The SEC issues second no-action letter for a digital token, but will “utility” token offerings reach the next level?

By Stephen P. Wink, Cameron R. Kates, Shaun Musuka, and Deric Behar

Gamers, rejoice! In only its second no-action letter to date for digital tokens, the SEC cleared the way for Pocketful of Quarters, Inc. (PoQ) to issue “Quarters,” one of two digital tokens issued by PoQ on the Ethereum blockchain.[i] PoQ, which was co-founded by a 12-year-old entrepreneur and his father, sought guidance from the SEC as to whether its offering of the stablecoin would require registration under Section 5 of the Securities Act and Section 12(g) of the Exchange Act. PoQ explained that Quarters are intended to be a “universal gaming token” that buyers can use across games deployed on PoQ’s platform. The benefit to gamers, PoQ asserts, is more efficient usage of value across participating online games rather than “siloed video game economies [that] result in large unspent balances of in-game currencies.”

SEC’s Response Provides No-Action Relief and Stresses KYC/AML Compliance

The SEC’s Division of Corporation Finance issued an affirmative response to PoQ’s request, with a set of stipulations upon which the no-action position is contingent. In particular, the SEC set forth nine conditions to which PoQ must adhere in order for Quarters, as proposed, to maintain non-security status. For the most part, the stipulations mirror the same Howey requirements enumerated by the SEC in its no-action relief granted to TurnKey Jet, Inc. in April 2019 (discussed in this blog post). These stipulations include that Quarters will (i) be unlimited in supply and sold at a fixed price, with no prospect of appreciation; (ii) be immediately usable for the intended consumptive purpose on a fully functioning platform; and (iii) have restrictions on transfer and secondary market trading. One topic the PoQ no-action letter emphasizes that is absent from the TurnKey Jet no-action letter is the importance of anti-money laundering (AML) and know-your-customer (KYC) precautions. Because game developers and marketers will be paid in Quarters,[ii]which may be converted into Ether and then possibly into US dollars, the SEC wants to ensure that PoQ properly vets approved game developers and marketers in accordance with Bank Secrecy Act and AML regulations.

Reaction From the Cryptosphere Is Mixed

Many in the industry see no-action relief by the SEC for the issuance of any form of digital token as a major win, especially for digital tokens issued on the public Ethereum blockchain. Others quietly welcomed the no-action relief, but decried the issuance as an affirmation of the obvious — i.e., that a payment token need not register with the SEC as a security. While the SEC may be addressing what appears to be a softball fact pattern, the no-action relief is (hopefully) a promising sign that the agency is willing to engage with companies making good-faith efforts to bring innovative blockchain-based products and services to the marketplace.

[i] PoQ also developed the “Q2 Token,” which was sold in a Regulation D offering to finance the development of PoQ’s platform. PoQ readily acknowledges that Q2 Tokens are securities, and they are not the subject of the SEC’s no-action relief.
[ii] Going forward, holders of Q2 Tokens will receive a pro rata share of 15% of the Ether generated from sales of Quarters to gamers, a process that will be automated through the operation of two smart contracts. The other 85% of Ether will remain held in a smart contract and will be available for future distributions to approved developers and marketers in exchange for Quarters.