The United States Securities and Exchange Commission (SEC) has been very cautious in its statements on ICOs and cryptocurrency as they attempt to strike a balance between embracing a technological revolution and avoiding the stifling of innovation. They aren’t seeking to dismember the cryptocurrency space, but rather provide guidance on how to operate and comply with existing regulatory requirements.
However, companies have been caught between wishing to hold an ICO open to U.S. investors for a utility token – or one that provides functionality on a platform without the guarantee of trading or an investment return, and not drawing the ire of the government.
There have been plenty of ways in which companies have erred on the side of caution, most notably with the Simple Agreements for Future Tokens.
The creation of the Simple Agreements for Future Tokens or SAFT by law firm Cooley was an unofficial way of navigating the regulatory landscape in order to have a secure way of selling an ICO to accredited investors and venture capital firms. A play on the SAFE agreement (Simple Agreement for Future Equity), the SAFT seeks to lessen the risk of the sale, as the tokens are deliverable upon the actual completion of the network or protocol. Pre-functional tokens are not issued at any time.
The point of the SAFT was to open up sales to accredited U.S. investors, while keeping a barrier to the general public. However, it was as Jerry Brito puts it in his article: a “Symptom of Regulatory Uncertainty.” It allows a tip-toeing of the legal landscape outlined by the SEC by betting on both the potential for a token to be a security or utility.
But the burning question remains: how does the SEC truly feel about ICOs and cryptocurrency? They’ve been recently more vocal about having companies register with them, but a binary has yet to surface.
To understand how the SEC feels about ICOs and cryptocurrencies requires a step back to the summer when the SEC released their first major statement – notably on The DAO.
The DAO – The SEC Goes Public on Cryptocurrency
Back in the summer of 2017, the SEC released their first public report on ICOs, namely on The DAO, which was one of the most high-profile token sales due to a vulnerability which left millions of dollars in Ethereum stolen, and gave birth to Ethereum Classic.
It was quite obvious that The DAO offered a form of unlicensed security – it was the equivalent of a decentralized venture capital fund that provided a form of return on an initial investment. This was a clear failure of the Howey Test, which has become the general litmus test of whether or not a token being offered in a sale is a utility token or security.
The importance of this report was the fact that it provided a bit of optimism in the community. The SEC could’ve simply shut down ICOs altogether after this clear violation. They instead chose to offer options to keep those who wish to hold ICOs on the side of compliance.
The investor bulletin released the same day on ICOs provided a background on both the process of token sales, and a large “if” statement regarding coins that could potentially be considered securities:
Depending on the facts and circumstances of each individual ICO, the virtual coins or tokens that are offered or sold may be securities. If they are securities, the offer and sale of these virtual coins or tokens in an ICO are subject to the federal securities laws.
This kept the door open to many entities looking to hold a compliant token sale by offering a form of utility token. The SEC understood the innovation happening in the blockchain space, and knew an outright ban would possibly stifle progress. At the same time, they needed to provide investors with a bit of information to protect them from the ever-present scam offerings.
Over the next few months, the SEC would begin building up their Cyber Unit to deal with ICOs soliciting U.S. investors and offering unlicensed securities. The first move came in August when an ICO by the name of Protostarr took down their website in order to comply and refund investors after raising 119.6 Ether. Shortly after this, the SEC came out with their first major press release targeting a scammer in New York looking to raise money by selling tokenized assets.
Blatant Violations and SEC Stings
In September, the SEC flexed its muscles and took down two blatant scams run by a businessman in New York City. Maksim Zaslavskiy and his organization raised money in two fraudulent ICOs: REcoin Group Foundation, and DRC World – both of which looked to tokenize assets and provide an ROI. The SEC then froze Zaslavskiy’s assets, and charged him with violations of the anti-fraud and registration provisions of the federal securities laws.
After that, the next large sting by the SEC came in December when they froze the assets of PlexCoin – a $15 million ICO that promised “13-fold profit in less than a month.” These low hanging fruits allowed the SEC to set a precedent and deter scammers from operating highly-illegal offerings. This sting also allowed the SEC to come forward and display the results of their newly established “Cyber Unit,” that has a hand in taking down fraudulent ICOs.
Following PlexCoin’s takedown was most likely the largest intervention by the SEC to date: Munchee Inc. Munchee is a California-based company that was seeking to raise $15 million in an ICO, offering a token used to buy and sell goods and services.
Where Munchee slipped up were its promotions of returns on the investment, as the efforts of the company would “lead to an increase in value of the tokens” – a clear failure of the Howey Test. The company has since returned investor proceeds and never issued tokens.
On the same day, SEC Chairman Jay Clayton released a statement on both cryptocurrency and initial coin offerings to help guide “Main Street Investors,” and “Market Professionals.” He urged retail investors to exercise caution when presented with an offering that might ‘sound too good to be true,’ considering the number of scams propagating in the space. To market professionals, Clayton acknowledged the power of ICOs as fundraising vehicles for innovative projects. His main driving-point was to urge professionals to read the previously issued reports and releases, and to comply with existing regulations to ensure that laws are being followed.
Again, cautious but optimistic.
Clayton and Giancarlo: Create Efficient Regulation
Earlier this week, both Clayton and J. Christopher Giancarlo (Chairman of the Commodity and Futures Trading Commission), penned an op-ed published in the Wall Street Journal as a public statement and warning to both regulators and investors on cryptocurrency. In the piece, both Clayton and Giancarlo continually reason with readers to let them know that they understand the impact of blockchain technology, but sternly underpin it with warnings to those looking to circumvent any guidance they’ve since provided.
Our task, as market regulators, is to set and enforce rules that foster innovation while promoting market integrity and confidence.
However, a portion of the article was dedicated to a conversation on changing existing frameworks in order to ease the process and provide proper guidance to all things cryptocurrency related. Although they must be stern, this piece reaffirmed their willingness to work with the community and keep domestic innovation alive. They understand how quickly the space is moving and would like to work with it rather than against it. At the same time, their goal is to protect investors from malicious characters raising funds, which is why the tone is understandable.
In a perfect world for the SEC, every domestic ICO registers through one of their various outlets including but not limited to Regulation A+, but the future might see a distinct split between those who continue to offer utility tokens in ICOs, and those who go the registered securities route.
Security Tokens on the Rise – the Future Cryptocurrency Landscape
With the SEC being a bit more active in providing guidance, SEC complaint token sales might be a regular occurrence in the near future. Even major players like Kodak have come out to stake a claim in the growing cryptocurrency space by offering a security token of their own.
With the rise of security tokens, tZERO, a subsidiary of Overstock, has launched their own security token ICO, with the hopes of eventually creating the first SEC regulated cryptocurrency alternative trading system (ATS). By providing a trading platform for security tokens in the future, tZERO will most likely open the floodgates for other companies seeking to raise capital in an ICO and provide an SEC-compliant security token sale.
However, even with security tokens, this shouldn’t be treated as the end of utility tokens. Rather, the future might hold concurrent markets for both security and utility tokens, each catering to a subset of investors. What should be interesting, is seeing both the companies that capitalize on the opportunity to hold compliant security token sales, and the restructuring of the total cryptocurrency market capitalization between utility and security tokens.
The SEC hasn’t put a damper on ICOs, but rather are looking to protect investors, offer legal ways in which companies can utilize an ICO as a fundraising method, and weed out scams in the space. It seems as if it’s going to be smooth sailing for a bit – but always remember to be prepared for a storm.
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