As an authority in the legal field, particularly in the realms of cryptocurrency and Initial Coin Offerings (ICOs), my experience and insights are shaped by a rich professional background. My journey has taken me through significant roles, including serving as General Counsel for Grooveshark and playing a pivotal role in advising entities like the Uniswap Foundation in the crypto and Web 3.0 spaces. These experiences have granted me a deep understanding of the nuances and complexities inherent in the evolving landscape of digital currencies and token offerings.
Drawing upon these experiences, I am positioned to provide a comprehensive overview of the legal considerations for Initial Coin Offerings in 2024. The landscape of ICOs is continually changing, influenced by factors such as evolving regulatory frameworks and the increasing sophistication of blockchain technology. Based upon this, please see a helpful memo that I have prepared on this issue specifically that I would like to open-source:
In short, the legal considerations for ICOs vary depending on the jurisdiction and the specific facts of the offering. Generally, the key issues involve whether the digital tokens qualify as securities, commodities, property, or currency, and whether the offering must be registered with the SEC or qualify for an exemption.
Analysis
One key consideration for ICOs is whether the digital tokens qualify as securities. Several cases, including Balestra v. Atbcoin LLC, U.S. Sec. & Exch. Comm’n v. Kik Interactive Inc., and Rensel v. Centra Tech, Inc., apply the Howey test to determine whether the tokens are “investment contracts” and therefore securities. The Howey test looks at whether there is an investment of money in a common enterprise with the expectation of profits from the efforts of others. If the tokens are securities, they must be registered with the SEC or qualify for an exemption. Another consideration is the classification of cryptocurrency more broadly. In Diamond Fortress Techs. v. Everid, Inc., the court discusses whether cryptocurrency is a security, commodity, property, or currency. The court does not reach a definitive conclusion, but notes that the question is important for determining the applicable regulations. Some states have enacted specific legislation addressing digital tokens. For example, Colorado has the Colorado Digital Token Act, which exempts certain digital tokens from state securities laws if they have a “primarily consumptive purpose.” This statute is relevant for ICOs in Colorado, but it is not clear whether it applies to all types of ICOs. Finally, there are cases that address fraudulent or unregistered ICOs, such as U.S. Sec. & Exch. Comm’n v. Crowd Mach. and Hodges v. Harrison. These cases highlight the importance of complying with securities laws and avoiding fraudulent or deceptive practices.
Relevant Cases:
- Fedance v. Harris, 1 F.4th 1278 (11th Cir. 2021)The case Fedance v. Harris is relevant to the research request because it discusses an initial coin offering of cryptographic tokens, and addresses the question of whether the tokens were unregistered securities. However, the case does not directly answer the research request, as it focuses on the timeliness of the plaintiff’s claims rather than the substantive legal considerations for ICOs.“WILLIAM PRYOR, Chief Judge: This appeal is about an initial coin offering of cryptographic tokens promoted by celebrities to fund a new movie-streaming platform. The platform never launched, and the value of the tokens plummeted a few months after the offering.””To raise funds, FLiK created cryptographic tokens called “FLiK Tokens.” FLiK represented that investors could redeem the tokens on its platform after it launched.””Through these social media accounts, FLiK announced that it planned to launch an initial coin offering of FLiK Tokens on August 20.”
- Balestra v. Atbcoin LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019)This case is relevant to the research request because it discusses whether a particular digital asset (ATB Coin) qualifies as a security under the Securities Act of 1933. The court applies the Howey test to determine that the ATB Coin is an “investment contract” and therefore a security. Although the case does not address all legal considerations for ICOs, it provides guidance on one key issue.“OPINION & ORDER Vernon S. Broderick, United States District Judge Plaintiff Raymond Balestra, individually and on behalf of all others similarly situated, brings this putative class action against Defendants ATBCOIN LLC, Edward Ng, and Herbert W. Hoover, alleging that Defendants violated the Securities Act of 1933 (the “Securities Act” or the “Act”), 15 U.S.C. §§ 77a, et seq., by selling unregistered securities through an initial coin offering of the digital asset ATB Coin. Before me is Defendants’ motion to dismiss Plaintiff’s Complaint for lack of personal jurisdiction pursuant to Federal Rule of Civil Procedure 12(b)(2), and for failure to state a claim pursuant to Federal Rule of Civil Procedure 12(b)(6).””Defendants Edward Ng and Herbert W. Hoover are co-founders and officers of Defendant ATBCOIN LLC (“ATB”), a technology start-up company aimed at facilitating rapid, low-cost digital financial transactions through revolutionary blockchain technology. (Compl. ¶¶ 3, 15–16.) From June 12, 2017 through September 15, 2017, ATB conducted an initial coin offering, or “ICO,” through which ATB offered digital “ATB Coins” to the general public in exchange for other digital assets (the “ATB ICO”). (Id. ¶ 2.)””Accordingly, I find that Plaintiff’s Complaint plausibly alleges facts demonstrating that the ATB Coin qualifies as an “investment contract” under the Howey test.”
