Why 'Pass-Through' Economics Attract SEC Enforcement

The SEC applies a four-prong test: investment of money, in a common enterprise, with an expectation of profit, derived from the efforts of others. Pass-through models fail spectacularly on the last two points.\n- Direct Profit Link: Token value is explicitly tied to protocol fees or revenue, creating a clear profit expectation.\n- Managerial Efforts: Investors rely on the ongoing development and marketing work of the core team for returns.

Despite its decentralized operation, Uniswap Labs' proposal to funnel protocol fees to UNI stakers triggered immediate SEC scrutiny. This is the canonical case study.\n- Regulatory Tripwire: The mere proposal to enable fee-sharing was treated as a clarifying admission of the token's security-like attributes.\n- Chilling Effect: This action has frozen similar proposals across DeFi (e.g., SushiSwap, Curve), demonstrating the SEC's focus on economic reality over technical decentralization.

Not all utility tokens are equal. The SEC distinguishes between pure pass-through and functional 'work' models, where the token is a required input for a service.\n- Work Token Defense: Tokens like Ethereum's ETH (for gas) or Filecoin's FIL (for storage) are consumed as a utility to access a network resource.\n- Key Differentiator: Value accrual is indirect and secondary to the token's core utility function, creating a more defensible legal position against the Howey Test.

The 2023 ruling that XRP is not a security in secondary market sales offers little protection for pass-through models. The SEC's victory on institutional sales sets the dangerous precedent.\n- Institutional Sales = Security: Direct sales to investors with promises of ecosystem growth and profit are squarely within the SEC's jurisdiction.\n- Programmatic Sales Loophole: This narrow exemption for blind bid/ask sales does not apply to tokens whose entire value proposition is a revenue share, as that expectation is public and inherent.

These cases prove the SEC will pursue enforcement even for pre-functional networks if the marketing and economics promise future profits. Intent is everything.\n- LBRY Credits: Court found the token was sold to fund development and create an ecosystem, satisfying Howey, despite having a planned utility.\n- Telegram GRAM: $1.7B raised was deemed an unregistered security because initial purchasers expected to profit from Telegram's future work in launching the TON network.

Forward-thinking protocols are using non-transferable points and vested airdrops to align users without creating a security. This is the current regulatory escape hatch.\n- Points are Not Securities: As non-transferable, non-redeemable accounting entries, they lack the 'investment of money' prong of Howey.\n- Lock-Drops Mitigate Risk: Airdropping tokens with multi-year linear vesting (e.g., EigenLayer) decouples the distribution from any investment contract and emphasizes long-term alignment.

The SEC's 2021 case established that marketing a token's value based on future platform success and revenue sharing is a security. LBRY's documentation explicitly tied LBC value to the growth of a decentralized YouTube alternative, creating an expectation of profit from others' efforts.

• Key Flaw: Public statements framed token as an investment in the ecosystem.
• Outcome: $22M penalty and operational shutdown, setting a clear line for enforcement.

The SEC's 2023 action against the BarnBridge DAO targeted its SMART Yield bonds, which pooled assets and distributed profits. The violation was the direct pass-through of yields to token holders, framing participation as an investment contract.

• Key Flaw: Tokenomics designed to channel fees and interest directly to stakers.
• Outcome: DAO dissolved, $1.7M settlement, and a warning to all DeFi yield aggregators with similar models.

While not charged, Uniswap's Wells Notice highlights SEC scrutiny of retroactive airdrops to early users. The agency views these as profit distributions rewarding speculative investment in a common enterprise, especially when paired with protocol fee switch proposals.

• Key Flaw: Retroactive rewards create an investment narrative; fee switch debates signal profit expectation.
• Avoidance Tactic: Uniswap's pure utility token narrative and lack of explicit profit promise is its primary defense, a lesson for Aptos, Arbitrum, and Starknet.

Filecoin avoided SEC action by structuring FIL as a required collateral and payment mechanism for a functional storage market. No token value is marketed from protocol profit distributions; value accrues from utility demand within a verifiable physical ecosystem.

• Key Design: Token is consumptive, not investment-driven. Rewards are for service provision, not passive holding.
• Blueprint: A model for Helium, Arweave, and Livepeer—tokens must be operationally essential, not financialized pass-throughs.

Protocols that route user fees directly to tokenholders create an expectation of profit from the efforts of others. This is the core of the Howey Test. The SEC's case against Uniswap hinges on this fee distribution model, arguing the UNI token is an unregistered security.

• Key Risk: Token value becomes a direct proxy for protocol cash flow.
• Key Risk: Governance votes on fee switches are seen as managerial efforts.

Staking models that promise algorithmic yields from protocol revenue are functionally identical to dividend-paying stocks. The SEC's actions against Kraken and Coinbase targeted this exact structure. Native token staking with pass-through economics is a bright red line.

• Key Risk: Yield is derived from the business's operational success.
• Key Risk: Marketing emphasizes investment returns, not utility.

Architectures that burn fees or require token locking for utility decouple token value from profit rights. Ethereum's EIP-1559 fee burn is the canonical example—value accrual is deflationary, not dividend-based. Arbitrum's sequencer fee burn follows this safer precedent.

• Key Benefit: Token is a consumable resource, not an income share.
• Key Benefit: Value is driven by network usage scarcity, not cash flow rights.

Diverting fees to a decentralized treasury (e.g., DAO) controlled by tokenholders, rather than direct distribution, adds a critical legal buffer. This mimics corporate reinvestment. The key is that the treasury's use is discretionary for growth (R&D, grants), not guaranteed payouts. MakerDAO's Surplus Buffer operates on this principle.

• Key Benefit: Profit is used by the entity, not distributed to holders.
• Key Benefit: Creates a legal distinction between governance and equity.

Contrasting case study in staking design. Lido's stETH is a pure yield-bearing receipt token, making it a high-risk target. Rocket Pool's rETH is a value-accumulating token, where rewards are baked into the exchange rate via oracle updates—a subtler, potentially safer model. The SEC's focus is on the marketing and function of the derivative.

• Key Difference: Explicit yield (stETH) vs. implicit appreciation (rETH).
• Key Difference: Centralized operator set (Lido) vs. permissionless (Rocket Pool).

Compliance must be architected into the token's smart contract logic, not just off-chain promises. Use transfer restrictions for accredited investors, fee distribution timelocks voted by DAO, and clear utility gates for token use. Projects like Aave's GHO and Compound's Treasury are pioneering these on-chain legal primitives to pre-empt regulatory action.

• Key Benefit: Code-enforced compliance reduces regulatory surface area.
• Key Benefit: Creates auditable, immutable records of the economic structure.