because of its explicit acknowledgement that legal frameworks are often key drivers of social change, and vice versa.

4. Current Frameworks

4.1 Doctrinal Frameworks

Today’s dominant crypto classification framework is embodied in the Howey test.

Applied to crypto/blockchain instruments, Howey asks if a given crypto scheme is a so-called (1) security token versus a (2) utility token based on a list of factors. The basic standard in this binary test is to what extent an ICO or other token scheme holds itself out as an investment contract.

If the buyers of a given token reasonably understand it as a type of investment vehicle or, say, a distributed ownership instrument with the promise of residual returns, then it likely resembles a security, and should be regulated as such.

On the utility side of this binary spectrum are projects like Ethereum. Because the main purpose and function of Ether/ETH is to serve as the native currency and/or “gas” on the decentralized Ethereum network, the token serves a core operational function on the network as opposed to paying out returns like dividends or the like.

In the Ethereum case study, the utility argument usually proceeds as follows: (1) because ETH directly facilitates operation of the network, (2) Ethereum’s core value proposition is not some specified return on an investment, but rather (3) the ongoing secure operation of a large-scale global decentralized computing network. For historical reasons, ETH just happens to be a publicly-traded crypto instrument, but it was not sold under promise of future gain.

4.2 Enforcement Frameworks

The SEC’s Howey test has been applied by SEC officials through direct action and also indirectly.

For instance, in a public speech at the Yahoo Finance All Markets Summit on June 14, 2018, the SEC’s Corporation Finance Director William Hinman outlined a regulatory framework for digital tokens based on the level of decentralization of the token network. Applying this expanded standard, Hinman concluded that, for a network like Ethereum, “current offers and sales of Ether are not securities transactions.”

Though not formally binding, the guidance of a senior SEC official is highly persuasive on U.S. courts pursuant to settled canons of legislative and regulatory construction (see, e.g., Chevron doctrine). Because of its general pro-crypto effect, the Blockchain Association, a U.S. lobbying group, even went so far as to formalize the contours of an emerging “Hinman test” and to lobby for greater adoption.

Yet lest one infer a laissez-faire trajectory to these regulatory currents, the SEC has also assumed a vigorous enforcement posture. For example, the SEC recently announced a settlement that serves as precedent for holding individuals liable for, inter alia, operating unregistered decentralized crypto exchanges.

4.3 Legislative Frameworks

Crypto regulation is not just a matter of applying existing laws and regulations to specific blockchain instruments and/or broader crypto economic contexts (regulation of exchanges, potential regulation of wallet providers, taxation, capital control regimes, etc.).

In the U.S., both federal and state legislators are also asserting jurisdictional reach over the growing blockchain sector.

Prominent examples in the U.S. include Wyoming’s pro-crypto law, and related state-by-state efforts. At the federal level, Congress is currently considering the Token Taxonomy Act, and there are even calls by some legislators to ban cryptocurrencies altogether (e.g., Rep. Brad Sherman). Many related legislative efforts are currently undergoing reconciliation and harmonization.

Substantively, the key point of every intervention like this is to define the subject of the intended legislative reach. After defining and classifying a given crypto instrument, legislators can then charge enforcement authorities to carry out a given legislative scheme. This is a main reason why blockchain classification/taxonomies are now central battlefields in age-old global regulatory contests.

4.4 Theoretical Frameworks

There are several competing theoretical frameworks for token classification, which can be called: (1) propertarian; (2) contractarian; (2) institutional; (3) functional.