- Magill v. Elysian Glob. Corp., 1:20-cv-06742-NLH-AMD (D.N.J. Apr. 1, 2021)This case is relevant to the research request because it discusses an ICO in detail, including the definition, process, and potential legal implications. However, the case ultimately turns on a jurisdictional issue, so it does not provide a complete answer to the research request.“Presently before the Court is the motion of Defendants to dismiss Plaintiff’s complaint on several bases, including lack of personal jurisdiction, improper venue, and a valid arbitration provision.””Beginning in October 2017, Ameri contacted Plaintiff through Facebook Messenger asking him to invite his “crypto buds” to a Facebook group called “Cryptocurrency Mastermind.” In a series of conversations through Facebook messenger, Ameri asked Plaintiff to join a team of eight individuals to participate in an “ICO project,” which stands for “initial coin offering,” and is almost identical to an initial public offering (“IPO”), but depending on the circumstances of the offering may be outside of the purview of the Securities and Exchange Commission (“SEC”).””Recently promoters have been selling virtual coins or tokens in ICOs. Purchasers may use fiat currency (e.g., U.S. dollars) or virtual currencies to buy these virtual coins or tokens.”
- Diamond Fortress Techs. v. Everid, Inc., 274 A.3d 287 (Del. Super. Ct. 2022)This case discusses the legal classification of cryptocurrency, specifically addressing the question of whether it is a security, commodity, property, or currency. It also discusses the Howey test for determining whether a transaction qualifies as an investment contract, which is relevant to the research request. However, the case does not directly answer the research request, and the proposed legislation it references has not yet been enacted.“Like an initial public offering in a securities context, an initial coin offering, or ICO, occurs when a new species of cryptocurrency token is issued in exchange for fiat or already circulating virtual currencies to raise capital. Archer v. Coinbase, Inc. , 53 Cal.App.5th 266, 267 Cal. Rptr. 3d 510, 513 (2020).””Before the Court can fashion a proper damages award, it must first determine how to classify cryptocurrency, i.e. , is it a security/investment contract, a commodity, property, or currency? Lending to this problem is a lack of consensus among certain authorities on how to treat cryptocurrency.””Eva Su, Digital Assets and SEC Regulation , Congressional Research Service (June 23, 2021) https://sgp.fas.org/crs/misc/R46208.pdf (“When a digital asset meets the criteria defining a security, it would be subject to securities regulation, per existing SEC jurisdiction.”
- U.S. Sec. & Exch. Comm’n v. Crowd Mach., 4:22-cv-0076-HSG (N.D. Cal. Dec. 5, 2023)This case is relevant to the research request because it discusses a fraudulent and unregistered ICO, and the court’s analysis provides guidance on the legal considerations for such offerings. However, the case does not address all aspects of ICOs, and it is not clear whether it remains good law given that there is no citator information available.“Id. ¶¶ 26-27. Between January and April 2018, defendant Craig Sproule, Metavine, Inc., Crowd Machine, Inc. and Crowd Machine SEZC raised more than $33 million from hundreds of investors in the United States and abroad through a fraudulent and unregistered “initial coin offering” or “ICO” of digital asset securities, which they called “Crowd Machine Compute Tokens” or “CMCTs.” Id. ¶¶ 2. Defendants represented that ICO proceeds would be used to fund the development of a “global decentralized” peer-to-peer network, or “Crowd Computer.”””Id. Users also could pay software developers in CMCTs for making available source code that users could compile into custom applications “with unparalleled speed.” Id. In November 2017, Defendants began marketing the initial coin offering. Id. ¶ 27.””Between January 28 and April 20, 2018, in what Defendants called a “private presale” (the “First Phase”), Defendants would offer CMCTs through “Simple Agreements for Future Tokens” (“SAFTs”).”
