Are Airdrops the Next Target? New Research Flags Them as Securities Under US Law

• Blockchain projects use airdrops to attract users and reward early supporters.
• However, airdrops may be classified as securities if they involve a financial relationship.
• The SEC is increasingly scrutinizing airdrops, especially those that involve financial interdependence between the project and its users.

Airdrops, a popular marketing tactic in the crypto world, offer users free tokens in exchange for completing specific tasks.

As the U.S. Securities and Exchange Commission (SEC) scrutinizes the crypto industry, airdrops that involve financial obligations or expectations of profit may be classified as securities, subjecting them to stringent regulations.

Explaining Airdrops

An airdrop is a marketing strategy used by startup protocols to attract users by distributing tokens as rewards for their contributions. These tokens can often be traded for significant value depending on factors like the protocol’s popularity, venture capital funding, and the size of the airdrop.

Airdrops can be free or require users to invest time, effort, or capital. Unlike bank promotions that clearly announce rewards upfront, airdrops typically remain unannounced, incentivizing users to engage with the protocol in anticipation of future rewards.

Protocols often launch without tokens to build adoption and showcase their technology. Once established, they release tokens during a Token Generation Event (TGE) to reward early users. They often use governance tokens that empower users to influence the protocol’s direction.

The distribution of these tokens helps boost network activity and attract further investment. Thus, airdrops serve both as user acquisition tools and as a way to compensate early supporters for driving the protocol’s initial success.

Are Airdrops Securities?

According to University of Virginia researcher Peter Sie, “[…] airdrops can constitute investment contracts  if they satisfy the four elements of the Howey test, thereby rendering their issuance a security under its definition in Section 5 of the Securities Act of 1933 and subjecting protocols to SEC regulation.”

“Free airdrops are not securities, as there is no contract, scheme, or ‘investment of money’ by the users who receive the tokens,” he clarified.

However, when tokens are distributed in a manner involving mutual interdependence, where users’ efforts benefit the protocol, and there is an expectation of profit through the airdrop, the relationship forms an investment contract, making the tokens a security.

“The interactions between blockchain projects and users often create express or implied-in-fact contracts, depending on the type of transactions involved,” Sie added.

In liquidity-based protocols, it is typically possible to find an express contract due to their loyalty points programs. On the other hand, an implied-in-fact contract is common in transaction-based protocols because of the numerous transactions required of users.

These contracts may be interpreted as investment contracts, potentially classifying the project’s token issuance via an airdrop as a security. Although blockchain projects may argue that their airdrops are not investment contracts and thus not securities, this quid pro quo financial relationship suggests otherwise.

The SEC May Target Airdrops

Cryptocurrency airdrop farming has recently gained significant attention, drawing individuals to blockchain technology in hopes of financial gains. This interest has shifted blockchain projects from merely giving away tokens to a reciprocity model.

The SEC views most cryptocurrencies as securities, but it remains unclear if tokens distributed via airdrops fall under this classification. Many projects argue that airdrops aren’t securities since they’re free.

However, project-user interactions often reveal financial relationships that can form express or implied contracts. This may suggest that these airdrops may qualify as investment contracts under the Howey test.

Free airdrops without obligations, like in the “Beba v. SEC ” case, are typically outside SEC jurisdiction. However, when financial interdependence is clear, these airdrops likely fall under the SEC’s regulatory scope as securities.