Once considered a popular alternative method to funding a cryptocurrency startup, Initial Coin Offerings (“ICO”) have recently faced the ire of the U.S. Securities and Exchange Commission (“SEC”). A joint investigation by Yahoo Finance and Decrypt revealed that the agency sent out a series of information-seeking subpoenas to cryptocurrency startups, inquiring into their failure to sell their token, distributed cryptocoins purchased with fiat or virtual currency, exclusively to accredited investors. The SEC’s objective is to exert enough pressure on these companies to settle, in which dozens have already conceded by paying fines and refunding investors.
In an ICO, according to senior Yahoo Finance reporter Daniel Roberts, “an internet startup sells you digital tokens it has created, for later use in their ecosystem. Investors typically buy the new token with existing cryptocurrencies like ether or bitcoin, or with US dollars. . . . [Unlike an IPO], [i]f you buy tokens in an ICO, you get no equity in the company. . . . They may hypothetically rise in value based on the success of the company, but they may not, even if the company is successful. And the company owes you no real commitment.” It is projected that in the past four years, more than $20 billion has been raised in ICOs. However, concerns over the legality of token sales have disrupted this initial boom.
The prevalent dispute is whether a company’s ICO tokens qualify as securities, and if so, do they register its offering with the SEC, or ensure that it’s qualified for an exemption? Any U.S. company offering a security must register its offering with the SEC. The purpose of the registration provisions, is to ensure that investors are sold investments that include all the proper disclosures and are subject to regulatory scrutiny for investors’ protection. To qualify for a security exemption, one may sell only to accredited investors, investors outside the U.S. or “any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.”
In July 2017, the SEC found tokens offered by one ICO which raised more than $150 million as securities and was, therefore, subject to federal securities law. In its associated press release, the agency cautions the cryptocurrency industry and its market participants that “the federal securities laws apply to those who offer and sell securities in the United States, regardless whether the issuing entity is a traditional company or a decentralized autonomous organization, regardless whether those securities are purchased using U.S. dollars or virtual currencies, and regardless whether they are distributed in certificated form or through distributed ledger technology.”
The SEC measures ICOs on a case-by-case basis. While many companies refer to their ICO offering as a “utility token” or “Simple Agreement for Future Tokens,” the SEC regards such labels as irrelevant. William Hinman, the SEC’s Director of Corporate Finance, clarifies that “calling the transaction an initial coin offering . . . or sale of a ‘token,’ will not take it out of the purview of the U.S. securities law.”
Some ICOs, however, are converting their utility token to a security token in order to avoid the SEC’s vast crackdown. For instance, Iconomi wrote that its token holders “will be able to exchange their ICN tokens for tokenized shares in a joint-stock company presented as eICN tokens.” The company maintains this will ultimately bring legal clarity for all stakeholders. Many crypto companies nonetheless still believe there is an overt lack of regulatory clarity and have hired D.C. lobbyists to push Congress on behalf of the industry.
Only time will tell whether the U.S. Government will be more receptive to the world of cryptocurrency, but as of right now users should proceed with utmost caution.
Nathaniel Reiff is a second-year law student at Wake Forest University School of Law. He holds a Bachelor of Arts in Business Administration and a Master of International Business from the University of Florida. Upon graduation, he intends to practice corporate and tax law.