Token Sales and Exchange Listings: The Rundown
When an Initial Coin Offering (ICO) is listed on an exchange, it gives the public an opportunity to purchase that ICO in what results in a token sale. Tokens are purchased by investors who are interested in the company behind the ICO and with that token purchase, the investor can use it as they please whether that be for trading, a form of currency to purchase goods or services, or to show stake in the company. When a token is listed on an exchange, it is important to note if that token is considered a security or a utility. If the token is considered an STO, then it will be regulated and compliant with existing laws established by the Securities and Exchange Commission (SEC) around securities.
Crypto Tokens
Created on its own blockchain, tokens are built and used as crowdfunding for an ICO in a distribution, transaction, and circulation capacity, but they can also be used for investment purposes as a crypto asset/unit of value. Before you purchase a token, it’s important to understand the differences between tokens, as there can be legal regulations and implications to what kind of token you invest, sell, purchase, and complete transactions with.
Utility Token
A utility token has a specific function or are used for very specific services usually on the same platform it was developed on. For example, if you were to purchase a Podcast Token then you can use that token to pay for podcasts but nothing else. If you wanted to use your Podcast Token to pay for something else that is not a podcast, then you would need to exchange the Podcast Token for a crypto coin or fiat money. Utility tokens are the most common type of token sold by an ICO. Utility tokens can be vulnerable and susceptible to fraudsters as they are not regulated.
Security Token
Security tokens, also known as equity tokens, are tokens purchased that act like stocks or shares within the company behind the ICO. At its core, a security token is an investment contract representing legal ownership of a digital asset and has been verified within the blockchain. A token must pass the Howey Test in order to be considered a security token. The Howey Test consists of four criteria: (1) the investment of money (2) in a common enterprise (3) with reasonable expectation of profits (4) derived from the effort of others. Should the token pass the test then it is considered a security token and is subject to SEC regulations.
Reward Tokens
Reward tokens are exactly as they sound. Reward tokens are given as a reward for services provided but do not necessarily have any value.
Asset Tokens
Asset tokens represent the trading of physical assets (e.g., gold, real estate) on digital platforms.
Currency Tokens
Currency tokens act as actual currency. Bitcoin is the most popular currency token, and it can be used to purchase and sell services and goods between online and offline merchants. Currency tokens can also be used in a trade for fiat money and other types of cryptocurrencies.
Listing Your Token on an Exchange
There is no standardization or formula when it comes to listing your token on an exchange. It is best to consider the multiple, general factors involved when listing a token on a crypto exchange. Factors to consider are:
Listing a token on an exchange takes a lot of work and can be very expensive. With the right agent, crypto advisor, or company that can assist in the listing, you can find the right exchanges that work for your token.
- Which exchanges are appropriate and will get the most traction for your token
- Which exchanges do you want to steer clear of or could be scams
- What is the exchange listing price and does it fit within your budget
- What price are you willing to negotiate to in order to list your token
- What is the strategy after the token is listed to maintain the token (e.g., marketing, advertising, engaging with community members, PR, etc.)
Types of Crypto Exchanges
When researching where to list your token on a crypto exchange network, there are two different types of crypto exchanges: decentralized exchanges (DEX) and centralized exchanges (CEX). It is important to do your research on what type of exchange and which exchange you want to list your token on while keeping in mind that the higher the trading volume is on the exchange, the more likely it is that your token will be accepted and listed.
Decentralized Exchange
Decentralized exchanges operate without regulation from a governing body. They are autonomous, transactions are anonymous, and they eliminate the middleman and function within a peer-to-peer (P2P) or buyer and seller trading platform that operates on a blockchain. When transfers are made involving bank transfers, miners validate the information, and your information is no longer anonymous. DEXs require fees. Some disadvantages to DEXs are that they are crypto-to-crypto exchanges so there is a lower trade volume and smaller liquidity, which can mean it takes longer to find a buyer/sell or to exchange cryptocurrency to fiat money, and that is not profitable to investors.
Well known DEXs are:
- AirSwap
- Bisq
- BlackHalo
- Block DX – Blocknet
- Coinffeine
- CryptoBridge
- EtherDelta
- Fork Delta
- IDEX
- Kyber
- Omega On – Omega Dark
- OpenLedger
- Radar Relay
- Wavesplatform
Centralized Exchanges
Centralized exchanges operate on user-friendly platforms allowing almost anyone with money to invest to experiment in crypto investments. CEXs can be crypto-to-fiat, fiat-to-crypto, and crypto-to-crypto exchanges. Unlike DEXs, CEXs will allow you to purchase cryptocurrency with your fiat money via bank transfer and even on credit. Additionally, CEXs have higher trade volume and liquidity, which means you can convert your crypto to fiat money quickly.
Well known CEXs are:
- Binance
- Bitifinex
- Bitstamp
- Bittrex
- CEX.IO
- Coinbase
- Coincheck
- Coinmama
- Gemini
- Huobi
- Kraken
- OKEx
- Poloniex
- Robinhood
You can find a full listing of crypto exchanges and fraudulent exchanges on the Cointelligence website.
Exchange Compliance
As cryptocurrency gains in popularity, so do the opportunities for money laundering and covertly funding terrorism. In the past few years there have been billions of dollars laundered through cryptocurrency exchanges and cross-border funding of terrorist organizations. In order to prevent money laundering and implement strong fraud prevention configurations, some exchanges are implementing cyber security measures listed below.
