On July 25, 2019, staff of the Securities and Exchange Commission (“SEC”) granted its second no-action letter in the digital asset space to Pocketful of Quarters, Inc. (“POQ”), permitting POQ to sell digital tokens (“Quarters”) recorded on the Ethereum blockchain without satisfying registration requirements under the Securities Act of 1933 and the Securities Exchange Act of 1934 (the “Acts”). Like the SEC’s prior no-action letter to TurnKey Jet, Inc. (“TKJ”), which permitted TKJ to sell digital tokens pegged to $1.00 for the limited purpose of purchasing air charter services, Quarters will also be sold at a fixed price and limited to a purely consumptive purpose within the Quarters platform.
Due to these similarities, the POQ letter does little to clarify the SEC staff’s most recent guidance, released with the TKJ letter on April 3, 2019, that lists characteristics of a digital token that may affect its classification as a “security” under the Acts (the “Framework”). The POQ letter merely reemphasizes that projects where the platform is already fully developed and the digital asset is subject to extensive restrictions on secondary trading, like TKJ, are more likely to fall outside the scope of federal securities laws.
The SEC has generally analyzed whether digital tokens are “securities” subject to the registration requirements of the Acts under the Howey test, where an instrument is an investment contract, and thus a security, if it evidences (1) an investment; (2) in a common enterprise; (3) with a reasonable expectation of profits from the entrepreneurial or managerial efforts of others.
Howey is a facts and circumstances test, and the Framework provides further guidance on how certain characteristics of digital token may affect the Howey analysis. Despite noting considerations which may warrant against classification as an investment contract under Howey (which include maintaining a stable value, use for a purely consumptive purpose and restrictions on secondary trading), the Framework was criticized for not providing more guidance on which considerations were more or less significant to the overall analysis.
POQ No-Action Letter
Quarters is designed to be a universal currency for use in online video games. Currently, many online video games have native in-game currencies that players (“Gamers”) can use to make in-game purchases. These in-game currencies are purchased from the game’s developers (“Developers”) or earned within the game, but cannot be exported to other online games.
The Quarters platform permits Gamers to register and create a Quarters-specific digital wallet (a “Quarters Wallet”) with POQ and purchase Quarters at a fixed price from POQ or other distributors (e.g., the Apple Store and Google Play Store). Gamers may also receive free or discounted Quarters by redeeming promotional codes provided by POQ, Developers of participating online games (“Participating Games”) and certain video game marketers tapped by POQ to promote Quarters (“Influencers”). Gamers can only use promotional codes to obtain Quarters directly from POQ.
Gamers can then use Quarters for in-game purchases in Participating Games or to pay to participate in e-sports events hosted by POQ, Developers of Participating Games or Influencers.
Developers of Participating Games and Influencers who have received Quarters through in-game purchases or entry fees for e-sports events can then redeem received Quarters for Ether, Ethereum’s native virtual currency (“ETH”), after going through AML/KYC checks and being onboarded to the Quarters platform. Developers may also re-distribute Quarters to Gamers as in-game rewards.
In providing no-action relief, the SEC focused on the following key factors of the Quarters platform.
- The Quarters platform is already developed and fully functioning. No funds from the sale of Quarters will be used to build the Quarters platform.
- Quarters will be immediately useable for their intended purpose when sold.
- In order to receive and redeem Quarters, Developers and Influencers are subject to KYC/AML checks at account creation, as well as on an ongoing basis (these Developers and Influencers, “Approved Accounts”).
- Quarters are subject to extensive transfer restrictions and cannot be transferred outside the Quarters platform.
- Gamers will only be able to transfer Quarters to Developers with Approved Accounts or to POQ for participation in e-sports events.
- Only Approved Accounts can exchange Quarters for ETH, which will be done at pre-determined exchange rates by a Quarters smart contract.
- Quarters’ purchase price is fixed (initially at $0.0025) and there is no cap on its creation. Gamers can always purchase new Quarters.
- The price of Quarters will be correlated with the market price of interacting with Participating Games because Developers will independently set Quarters’ purchasing power in their games. Accordingly, a change in the price of Quarters should have no economic impact as Developers will merely adjust Quarters’ purchasing power in their games.
- Quarters will be marketed and sold to Gamers solely for the consumptive use of interacting with Participating Games.
Similar to the TKJ token, Quarters is subject to significant transfer restrictions, sells at a fixed price, will be usable on a fully developed platform at launch and serves a purely consumptive purpose within the token’s platform. However, unlike the TKJ token, which was isolated on its own private blockchain, Quarters is an ERC-20 token redeemable by Approved Accounts for ETH, one of the top five most traded cryptocurrencies.
Nonetheless, the similarities between Quarters and the TKJ token mean the POQ letter does little to clarify further how considerations set forth in the Framework should be weighed. Rather, it generally indicates that the SEC is continuing to pick relatively “easy” cases for no-action relief. The POQ letter also reemphasizes that projects where the platform is already fully developed and the digital asset is subject to extensive restrictions on secondary trading are more likely to fall outside the scope of federal securities laws.
One characteristic of Quarters that bears consideration, however, is that POQ previously issued another digital token, Q2 Token, which it treated as a security, to raise funds for developing the Quarters platform. Q2 Token holders are entitled to a portion of the revenues from the sale of Quarters. Although the staff did not address the point, presumably temporal and functional separation between the offer and sale of Quarters and Q2 Tokens was relevant to their analysis.
Subject to addressing this issue, the POQ letter may illustrate SEC staff comfort with a pathway involving use of a security token to fund development of a utility token platform even where utility token sales are used to finance returns to security token investors.
 For a more detailed overview of the Framework and the SEC’s no-action relief for TKJ, see SEC Expands on Its Digital Asset Guidance: At Inception, (Nearly) Every New Token Is a Security.