You buy a token that lets you store files on a decentralized cloud network. Another token purchases compute time for an artificial intelligence program. A third grants access to a decentralized cellular network. None of these transactions look like investing in a company. They look like buying a service. Yet under current SEC enforcement practice, all of them risk being classified as securities.

In Function Over Form: Toward a Safe Harbor Framework for DeFi Regulation of Utility Tokens, published in the Louisiana Law Review, I argue that this classification is a doctrinal error with real economic consequences – and propose a concrete legislative fix.

The misclassification problem

The SEC derives its authority over most cryptocurrencies from the 1946 Howey test, which defines a “security” as an investment of money in a common enterprise with a reasonable expectation of profits derived from the efforts of others. The test was designed to focus on “economic reality,” not labels. But as I demonstrate, the SEC’s application has hardened into something closer to the opposite: a formalist approach where virtually any token sale gets swept into securities jurisdiction.

This is particularly problematic for what the industry calls “utility tokens” – tokens you buy to use specific products or features. Cloud storage for files. Compute time for AI. Access to decentralized cellular networks. In-game items. These are pay-for-use instruments, not investment contracts.

The distinction matters in ways that go beyond labels. Utility tokens make tiny, pay-as-you-go purchases possible and automatic in ways credit cards cannot. Cards charge a percentage plus a flat per-swipe fee, so very small payments get eaten by fees. Utility tokens let businesses meter usage in much less than pennies. The moment a token payment arrives, software can unlock a feature, open a file, or allocate network bandwidth – no manual billing, no invoices, no chargeback workflow.

The market is not trivial

These are not hypothetical use cases. Decentralized physical-infrastructure networks (DePIN) – providing access to radios, cellular, WiFi, sensors, storage, and compute – are worth roughly $30-50 billion in market value today. Blockchain-powered games relying on in-game utility tokens recorded about 7.4 million daily active users in 2024. McKinsey projects that tokenized digital-asset markets will be at least a two-trillion-dollar industry by 2030.

Meanwhile, the U.S. share of open-source crypto developers fell from roughly 38% in 2015 to about 19% in 2024 – a fifty percent relative decline during a period when global DeFi activity and market forecasts rose sharply. I connect these trends directly: the combination of the SEC’s aggressive posture with the doctrinal misfit of applying Howey to utility tokens contributes to U.S. innovation flight.

Why Howey fails here

Utility tokens often get caught in the Howey trap because of how decentralized networks launch. Many require an early “liquidity-bootstrapping” phase where users buy tokens before the service is fully live. This resembles a Kickstarter pre-purchase: prospective users fund development by prepaying for future access. The intended end is use, not profit.

The Supreme Court itself recognized this distinction decades ago. In United Housing Foundation v. Forman (1975), it held that what distinguishes a securities transaction is “an investment where one parts with his money in the hope of receiving profits from the efforts of others, and not where he purchases a commodity for personal consumption or living quarters for personal use.”

A token bought to store files is a commodity for personal consumption. But the SEC – and some courts – have treated many pre-launch sales as investment contracts anyway.

The function-based safe harbor

My proposal is specific: Congress should enact a narrowly tailored, function-based safe harbor for genuine utility tokens. Not a blanket exemption. A safe harbor with three conditions.

First, technical resilience. Eligible projects must demonstrate security through independent audits and maintain incident-response protocols. This is not about trusting developers; it is about verifiable infrastructure.

Second, accountable control. The framework requires defined upgrade authority and clear obligations for keyholders. Someone must be responsible for the protocol’s maintenance, and that responsibility must be transparent.

Third, calibrated oversight. Utility tokens would be subject to consumer-protection and operational requirements appropriate for access tokens – not the investor-protection regimes designed for capital raising. The distinction is critical: securities regulation protects people who invest money expecting returns. Consumer protection guards people who buy services expecting them to work.

A durable, uniform rule is needed to distinguish true utilities from investment contracts. Only Congress can enact such a rule. Agency guidance or case-by-case settlements cannot.

Function first, not form first

The deeper principle behind my proposal is a shift from form-based to function-based regulation. Instead of asking “Is this a token?” and defaulting to securities treatment, regulators should ask “What does this token do?” A token that grants access to cloud storage functions differently from a token that represents equity in a company. The regulatory framework should reflect that difference.

This is the first application of what I describe as a more general function-first framework for digital-asset regulation – one that could extend beyond utility tokens to governance tokens, collateral tokens, and other DeFi instruments, each regulated according to its actual economic function.

The cost of inaction

The status quo has a price. Every utility-token project that relocates overseas, every DeFi developer who chooses a jurisdiction with clearer rules, represents a loss of American innovation capacity in a rapidly growing global market. The safe harbor would not eliminate regulation – it would focus regulation where it belongs, on genuine investment instruments, while creating a predictable compliance path for pay-for-use services.

The $150 billion DeFi industry is projected to exceed $450 billion by 2032. The question is not whether this market will be regulated, but whether American law will regulate it intelligently or simply chase it offshore.

Read the full article: Seth C. Oranburg, Function Over Form: Toward a Safe Harbor Framework for DeFi Regulation of Utility Tokens, 86 Louisiana Law Review (2025).