Governance tokens in decentralized finance, or DeFi, have immediately jumped into prominence following the success story of Compound’s COMP token,
Governance tokens in decentralized finance, or DeFi, have immediately jumped into prominence following the success story of Compound’s COMP token, whose value motion and liquidity mining program resulted in elevated public curiosity.
In contrast to earlier iterations of “utility tokens” in the course of the preliminary coin providing mania, DeFi governance tokens lend themselves to a extra fundamentals-based evaluation. DeFi tasks normally have a well-defined income at a protocol degree within the type of buying and selling charges or rates of interest.
As Michael Anderson, co-founder of Framework Ventures, advised Cointelegraph earlier in 2020, the DeFi funding thesis hinges on token economics that might “seize the worth” generated by the protocol. Spurred by the COMP distribution, Anderson spoke as soon as once more with Cointelegraph on quite a lot of matters, together with the authorized standing of DeFi tokens.
Shares analogies
In simplified phrases, conventional shares entitle their holders to a voting share within the company board of the corporate and a portion of the dividends it could distribute. By these mechanisms, stockholders have a formalized manner of influencing company improvement and immediately taking advantage of its success.
Whereas the governance facet of DeFi protocol tokens is self-explanatory, a number of the token economics approaches will be in comparison with dividends as properly. Maker (MKR) makes use of a “buyback and burn” mechanism to seize worth with the MKR governance token. Proceeds from the curiosity paid by debtors are used to purchase MKR tokens by way of an public sale, and are then burned.
The mechanism creates a sensible value development dynamic by stimulating MKR demand and lowering its whole provide. Whereas this strategy is nearer to the idea of inventory buybacks, it generates worth for holders in the same method to dividends.
Compound’s group has but to determine a particular worth seize mechanism, as Anderson famous. A Maker-like system is an possibility, in addition to a extra direct “dividend” distribution.
Given the clear analogies with firm shares, there’s an intervention threat from the Securities and Change Fee, which could deem these tokens as securities.
Decentralization appears to be key
The decentralization of the community seems to be a key distinction when evaluating if a token is a safety.
Answering a query on the matter, Anderson summarized:
“I agree there are some parts of [governance tokens] that look security-like, however does not essentially imply that they’re securities.”
Whereas he prefaced by saying that he’s “not a lawyer,” he recognized the mannequin of giving freely tokens by way of utilization as a manner of avoiding a securities classification:
“I feel the equal with the Google shares instance, it will be as if I used to be to get a share of Google each time I seek for one thing in Google.”
Moreover, he revealed that Compound’s CEO Robert Leshner and Jake Chervinsky, its common counsel, “have spent a whole lot of time fascinated by this.” In response to Anderson, Compound token launch playbook obtained some validation by way of its itemizing on Coinbase, which offers a constructive sign:
“Coinbase in all probability has the highest authorized group within the U.S. because it pertains to itemizing and securities regulation. In case you get listed on Coinbase, it principally means, ‘OK, we have finished our due diligence, we have possibly talked to the SEC’ — who is aware of, I don’t understand how the method works exactly — however you type of assume you are okay if Coinbase is okay with you.”
Philip Moustakis, counsel at Seward & Kissel and former SEC senior counsel, advised Cointelegraph {that a} securities classification “depends upon the information and circumstances of every token.” As he defined, voting rights by themselves don’t outline if a token is a safety, citing the instance of the SEC’s investigation into The DAO and its points with the decentralization of the system, somewhat than voting rights.
Summarizing, he included a set of “essential questions for DeFi tokens,” together with whether or not they signify a capital increase, if the community is really decentralized, capital features and losses implications for transacting with the tokens, how lots of the tokens have been supplied and the way a lot they resemble shares in a community.
The COMP token may fall beneath some, however not all standards for outlining a safety. Whereas the judgement stays on the regulator and the courts, Anderson’s conclusion goes outdoors of the standard field:
“Personally, I feel we will must provide you with a brand new time period. It isn’t securities, it’s not commodities. Possibly we simply name them tokens and so they have a special algorithm. […] Nothing matches cleanly into the pre-described packing containers.”