- In re Xunlei Ltd. Sec. Litig., 18 Civ. 467 (PAC) (S.D.N.Y. Sep. 10, 2019)This case is relevant to the research request because it discusses the legality of a rewards program that the plaintiffs allege mimics features of an ICO. However, the case does not directly address the legal considerations for ICOs, and it is not clear whether the court’s analysis would apply to a different set of facts.“Xunlei also structured the Rewards Program in a manner that mimicked features often associated with an Initial Coin Offering (“ICO”). (Id. ¶¶ 30-32.) The Company “created a sense of urgency by making the cost cheaper—and the economic upside greater—for OneCoin/LinkToken’s earliest adopters.” (Id. ¶ 32.) Xunlei incorporated a “halving” feature into OneCoin so that the daily number of OneCoin issued to all miners on the OneThing Cloud network would be cut in half each year. (Id.)””The same month Xunlei launched OneThing Cloud, on September 4, 2017, the People’s Bank of China, Central Network Information Industry, Ministry of Industry and Information Technology, China Securities Regulatory Commission, China Banking Regulatory Commission, China Securities Regulatory Commission, and China Insurance Regulatory Commission jointly issued a notice regarding “Fundraising through Coin Offering” (the “2017 ICO Notice”). (Id. ¶ 28; Pao Ex. I., Dkt. 34.) The 2017 ICO Notice describes the central elements and risks associated with “fundraising activities through issuing tokens including Initial Coin Offering (ICO)” and goes on to formally and immediately ban “fundraising through coin offering.” (Pao Ex.”
- U.S. Sec. & Exch. Comm’n v. Kik Interactive Inc., 492 F. Supp. 3d 169 (S.D.N.Y. 2020)This case is relevant to the research request because it discusses the application of securities laws to the sale of digital tokens, which is a key legal consideration for ICOs. However, the case does not specifically mention ICOs, and the Second Circuit has not yet ruled on the issue, so the case’s applicability is not entirely clear.“With respect to the sale of Kin to the public (the TDE), the only disputed legal issue is whether the was the sale of a “security”; the parties agree that all other elements under Section 5 are met. Under Section 2(a)(1) of the Securities Act, the definition of “security” includes an “investment contract.” 15 U.S.C. § 77b(a)(1). In determining what constitutes an investment contract, courts rely on the test set forth in SEC v. W.J. Howey Co. : “[A]n investment contract for purposes of the Securities Act means 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.” 328 U.S. 293, 298-99, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946) ; see also Revak v. SEC Realty Corp. , 18 F.3d 81, 87 (2d Cir. 1994) (“three elements of the Howey test” are “(i) an investment of money (ii) in a common enterprise (iii) with profits to be derived solely from the efforts of others”).””Few courts in this Circuit have had the opportunity to apply Howey in the context of cryptocurrency.””See SEC v. Telegram Group Inc. , No. 448 F. Supp. 3d 352 (S.D.N.Y. 2020) (granting preliminary injunction to prevent planned distribution of digital tokens because there was a substantial likelihood that SEC would succeed in proving that plan constituted unregistered securities offering); Balestra v. ATBCOIN LLC , 380 F. Supp. 3d 340 (S.D.N.Y. 2019) (denying motion to dismiss in putative class action alleging that company sold unregistered securities through offering of digital tokens).”
