Back in October 2017, Protocol Labs and Cooley LLP designed a compliant framework that was to facilitate fundraising in the cryptocurrency space – it was termed ‘Simple Agreement for Future Tokens’, or SAFT.
At that time, Initial Coin Offerings (‘ICOs’) made a huge impact on the industry, with startups managing to raise millions of funds in days, and sometimes mere hours. In addition, regulatory worries began rearing their heads when investors started being allocated so-called ‘placeholder’ tokens that would represent their rights to the future fully-functional tokens. Such placeholder tokens were invariably issued as an ERC-20 token on top of the Ethereum network, and they were freely traded on secondary markets. Therefore, such placeholder tokens, deprived of any utility until the moment of the network launch, constituted securities according to the Howey test. Naturally, it did not take the SEC too long to react and embark on a broader digital enforcement push, issuing hundreds of subpoenas to digital asset market participants.
In order to provide some clarity and mitigate regulatory risks for all parties involved, the SAFT framework was developed. It aims to navigate the federal securities and money-transmitter laws, provide greater flexibility for tax management purposes, and apply investor and consumer protections.
What are SAFTs?
The idea for the SAFT is derived from the ‘Simple Agreement for Future Equity’, or SAFE. The SAFE has been widely used for financing purposes among early-stage companies, and acts as an investment instrument alternative to convertible debt. Although SAFE templates can differ, the overall goal was to create a set of basic funding terms startups and investors can adhere to while deferring decisions about valuation, liquidation preferences and participation rights until later-stage rounds of financing.
Thus, SAFE holders are early investors in a future priced round. Upon their signature, they are obligated to provide funds to the company, whereas the transfer of equity is set for a later point in time, and is usually tied to an agreed upon liquidity event.
The SAFT works in a similar manner. Accredited investors receive the right, at a discounted price, to fully-functional utility tokens, which functionality would be implemented at some point in the future, while developers receive the necessary funds to deliver on their project roadmap. Thus, SAFTs constitute investment contracts, and therefore fall under the U.S. securities regulations and all their implications. However, it is important to note that although the SAFT itself is subject to securities regulation, the tokens that are distributed to investors once the related platform or product is completed need not be securities per se; or, to be more specific, the fully-functional tokens need not be securities per se, and in fact, they rarely are.
Usually, tokens are delivered upon network launch (i.e. the network on which the tokens may be used), which would satisfy the requirement for the abovementioned liquidity event. As such, as soon as the tokens are equipped with utility and are genuinely functional, the SAFT investors’ rights automatically convert into a right to delivery of the said tokens.
Limitations of the SAFT Framework
The SAFT is certainly not a one fits all solution. The framework has limitations, and its benefits for each individual case need to be assessed independently. One of the rather obvious examples is that of a security token, which can represent tokenized equity in a company or a limited partnership interest in a fund, among others, and thus would undeniably constitute a security. The SAFT is in no position to alleviate any of the regulatory requirements in such a case. Furthermore, it cannot be automatically assumed that every already-functional utility token is destined to fail the Howey test, and thus not be classified as a security.
Other limitations are the exclusion of retail investors since SAFTs can only be entered into by accredited investors, and they are applicable to the U.S. market only. The SAFT framework is built around the U.S. federal law and thus can violate standing regulations in other jurisdictions.