Similar to an Initial Public Offering (IPO), an Initial Coin Offering (ICO) (or token offering) is the way funds are raised for new blockchain based startup cryptocurrency offerings. Since cryptocurrency is decentralized, nearly anyone can launch an ICO given the use of the right technology. To create an ICO, you would create a white paper detailing how the coin would work, ask for funding in either crypto or fiat money from people, and in return send them the coin or token you’ve created. Should this initial coin you created gain high circulation, then the value of the coin will increase. As the creator of the coin, you have now created a new cryptocurrency that could rival other ICOs like Ethereum. When creating an ICO there are various legal documents that need to be reviewed and compliant.
How Are Initial Coin Offers Created?
Anyone can create an ICO with the right team and technology in place. Below are common steps taken to create an ICO.
1. Ideation
Once you have an idea for your startup and are ready to raise funds through an ICO, you need to ensure the investment is attractive in terms of the project you want to fund and the token for sale.
2. Write a White Paper
When you’re ready to dive into the ICO landscape, you’ll need to write a white paper that documents everything your potential investors will need to know about the project. The white paper will detail market analysis, business strategy, goals, technical architecture, information on the coin and how it will be distributed, legal issues, a description of your team, a project roadmap, an allocation of funds, privacy terms, FAQs, and much more.
3. Create a Token and Smart Contract
Next, you want to develop a token. You can do this by either creating your own blockchain or fork an existing blockchain in which to program your token on. You’ll also want to set up and finalize your smart contract. The smart contract that exists on the blockchain will make automated transactions of your token between buyers and sellers with encoded preset rules.
As you’re developing your token, you’ll need to budget that token. Identify the funds you’ll need to raise though your ICO (hard caps or uncapped with fixed rates), consider conducting an ICO pre-sale to drum up enthusiasm, and allocate a number of tokens to founding and developmental teams.
4. Legal
If you are not providing a security token for your ICO you need to show proof you are not scamming investors out of their money. You’ll need to seek legal guidance on the appropriate documents needed to ensure your ICO is within regional and international laws. (See below for a list of legal documents.)
5. Marketing
In order for your ICO to get noticed and invested in, you’ll have to do a lot of marketing. Marketing of your ICO should include a comprehensive website that contains the white paper, ICO details, product and project descriptions, links to company social media channels, product design, and roadmaps. In addition to the website, you’ll want to create company/ICO profiles on social media channels and actively engage on those social media channels, advertise on appropriate platforms, own an earn positive PR, engage and promote on crypto forums, expand reach through newsletters and email campaigns, and much more.
6. Launch
Once you have the technical infrastructure in place and legal requirements resolved, you will be ready to launch your ICO.
Initial Coin Offering Use Cases
Initial Coin Offerings ultimately use a crowdfunding based model in the crypto world that helps entrepreneurs and startup businesses raise capital for business development and growth. The investors who get in on the ground floor of a successful ICO will benefit in the long run. Examples of successful ICOs include:
- Banco – Bancor enables crypto investors to participate in an open-source financial marketplace. Bancor’s ICO generated over $150MM in digital currency.
- Ethereum – Ethereum powers the cryptocurrency ether (ETH) and decentralized applications. Ethereum’s ICO generated over $17MM in digital currency.
- Filecoin – Filecoin is a decentralized data storage network secured by blockchain technology. Users can access servers and share storages in exchange for Filecoins. Filecoin’s ICO generated over $250MM in digital currency.
- NEO – NEO utilizes decentralized commerce and smart contracts. NEO’s ICO generated for nearly $71MM in digital currency.
- Sirin Labs – Sirin Labs created a blockchain smartphone enabling secure crypto transactions. Sirin Labs’ ICO generated over $155MM in digital currency.
- Sorj – Sorj is cloud storage decentralized. Instead of storing files in on-prem data centers, Sorj encrypts files and stores data in a global cloud network. Sorj’s ICO generated $30MM in a week in digital currency.
What Are The Advantages To An Initial Coin Offering?
Initial Coin Offerings are high-risk and high reward. Below are the advantages to creating an ICO and making a high-risk investment in ICOs.
Equity
Startup ICOs have a lot to profit from should their digital currency gain high circulation. When an investor buys into an ICO they are do not gain shares in the company. This means that the entrepreneur selling their ICO does not forfeit ownership and keeps all the equity within their company
Efficiency
Once an ICO is available, it can immediately be sold on the crypto market. Globally, anyone with the appropriate digital currency (e.g., Bitcoin or Ethereum) can purchase the new ICO instantly. In comparison, should an investor buy into an IPO via wire transfers then the middleman to the investment—the bank or financial institution—could freeze the assets.
