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Lawsuit Filed Against Solana Alleging $SOL to Be an Unregistered Security:
What makes a common enterprise?
By: Nick Corso
On July 1, 2022, a class action lawsuit was filed alleging Solana Labs sold Sol tokens as an unregistered security in violation of the Securities Act. Securities laws - which are regulated and defined by the Securities Exchange Commission (SEC) - continue to draw the ire of the Web3 community at large due to the murky nature of their definitions and even more ambiguous nature of their applications in the digital space.
Howey & DeFi
The SEC uses the framework provided by the Howey test to determine if an asset is a security. In order to meet this classification, an asset must consist of an investment of money; in a common enterprise; with the reasonable expectation of profit; resulting from the efforts of others. It is difficult to refute that the Sol token, along with many other digital assets, is not an investment of money given that SOL tokens are sold on centralized exchanges for fiat currencies. The complaint also makes the case that Solana is a common enterprise, because Solana Labs not only promotes and issues Sol tokens, but also builds the Solana Network, and holds a large percentage of the Sol supply, resulting in the highly centralized nature of the network. The complaint further alleges SOL investors reasonably expected profit, resulting primarily from the efforts of Solana Labs.
What does it mean for Solana?
This complaint raises many questions regarding the decentralization of smart-contract protocols and what is legally considered a common enterprise. The cryptocurrencies that partake in ICOs could potentially be viewed as a common enterprise because all of the assets were sold from one entity. However, as a smart-contract protocol develops users, different applications, and grows more decentralized the underlying tokens may negate part of the Howey test because of its increased utility, and no longer only being held as an investment with the anticipation of profit. For example, users can purchase a token then proceed to buy an NFT or other tokens to participate in metaverses or play to earn gaming platforms.
The complaint seems to argue SOL is still tied to a common enterprise because of Solana’s centralization and supply distribution. Solana critics have expressed concerns about the centralized nature of the blockchain. The core node is developed only by the Solana Foundation, Sol supply is highly concentrated in the hands of Solana insiders, leading to a form of plutocracy, and Solana has a relatively low number of validators - roughly 1,600. Due to the inherent entrance barrier created by the significant investment costs required to run and maintain validator nodes, Solana created a subsidy program that awards operators that meet certain criteria, effectively allowing Solana Labs, to an extent, to choose their own node validators.
There may well be some merit to the complaint alleging contributors invested money into the Solana common enterprise when buying the SOL token, but what are the potential implications for smart-contract protocols that are more decentralized, and what are the prerequisites and determinative qualities which define a common enterprise? For example, Ethereum has substantially more validators that are not connected to or chosen by the founding company, and the developers have far less control over the assets.
With the success and security of a blockchain being connected to its validators, does a blockchain’s level of decentralization play a role in determining whether an investor is investing in a common enterprise, an important prong in determining if an asset is a security?