Earlier this week Crypto Insider published a post with practical advice to Initial Coin Offering (ICO) planners, followed by a post covering recent statements by the US Securities and Exchange Commission (SEC), according to which ICOs should be subject to the requirements of the federal securities laws. Here I’m posting more thoughts on ICOs and token sales.
Besides the articles referenced in the previous two posts, read “How to do an Initial Coin Offering (ICO): A basic introduction for startup founders,” by Collin Thompson.
Promoting an ICO as an investment opportunity is “like painting a sign on your forehead that says: hey, please investigate me SEC,” warns Thompson. “From a purely utilitarian perspective; what is supposed to power your application, is more like a token at Chuckee Cheese, chips at a casino, or a donation for access to a product/experience on kickstarter.”
This is essentially the same advice given in our first post. In fact, Thompson recommends not calling your token sale “ICO.” But words are not enough: The SEC stated that its requirements apply “regardless of the terminology or technology used.”
Please note: Thompson warns US citizens and residents that “just because your company is listed offshore does not mean you are immune to the long reach of the SEC.”
So what can ICO planners in the US do? Here are some possible strategies.
In fact, Thompson’s advice to blockchain startups in the US, seeking to get funding via a token sale, is that “it is probably best that you make them [the SEC] your partner by complying with US regulation,” including AML, KYC, and securities/tax law.
A key point made by the SEC is that, if buyers purchase tokens “with the expectation of earning profits from the efforts of others,” the token sale will be considered as a securities sale and subject to all SEC regulations.
The advice in our first post: “tokens should not represent fractional ownership of a project, but access rights, use rights and payment means within the project’s ecosystem,” seems safe and compliant with the spirit of the SEC statements.
For example, the Basic Attention Token (BAT), whose crowdsale in June raised $35 million in less than 30 seconds, can be exchanged between publishers, advertisers, and users of the Brave browser’s publishing and advertising platform.
The Gnosis token ($12.5 million raised in ten minutes) is the internal currency of a decentralized platform for prediction markets, built on Ethereum. The RLC token ($12 million in three hours) is the native currency of the iExec distributed grid computing network. Tokens can also allow access to physical facilities like adult entertainment clubs.
Based on these and other examples, Coin Center emphasizes that some tokens “do not fit into the definition of securities, particularly tokens with an underlying utility rather than a mere speculative investment value.”
The tokens that, like the BAT, are meant to be used to do something useful instead of simply buying low and selling high, can be designed and promoted in such a way as to escape securities regulations. Of course, if the Brave platform becomes very popular, many people will buy BAT on the open market, which will push its value up. Same for Gnosis and RLC.
It could be argued that those who buy these tokens do so “with the expectation of earning profits from the efforts of others,”and therefore the SEC could decide to consider these tokens as securities, but it doesn’t seem that the SEC is willing to go that far. If the primary use of your token is to allow holders to use your platform to do something, you should be reasonably safe and still able to raise significant funds with your token sale, as in the examples above.
Another strategy: Move offshore and comply
If you can credibly establish your operations in a more friendly offshore (non-US) jurisdiction. perhaps you should consider doing so. The keyword is “credibly” (remember that bit about the SEC coming and getting you anyway). This is what, for example, online gambling businesses do.
The world is big, and there are different legal jurisdictions. Thompson mentions Switzerland, Liechtenstein, Singapore, and Mauritius as especially friendly to blockchain startups. We can add that other jurisdictions, such as Estonia, Dubai, and the Isle of Man, want to be blockchain-friendly as well.
These places do have strict regulations, but arguably more friendly to blockchain technology innovation and ICOs.
For the adventurous, China could be another option:
“[It’s] suggested to be tolerant of ICO and give some inclusive immunity in terms of listing approval, investor restrictions, publicity and promotion of the project,” said Yao Qian, Director of the People’s Bank of China (PBOC) Digital Currency Research Institute, concluding with a recommendation to “implement regulatory sandbox policy for ICO” aimed at creating safe innovation spaces that allow ICO projects to conduct testing activities without worrying about regulatory consequences.
Blockchain regulations are evolving fast, and there could be other options soon.
Yet another strategy: Don’t comply
Of course, there’s yet another possible strategy: just ignore the regulators. Do feel free to say that buying in your ICO is the investment opportunity of a lifetime, and your skillful management will multiply shareholders’ investments a thousandfold in a few years (which at times has been true).
Go to the most lawless jurisdiction that you can find, and pilot your ICO from there. Don’t bother with incorporating a company, because the unregulated blockchain is your friend. Accept anonymous investments, and be anonymous yourself.
Promote your project, show that you are brilliant and know your business, and write rock solid open source smart contracts to ensure your investors that they will have all the rights you are promising, including perhaps a share in your profits. Just remember that smart contracts don’t work yet for cash-based real-world operations.
I’m not recommending this third strategy. At the same time, it can be argued that the real innovation brought by ICOs is precisely their potential to permit investing in promising projects, with fractional ownership rights, to anyone, anywhere, not only to “accredited investors” in one country. Juts like online porn and gambling fueled internet innovation, perhaps pirate finance will fuel next-gen innovation.
I say let a thousand flowers bloom.
Picture from USDA/Flickr.