What is a ‘Simple Agreement for Future Tokens’ (SAFT)?
A SAFT is an investment contract (security) offered by blockchain developers to accredited investors. The tokens that are ultimately delivered to the investors, though, should be fully-functional, and therefore not securities under U.S. law. The SAFT imitates the Y Combinator Simple Agreement for Future Equity, or “SAFE,” which has been widely used to finance early-stage companies for years.
What’s the problem?
The ICO model is an increasingly popular mechanism to raise startup funds from all over the world. Without clear regulations, token issuers and investors have operated under a cloud of legal uncertainty. Did these public sales result in unregistered securities? Why does that matter?
Issuing unregistered securities is a violation of Section 5 of the Securities Act of 1933. Beyond significant monetary penalties, issuers could face a maximum of five years of federal prison.
At a U.S. Senate hearing in February, Securities and Exchange Commission chairman Jay Clayton stated, “I believe every ICO I’ve seen is a security.” As technology continues to outpace regulations, the industry is in desperate need of a standard, compliant transactional framework to finance token networks.
The SAFT: A Potential Solution
The reasoning behind the SAFT framework is the fact that there is no bright line determining which types of tokens are securities and which are not.
Security tokens may serve as a substitute for traditional securities such as corporate stocks. On the other hand, utility tokens are designed to function like a Chuck-E-Cheese token, providing utility to purchase a service on its native network.
The SAFT framework initiates a way to help utility token issuers finance a distributed network without breaking financial regulations; specifically securities laws. Although utility tokens aren’t designed to be securities, they might end up being considered securities at the time of issuance by the U.S. Securities and Exchange Commission (SEC) when sold to the public.
How does a SAFT Work?
Developers of a token-based decentralized network enter a written agreement (SAFT) with accredited investors. The document calls for investors to fund the development of the network in exchange for discounted tokens at a future date. The company developing the network registers with the SEC and does not issue tokens.
The developers use investor funds to develop the network. Investors do not receive tokens at this point.
Once the network is functional, tokens are issued and delivered to investors. At this stage, tokens can be sold to the public directly or through exchanges.
At a high-level, you can think of a SAFT as a deferred ICO. Rather than issuing tokens for cash simultaneously, developers create a contract (SAFT) and raise money to develop a functional platform before creating tokens.
At this time, utility tokens are genuinely functional, supporting the argument that they are not actual securities. This argument is essential as no court, regulator, or taxing authority has yet interpreted the SAFT framework.
The framework can work within existing laws, one that doesn’t assume legislative change to accommodate the technology.
SAFTs can reduce risks for institutional investors, and public investors can still access tokens, albeit at a later date.
Potentially mitigates the mass exodus of crypto developers to foreign jurisdictions.
The SAFT framework is not very useful to non-utility tokens that are themselves securities when sold to the public
It won’t aid utility tokens where purchasers rely on efforts of the seller to increase the price after the token is already in circulation. Examples include buybacks and promises to develop functionality after the token sale.
The framework currently focuses on U.S. federal law and potentially deemed illegal in other jurisdictions.
Excludes public investors from participating in the early stages of a presale.
A Move in the Right Direction
The SAFT framework is an initial step towards an emerging standard for how blockchain network developers can responsibly innovate. It provides one approach to balancing the risk and reward among stakeholders and benefits from adhering to existing laws.
The SAFT project is a community attempt at self-regulation and has a long way to go before becoming an industry standard. That said, there is an open call for participation, and you are encouraged to join the project.