Is the Frankencoin a Security?

Determining whether a token qualifies as a security can have significant consequences. Securities are highly regulated, which makes their classification crucial. But what does Frankencoin qualify as?

The Three Types of Tokens

The Swiss Financial Market Supervisory Authority (FINMA) defines three different types of tokens: Payment tokens, utility tokens, and investment tokens. These different types of tokens come with different regulatory guidelines.

Payment tokens function as a medium of exchange, similar to regular currency, and are used to buy goods and services, or exchanged to other tokens. Examples include Bitcoin and Ethereum. The FINMA has a special subcategory here for stablecoins.

Utility tokens on the other hand provide access to a specific service. They are not meant to function as an investment or a currency but are only used within a specific platform. They are often used for governance.

Investment tokens are, as the name suggests, tokens that give the holder rights similar to traditional financial instruments, like bonds or stocks. These tokens are expected to increase in value and give the holder a financial claim.

The ZCHF

The Frankencoin is a stablecoin pegged to the Swiss franc. Users can mint new ZCHF by depositing collateral into the system.

Swiss law firm LEXR defines the ZCHF as a payment token. There are several reasons for that. First, LEXR states that the ZCHF clearly fits the description of a payment token. Second, the token does not align with the characteristics of any of the other categories. The ZCHF is no utility token as it does not provide or unlock any special service on any platform that isn’t otherwise accessible. It is neither an asset token as it does not have any function analogous to an equity or a bond. It neither gives any type of financial claim – the ZCHF are minted by a decentralized smart contract and are not issued by any authority, hence there is no legal claim.

The FPS

The Frankencoin Pool Share is a freely transferable ERC-20 token and gives its holder the right to veto new positions. The FPS holders profit from the performance and stability of the Frankencoin system.  

LEXR states that the most likely classification for the FPS is the utility token category. This is because the FPS is required in order to access the veto function. The FPS is not seen as a payment token as the FPS is not intended to be used as such. In addition, LEXR does not believe the FPS to be an asset token, as, just like the ZCHF, it does not provide any legal claim against an issuer.

Securities?

The security classification is particularly concerning for crypto projects due to its legal implications. This is because of the legal implications of this classification. However, neither the ZCHF nor the FPS are classified as securities according the LEXR. The ZCHF lacks all characteristics of a security put forth by the FINMA as there are not even expectations of future price increases. The value of the FPS can fluctuate, but LEXR believes that the speculative nature is not sufficient; the FPS is purchased with the intention of using it as a governance token, not an investment. Furthermore, one key distinction is the decentralized nature of the reserve pool. By depositing capital into the pool, there is no transfer of ownership to any authority. The capital is in the pool and can not be accessed.

In addition, neither the ZCHF nor the FPS were ever used to raise funds. This is another important factor to consider. The Frankencoin Association has never sold and will never sell ZCHF or FPS. Both tokens are issued by the smart contract, and not the Frankencoin Association.

Note: The opinions expressed in this article are the opinions of Swiss law firm LEXR, not the Frankencoin Association. The full memo summary can be found on the Frankencoin website at the bottom of the page, or by following this link.