Decentralization
Since an ICO is built on a blockchain by its very nature it is visible to all investors. Investors have the opportunity to view the day-to-day progress of the ICO and identify any fraudulent activity involved with the investment.
High Liquidity
Since cryptocurrency is not made of a tangible material to be exchanged the buying and selling of crypto coins can be very fast and still retain most its market value.
What Are The Disadvantages To An Initial Coin Offering?
Whether you are newly investing in ICOs or a seasoned investor, it is important to understand the disadvantages to ICO investments.
Fraud
Initial Coin Offerings have become methods for fraud due to little regulation or securities law. Investors can identify fraudulent behavior by doing their research, reading the ICO’s white paper, and asking for full transparency from the company running the ICO. If the white paper doesn’t mention securities regulations or guarantees return on investment, then it is most likely a scam. Unfortunately, when scams and fraudulent behavior do occur within the crypto space, there are few options to regain funds or hold fraudsters accountable.
SEC Violations
When creating or investing in an ICO, it is important to do your research on whether the ICO needs to comply with securities laws, or whether or not it may qualify under an exemption. Unregistered offerings can result in paying penalties for distribution, disabling tokens, and can cause financial harm to investors.
If your ICO is a security offering, then it may need to register with the SEC as well as develop some other documentation. To stay compliant with the SEC, legal requirements may include:
- Register with the SEC
- Create Know Your Customer (KYC) Policy and Procedures documentation
- Create Anti-Money Laundering (AML) Policy and Procedures documentation
To be clear, if you’re selling tokens, such token issuances could be deemed securities. This is not to say all are tokens classify as securities; there are a variety of mechanisms in which people circulate initial token offerings and should be viewed as circumstantial and judged in a case-by-case manner. If you are soliciting investors for money, always assume you are issuing a security unless you speak directly with regulatory authority or qualified attorney who informs you otherwise.
High Risk
Half of ICOs fail within the first months of their offering. When an investor decides to fund an ICO with crypto or fiat money, the investor must know that that ICO is literally valueless digital currency. It isn’t until the coin gains high circulation that it will gain any sort of value. It is a risk to invest in an ICO should it not gain value in circulation. If it does not gain value, investors lose their money.
Why Do I Need Legal Guidance On ICOs?
Entrepreneurs looking to hit it big with the next, new ICO are aware that there is big risk and big reward. It’s best to error on the side of caution legally when dealing with such high risk from both a documentation standpoint and Securities and Exchange Commission (SEC) compliance standpoint. Here is a list of the possible paperwork that is legally required or will require legal review for an ICO.
Articles of Association
A document that defines the company’s purpose and operations
Business Structure
A legal document that indicates the type of business you are establishing (e.g., sole proprietorships, partnerships, corporations, S corporations, and Limited Liability Company (LLC)) Certificate of Incorporation – A legal document necessary to form a corporation or company
Employment and Services Agreements
A contractual agreement for independent contractors to work on specific projects
Intellectual Property
Legal documentation to protect and register copyrights, trademarks, patents, business names, ICO names, and domain names
Legal Disclaimer Clause
A disclaimer that protects you against liabilities from the ICO.
Tax Regulation documents
Regulations in place if there are necessary taxes due on the ICO
Terms of Use/Terms and Conditions and Privacy Policy
Legal documents generally provided on the ICO’s website that describe the means in which to use the product and way in which a consumer’s data is used
Token Sale Agreements/Contracts
An agreement between the buyer and the seller of a token
White paper
A detailed document that describes every aspect of the project in great detail. Details can include but are not limited to market analysis, business strategy, goals, technical architecture, information on the coin and how it will be distributed, legal issues, a description of your team, and list investors and advisors
Legal Opinion Letter
An exhaustive and extensive analysis of your project and tokenomics in accordance with your local jurisdiction’s securities laws written by a qualified third-party. An expert securities attorney will provide their legal opinion on whether or not your token qualifies as a utility token and you are outside of the scope of securities law.
Mini-Glossary
Here are some important terms to learn when it comes to Initial Coin Offerings:
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.
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.
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).
Blockchain Forking: To fork a blockchain is to make a change to the network’s protocol. Forking will allow two different coins to run on the same blockchain.
Creating an ICO is detailed and complicated work. If you are in the process of creating one, contact us for legal advice on what is the right, legal documentation needed for your particular ICO and how to stay compliant with the SEC. 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.
