The Legal Strategy Behind Crypto Exchange Backpack’s Token-to-Equity Program

Not long after Backpack teased last Monday that its upcoming token would enable users to earn equity in the crypto exchange, people from across the industry began reaching out with the exact same question, according to co-founder and Chief Compliance Officer Can Sun.

Everyone wanted to know how the arrangement was structured in a way that wouldn’t turn the token into a security, he told Decrypt. And the answer involves a strategic separation between the digital asset’s capabilities and Backpack’s business, he said.

Although regulators in the U.S. have historically scrutinized tokens that offer a direct claim on a company’s success, Backpack is betting that a clever bit of legal engineering can keep the regulators at bay. Sun argued that the conversion property won’t actually be attached to the token itself. Rather, it’ll be attached to an upcoming VIP program, he said.

Becoming a VIP on Backpack will entail trading on the exchange and using the company’s other services, Sun said, in addition to locking the token up for a prolonged period of time.

“The token could be floating out there to anyone, but if you don’t use Backpack, if you don’t stake it for a year, then it has none of those rights,” Sun explained. “It’s not a property of the token itself, it’s the property of a VIP program that we’re running.”

Backpack is leaning into that approach amid discussions to raise $50 million at a pre-money valuation of $1 billion, as reported by Axios earlier this month. Meanwhile, Sun said Backpack has generated interest among SPACs—publicly traded companies set up for the purpose of acquiring private ones—and bankers that want to take the firm public.

“We have a lot of interest, but we want to find the right time to do it,” he added, noting that the supply of Backpack’s token is expected to unlock in relation to that timeline.

The company’s legal strategy may resemble an unprecedented move amid an increasingly supportive regulatory backdrop in the U.S., but Sun said the company has a backup plan that involves registering the tokens as securities during an anticipated public offering.

“The remedy for an unlicensed securities offering is registration,” he said. “We’re just going to register an additional class of securities on our IPO. That cures it in the worst-case scenario.”

Sun, who previously served as general counsel at collapsed crypto exchange FTX, wagered that the token-to-equity conversion program would’ve been allowed under former SEC Chair Gary Gensler, who notoriously pursued lawsuits against myriad crypto firms.

Sun pointed to a filing that Coinbase submitted to the SEC in 2020, which he worked on at law firm Fenwick. Before pivoting to a direct listing on the Nasdaq, the exchange attempted to register a “Class T common stock,” which would be tokenized, as part of a public offering.

SEC documents show that Coinbase was asked to provide legal analysis on how tokenized shares weren’t a completely different, and potentially more complex, type of investment than traditional stock. Ultimately, Coinbase dropped the idea, citing “further consideration.”