Ashley J. Beth
Senior Editor
Loyola University Chicago School of Law, JD 2022
While a new category of digital assets has become mainstream in Europe, regulatory concerns in the U.S. have largely kept American sports enthusiasts out of the market for now. These new digital assets are referred to as “fan tokens“, a blockchain-based technology that allows teams to enhance their fan engagement. Simply put, a fan purchases tokens generally in exchange for participation in non-managerial decisions for their team and other exclusive benefits. Despite the allure, they are highly volatile, laden with potential risks, and do not fit precisely into a regulatory status, posing concern for U.S. sports entities. Sports entities should proceed with immense caution while federal guidance catches up to the new technology.
What are fan tokens and where are the active markets?
In recent years, non-fungible tokens (“NFTs”) and cryptocurrency have become major players in the sports industry. Fan tokens are the most recent application of blockchain technology to hit the market. Fan tokens are digital utility tokens that can offer fans exclusive owner perks and the ability to vote on certain management decisions. The popularity of these assets came largely as a byproduct of the Covid-19 pandemic, which kept fans out of the stands, thereby eliminating a significant share of profits teams rely upon.
The first player and market leader of fan tokens is the issuing platform Socios, a Malta-based company. Sports franchises collaborate with the platform to launch a Fan Token Offering where a finite number of team fan tokens are put up for sale at a fixed price before hitting the marketplace. To purchase team or league tokens on Socios, buyers are required to convert their currency to the cryptocurrency, ChiliZ. All tokens are logged in a secure ledger on the Chiliz Ethereum blockchain, which exclusively supports fan tokens. Unlike NFTs which grant ownership rights by virtue of digital copyright that cannot be exchanged, these assets are fungible and exchangeable. Alexandre Dreyfus, a successful entrepreneur in sports and gaming, is the CEO and founder of Socios and ChiliZ.
After launching in 2019, Socios has partnered with over sixty elite professional European leagues and teams. The tokens have not been fully embraced by all fans. Some fans think teams are failing to advertise the risk, lack of regulation, and limited benefits. In December of 2021, the U.K.’s advertising watchdog, Advertising Standards Authority, published a ruling against football club Arsenal for what it described as irresponsible marketing of the tokens. Other regulators abroad have been closely monitoring fan token activity.
Emergence in the United States and the regulatory concerns
Socios is committing $50 million toward its goal of creating fan tokens for teams across the five major U.S. sports leagues. It has already secured deals with dozens of teams and leagues, including twenty-eight NBA teams, fourteen in the NHL, the UFC, and a NASCAR organization. Unlike in Europe, Socios’ U.S. deals have yet to include the release of any actual tokens. The deals are limited to fan engagement and marketing activation. The team’s cite regulatory concern for their limited deals.
U.S.-based sports entities intending to engage with fan tokens need to ensure they understand U.S. securities law before utilizing the full potential of fan tokens. Current regulations are not adequately designed to accommodate digital assets. Fan tokens do not fit precisely into a category of assets under the purview of the U.S. Securities and Exchange Commission (“SEC”). Since the distinguishing feature of tokens is that they are fully interchangeable, tokens can be easily exchanged for availing products or services of the enterprise backing them. Under SEC regulations, if the tokens are designed to provide an expectation of profit to the buyer based upon the marketing efforts of the seller, then they may be considered a “security”. Securities require certain disclosures, processes, and other investor protections.
Further, on average, the issuing team controls a majority of the tokens which does not give a true representation of the token price or how the market truly lies. This issue of control and the limited number of investors, makes tokens tremendously volatile. Additionally, the value depends greatly on the success of the team. For example, when world-renowned football player Lionel Messi joined a new club, the fan tokens of the club rose exponentially. One week later the hype disappeared and the price of the coin dropped by thirty-four percent. Moreover, there is a threat that tokens will be purchased with the intent to negatively impact teams.
A similar model to watch: Fan Controlled Football League
A similar concept has been attempted, scrapped, and is now active. In 2017, the Fan Controlled Football League (“FCF”) was created to allow American football fans to purchase crypto tokens in exchange for the ability to vote on rules, call plays, and make other management decisions. Around the same time, the SEC began targeting similar Initial Coin Offerings, describing them as unregistered securities offerings. This prompted the league to cancel its efforts after raising over $5 million.
In 2021, the league rebooted and took a new approach that allows fans to purchase NFT’s which provide holders with rights to make game management decisions. The league appears to be exploring other benefits for its rights holders, but NFTs are the exclusive blockchain mechanism for now. As of April 2022, no regulatory bodies have targeted the NFT business model. While the U.S. major leagues are less risk averse in blockchain technology, the FCF can afford to test this similar crypto-backed concept considering the business model is built on innovation and risk.
Conclusion
The technology is already in the U.S. market and deals are in place with platforms capable of hosting fan tokens. As the major professional sports entities are exploring innovative revenue streams, it is likely the tokens will enter those leagues soon. Sports enthusiasts who wish to become active investors will be playing a new game in the crypto-space laden with high risk and questionable reward. Teams and leagues collaborating with fan token platforms must conduct due diligence to ensure they are following all regulatory guidance and future changes. Legislation is likely to be reactive rather than proactive in this space.