⚠️ Myth: If a DAO issues a token, it must be a security.

This comes up often in our discovery calls.

DAO creators worry that the tokens they mint will be considered securities, which will lead The Securities and Exchange Commission to fine them and block them from issuing securities in the future.

The reality is that your tokens don’t have to be securities. You can design a tokens that aren’t securities.

In SEC v. W.J. Howey Co, The US Supreme Court established four criteria for an investment contract. Known as “The Howey Test,” the criteria are:

1. An investment of money
2. In a common enterprise
3. With the expectation of profit
4. To be derived from the efforts of others

Based on that, a DAO’s token can avoid being called a security if it doesn’t entitle its holders to distributions.

If you’re setting up a token for your DAO and want it to stay clear of being considered a security, set your token’s policy not to entitle its holders to future distributions. Keep it strictly a governance token, which entitles its holders a voice in the governance of the DAO.

Like many misconceptions, this one is based in reality. On July 25, 2017, the SEC shocked the crypto world when it charged that tokens of the very first popular DAO, known as “The DAO,” were securities. But in section B of SEC’s report clearly says that The DAO’s tokens failed The Howey Test, because investors in The DAO invested money, with reasonable expectations of profits, from the managerial efforts of others. Avoid passing the Howey test and your token won’t be considered a security.

A related misconception is that if a token is traded on an exchange where its value can increase, it can be considered a security. But notice that the Howey Test doesn’t say that a sale on a secondary market leads to the creation of a security. For example, Beanie Babies can be sold on eBay for more than their original prices, but no one would mistake them for a security.