- Rensel v. Centra Tech, Inc., 1:17-cv-24500-RNS/JB (S.D. Fla. May. 31, 2022)This case is relevant to the research request because it discusses the application of securities laws to an ICO, specifically addressing claims under the Securities Act and the Exchange Act. However, the case is limited in that it only addresses the specific facts of the Centra Tech ICO, and does not provide a broader analysis of the legal considerations for ICOs in general.“I. PROCEDURAL BACKGROUND On December 13, 2017, Plaintiff Jacob Zowie Thomas Rensel (“Rensel”), individually and on behalf of others, filed suit alleging that he was deceived by Defendants Centra Tech, Inc. (“Centra Tech”), Sohrab Sharma (“Sharma”), Raymond Trapani (“Trapani”), Robert Farkas (“Farkas”), and William Hagner (“Hagner”), in connection with Centra Tech’s Initial Coin Offering (“ICO”). ECF No. [1]. Centra Tech claimed to be “the world’s first Debit Card that is designed for use with compatibility on 8+ major cryptocurrencies blockchain assets[, ]” id. ¶ 30, and conducted the ICO to raise capital for further development of the Centra Debit Card and Centra Wallet, id. ¶ 2. During its ICO, Centra Tech offered sales of the Centra Token (“CTR”).””First, as to the claim under the Securities Act (Count I), Plaintiffs argue that liability has been established based on Centra Tech’s “unlawful solicitation, offer and sale of unregistered securities” and “unlawful offering of unregistered securities, in the form of CTR Tokens, for which no exemption from registration was available under the federal securities laws.”””Second, as to the claims under the Exchange Act (Count III), Plaintiffs argue that liability has been established based on Centra Tech’s “fraudulent and manipulative scheme” involving the issuance of “false and materially misleading statements concerning, inter alia: (1) relationships with Visa and Mastercard; (2) relationships with Bancorp; (3) the experience and existence of Centra Tech’s executive team; (4) the value of CTR Tokens and the benefits from owning CTR Tokens; (4) Centra Tech’s insurance covering investors’ funds; (5) the listing of CTR Tokens on virtual exchanges; (6) state licenses Centra Tech had acquired to operate the Centra Products; and/or (7) the nature of Centra Tech’s relationships with the Promoter Defendants.””
- Hodges v. Harrison, 372 F. Supp. 3d 1342 (S.D. Fla. 2019)This case is relevant to the research request because it discusses the application of securities laws to an ICO, including the requirement to register with the SEC or obtain an exemption. However, the case does not provide a comprehensive overview of all legal considerations for ICOs, and the court acknowledges that the legal theories involved are “somewhat novel.”“Monkey Capital scheduled an Initial Coin Offering (“ICO”) to occur in July of 2017. (SUF ¶ 11). Harrison solicited people to invest in Monkey Capital at a valuation premium before the Monkey Capital ICO. (SUF ¶ 11). Harrison solicited investors in the Monkey Capital ICO, Coeval, and Monkey Coin. (SUF ¶¶ 12-14).””Monkey Capital issued tokens, Monkey Coin and Coeval and offered these for sale across the United States, using electronic means. (SUF ¶¶ 52-54). Monkey Capital did not register its business — including the issuance of tokens, Monkey Coin or Coeval — with the U.S. Securities and Exchange Commission, nor did it obtain any exemption from registration requirements from the SEC. (SUF ¶¶ 36-51).”
- Commodity Futures Trading Comm’n v. McDonnell, 287 F. Supp. 3d 213 (E.D.N.Y. 2018)“CFTC alleges defendants “operated a deceptive and fraudulent virtual currency scheme … for purported virtual currency trading advice” and “for virtual currency purchases and trading … and simply misappropriated [investor] funds.” See CFTC Complaint, ECF No. 1, Jan. 18, 2018, at 1 (“CFTC Compl.”).CFTC seeks injunctive relief, monetary penalties, and restitution of funds received in violation of the Commodity Exchange Act (“CEA”). Id. at 11. Until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency.””A. Commodity Futures Trading Commission (“CFTC”) Standing The primary issue raised at the outset of this litigation is whether CFTC has standing to sue defendants on the theory that they have violated the CEA. Title 7 U.S.C. § 1. Presented are two questions that determine the plaintiff’s standing: (1) whether virtual currency may be regulated by the CFTC as a commodity; and (2) whether the amendments to the CEA under the Dodd–Frank Act permit the CFTC to exercise its jurisdiction over fraud that does not directly involve the sale of futures or derivative contracts.”
