Even if you have nothing to do with the world of high finance and technology, you must’ve heard about Bitcoin, cryptocurrencies, and ICOs on the news more than once – media has been abuzz over them lately.
The reporters usually make just a cursory attempt to explain these concepts, so you are probably still wondering if an ICO is an animal, vegetable or mineral.
The answer is “none of the above.” Many compare ICOs, or initial coin offerings, to the initial public offering of securities, only for digital currencies called tokens, although this analogy is not always correct. Any company may decide to offer its tokens to the public as a means to engage backers for its project. Unlike IPOs, which are very tightly regulated in the US, there is virtually no regulation covering all ICOs as a class: each token issue is subject to the laws governing a particular type of token. If a token is a security it is subject to securities regulation; if it is a product, it is governed by laws regulating the production and sale of goods and services. In each case, a determination needs to be made which type of tokens is being issued. SEC recently stepped in and delivered a decision in the case of one of such ICOs which signals that the era of free-for-all may be coming to an end soon.
ICO technology is a powerful crowd-selling tool, and it has quickly become a sizeable market: Experts report that in 2015 the volume of raised funds hit $34 billion, and in 2016 just Top 8 ICO raised $240 million. This market is growing at lightning speed.
What are the hazards?
Some experts believe that the market is oversaturated and could collapse at any moment. The thirst for seemingly quick and easy funding attracts all sorts of actors – and some of them may be unsavory or just incompetent. Some are trying to sidestep the existing laws. Inexperienced market participants can’t always spot the bad eggs, and that’s why the Securities and Exchange Commission recently investigated one of such ICOs, that of an entity called “The DAO,” and made its pronouncement on the fate of some ICOs: DAO Tokens, A Digital Asset, Were Securities, And U.S. Securities Laws May Apply To Offers, Sales, And Trading Of Interests In Virtual Organizations.
SEC’s press release says: “The SEC’s Report of Investigation found that tokens offered and sold by a “virtual” organization known as “The DAO” were securities and therefore subject to the federal securities laws.” Last year, DAO raised over $100 million in a crowd-sale before it was hacked and a hacker managed to siphon tens of millions of dollars worth of digital currency, leading to the company’s collapse. The SEC launched its investigation in order to prevent other similar incidents.
Steven Peikin, Co-Director of the SEC’s Enforcement Division said, “As the evolution of technology continues to influence how businesses operate and raise capital, market participants must remain cognizant of the application of the federal securities laws.”
But the future is not really as dim as it seems.
How to do ICOs right
Despite SEC’s conclusion, we believe that it’s too early to declare the death of ICO technology. It is certainly possible that an ICO can be organized and carried out in a way that makes its legal position sound. In our view, a way to do it right is to offer token holders something useful and useable in return.
Let us look into it a little deeper. Most startup companies have brilliant ideas. But many of them are strapped for cash to pay for bringing their product to the market. Through an ICO, they can collect the required funds by crowd-selling their tokens, which would be backed up by the startups’ product or services. This way, their tokens will not be considered securities if examined under the so-called Howey Test.
Howey test is one of the most significant and commonly applied tests to determine whether tokens qualify as securities. It originates from the U.S. Supreme Court case SEC v. W.J. Howey Co dating back to 1946. Under the Howey test, an investment contract is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
Consequently, if the token fits into this definition, it will most likely be considered a security and cannot be legally issued without satisfying the legal requirements applicable to the sale of securities. This is done to protect the public from unsavory or incompetent actors.
Therefore, a startup ICO shouldn’t promise its supporters a pie in the sky if it can provide them with something much better – access to their innovative future product or service, even if it comes at some later date (postponed delivery comes with an important requirement, more on that later). To carry out this type of an ICO, a project must structure its token in a way that makes it a valid useable and useful product and not a veiled security. The product can come in many forms, such as a license to use software, membership in a cool private club, discount on services, credit to be used inside a system, etc. Essentially, this is a way for startups to sell their exciting ideas before they actually built the product. But there is a catch: Until the token holders can actually use the product, the project should not have access to the funds, which should be kept in escrow to maintain complete transparency and fairness to both sides and make sure the tokens will not qualify as securities. Those startups who have products which would be available for use immediately upon the end of token sale would be able to use all collected funds as soon as the tokens are distributed to the buyers; however, the use of escrow during the token sale is advisable.
So now that you understand the basic concept of an ICO and its legal regulation let’s look at what’s involved in actually carrying one out. Below are just several main components the project will need:
- White Paper – the key document describing, in minute detail, the business model, the token concept, the ICO conditions and the benefits to the token holders, and also stating any potential risks, restrictions, disclaimers, etc.;
- Landing page offering basic information on the prospective ICO;
- User agreements, including Terms of Use, Privacy policy, etc.;
- Book building platform;
- Smart contract which will drive the tokens;
- Marketing strategy;
- Skilled staff to handle all of these, and many more issues.
Although this list is not exhaustive (but tiring just to read!) it gives you some idea of the scope of work needed to complete the ICO.
Most startups do not have the know-how to conduct their own ICOs. So they turn to turnkey ICO services. This is a wise approach, but there are issues with it: (i) these services are extremely expensive; (ii) despite the high price tag, they are hard to find; and (iii) because of their shortage, the wait time is very long, sometimes taking months for an agency’s team to get around to working with you. And in some ways, it’s a Catch-22: startups tend to be idea-rich by cash-poor
But where there is a will there is a way. Many companies are working on creating a solution, and gradually products which can solve this problem are emerging. For instance, a new company ICOBox seems to have found a great state-of-the-art approach: According to ICOBox’s website https://icos.icobox.io/ , they automated certain parts of the ICO technology, so that product ICOs could be organized much easier, faster, and cheaper. Basically, they offer a flat-fee 3-piece ICO construction kit priced at 25-50 BTC depending on the selected service package (they offer technology, legal, and marketing solutions), so startups can organize and conduct their own product ICOs with the tools built by ICOBox experts. The tools are alleged to be ready-made and easy to deploy, and, according to ICOBox, the entire process can be done in just under two months. Also, according to ICOBox, this technology comes with no wait time and at a much more reasonable price than the average market rates.
We hope that we were able to answer some of your questions about ICOs, so next time you hear about them, you’ll know what people are actually taking about. In fact, now you may even be able to do your own!