Know Your Customer (KYC)
This is the process a business can take in identifying and verifying a new customer when onboarding them to a new account. The main objectives of KYC are identifying the customer, verifying what is provided is not a false identity, understand the intentions of the customer’s financial activities, and monitor customer transactions to manage risk. Crypto exchanges that classify as fiat-to-crypto transactions have begun to adopt KYC as they work with traditional currency and conduct business with traditional financial institutions like banks, which are already subject to KYC standards and will generally only do business with entities that follow KYC procedures.
Well known fiat-to-crypto exchanges that have adopted KYC are Bitfinex, Bitstamp, Bittrex, Coinbase, Gemini, Kraken, and OKEx. On the other hand, exchanges that are primarily crypto-to-crypto are slower to adopt KYC as they do not necessarily have to conduct business using fiat currency or work with traditional financial institutions. Popular crypto-to-crypto exchanges that have some KYC depending on the volume of crypto exchanged are Bibox, Huobi, and OKEx.
Anti-Money Laundering (AML)
Anti-Money Laundering are the laws and controls in place that are intended to prevent criminals from disguising illegally acquired money as legitimate income. Under AML, financial businesses are required to monitor customer transactions and report any suspicious activity. Suspicious activity can include trade in illegal goods, tax evasion, market manipulation, misappropriated funds, and other financial criminal doings.
Identity Verification or Electronic Identity Verification (eIDV)
Some exchanges have implemented identity verification features like providing a valid driver’s license as a layer of security.
Strong Customer Authentication (SCA)
Strong Customer Authentication is a requirement by the EU to conduct multi-factor authentication access to prevent fraud on financial transactions.
Certain government agencies have begun to place regulations on cryptocurrency exchanges. For example the Financial Crimes Enforcement Network (FinCen), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC) are now defining cryptocurrency exchanges as money service businesses (MSBs) that are subject to the Bank Secrecy Act (BSA). The BSA defined by the Office of the Comptroller of Currency (OCC) states, “The OCC prescribes regulations, conducts supervisory activities and, when necessary, takes enforcement actions to ensure that national banks have the necessary controls in place and provide the requisite notices to law enforcement to deter and detect money laundering, terrorist financing and other criminal acts and the misuse of our nation’s financial institutions.”
Under BSA guidelines certain exchanges are required to incorporate fraud prevention methods like AML protocols, maintain accurate recordkeeping on transactions, submit Suspicious Activity Reports (SAR) should suspicious activity be red flagged, as well as other necessary measures. If cryptocurrency exchanges that are required to follow the BSA willingly violate the BSA program, then those exchanges and the businesses and people who own and operate them can be subject to criminal fines and/or prison sentencing.
Why Do I Need Legal Guidance On Token Sales And Exchange Listings?
When your ICO is at the point that it is listed on an exchange, that token sale requires a number of legal documents that Montague Law can assist with such as token sale documents, terms and conditions of token sale, white paper legal review, and drafting articles of association. Additionally, in the event that your token sale is part of an exchange listing, we can advise on token and coin compliance with securities laws, decentralized finance (DeFi) launch and compliance, SEC No-Action relief and FinHub engagement, Initial Liquidity Offerings (ILO), and Security Token Offerings (STO).
Mini-Glossary
Here are some important terms to learn when it comes to token sales and exchange listings:
FinTech
FinTech is the abbreviation for the integration of finance and technology space.
FinHub
FinHub is the SEC’s Strategic Hub for Innovation and Financial Technology. FinHub facilitates the SEC’s engagement with innovators, developers, and entrepreneurs as well as acts as a resource for SEC information and viewpoints on FinTech.
Token
A token is built on an existing blockchain and holds a certain amount of value, but that value is not considered money or currency. Most tokens will be used with decentralized applications (dApp).
Coin
A coin is a store of value that is primarily used as a form of money/currency. Coins exist on their own blockchain. Examples of coins are Bitcoin and Dogecoin.
Exchange
A cryptocurrency exchange is the digital space in which both buying and selling operations of different digital currency is available.
Liquidity
The ability to buy or sell an asset without affecting the asset’s value. In the crypto world, you want high liquidity, meaning crypto coins can be converted into other crypto coins or fiat money easily and quickly.
DeFi
DeFi, also known as decentralized finance, performs financial transactions over a blockchain cutting out the middleman by bypassing traditional banks and financial institutions.
Initial Coin Offering (ICO)
Initial Coin Offering (ICO) is the way funds are raised for new blockchain based startup cryptocurrency offerings.
Initial Liquidity Offering (ILO)
Similar to ICOs, an Initial Liquidity Offering (ILO) is a new fundraising strategy for projects and startups through the sale tokens on a decentralized exchange.
Security Token Offering (STO)
A Security Token Offering (STO) is a unique token that is a regulated offering of securities (i.e., remain compliant with existing laws and rules around securities) using a blockchain. STOs are categorized as equity tokens, debt tokens and asset-backed tokens.
To find out how Montague Law can help you with your token sales and exchange listings, please call us at 904-234-5653 or contact us here.
The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Securities law is complex and highly fact specific to any given circumstance and readers should contact an attorney for advice regarding any type of legal matter.