- United States v. Sharma, 18 Crim. 340 (LGS) (S.D.N.Y. Jun. 3, 2022)“Between approximately July and October 2017, Defendants fraudulently solicited approximately $39 million in digital assets from investors, including at least 100, 000 units of “Ether, ” in exchange for digital purchase “CTR” tokens that were issued by Defendants’ company Centra Tech., Inc. (“Centra Tech”) as part of an initial coin offering (“ICO”). Defendants generated interest in the ICO by fraud to pump up the price of CTR tokens on a cryptocurrency exchange. CTR token prices remained artificially inflated as Defendants continued their market manipulation until their arrests in April 2018. Between July 2017 and April 2018, potentially thousands of individuals purchased CTR tokens in connection with the ICO, and those ICO investors sold CTR tokens to secondary market buyers at artificially inflated prices. Following Defendants’ arrests and exposure of the fraud, CTR token prices collapsed.”
- United States Sec. & Exch. Comm’n v. Cutting, 2:21-cv-00103-BLW (D. Idaho Sep. 28, 2022)“Often called “cryptocurrencies,” there are now numerous digital assets based on blockchain technology, which allows asset owners to hold and transfer assets without the need for a centralized processing authority. Perhaps the best-known digital asset is Bitcoin, but there are now more than 5,000 alternative blockchainbased assets generally known as “altcoins.” Altcoin issuers commonly begin sales of altcoins in “initial coin offerings” or “ICOs” in a process that resembles an informal initial public offering of unregistered securities. More recently, altcoin offerings called “initial exchange offerings” or “IEOs” have moved to online trading platforms purporting to be legitimate securities exchanges engaging in offerings for companies raising capital. Collectively, ICOs and IEOs are referred to as “altcoin offerings.””
- Risley v. Universal Navigation Inc., 22 Civ. 2780 (KPF) (S.D.N.Y. Aug. 29, 2023)“Specifically, this Opinion resolves a series of motions to dismiss a putative securities class action filed against Universal Navigation Inc., doing business as Uniswap Labs (“Labs”), and its CEO Hayden Z. Adams (“Adams”); the Uniswap Foundation (the “Foundation,” and together with Labs, the “Uniswap Defendants”); Paradigm Operations LP (“Paradigm”), AH Capital Management, L.L.C., doing business as Andreesen Horowitz (“Andreesen Horowitz”), and Union Square Ventures, LLC (“USV,” together with Paradigm and Andreesen Horowitz, the “VC Defendants,” and together with the Uniswap Defendants, “Defendants”). Plaintiffs claim that they lost money after investing in what turned out to be various “scam tokens” that were issued and traded on the Protocol (the “Scam Tokens” or “Tokens”).””Issuers would instead issue whitepapers regarding their new coin offering; these documents provided little if any information that would otherwise be required as part of an SEC registration statement, namely: (i) a “plain English” description of the offering; (ii) a list of key risk factors; (iii) a description of important information and incentives concerning management; (iv) warnings about relying on forward-looking statements; and (v) an explanation of how the proceeds from the offering would be used. (Id. ¶ 48). Additionally, token issuers would market their offerings through social media sites, piggybacking off of the “meme stock” craze in 2020, which led to a rise in amateur investor activity. (Id. ¶¶ 55-59).””While v2 of the Protocol created a “switch” that, when turned on, allows a five-basis-point portion of that fee to be allocated back to the Protocol, that switch has never been turned on. (v2 Whitepaper 1; FAC ¶¶ 63, 91).”
- Commodity Futures Trading Comm’n v. McDonnell, 18-CV-361 (E.D.N.Y. Mar. 6, 2018)“Until Congress clarifies the matter, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency. An important nationally and internationally traded commodity, virtual currency is tendered for payment for debts, although, unlike United States currency, it is not legal tender that must be accepted.””Presented are two questions that determine the plaintiff’s standing: (1) whether virtual currency may be regulated by the CFTC as a commodity; and (2) whether the amendments to the CEA under the Dodd-Frank Act permit the CFTC to exercise its jurisdiction over fraud that does not directly involve the sale of futures or derivative contracts. Both questions are answered in the affirmative. A “commodity” encompasses virtual currency both in economic function and in the language of the statute.”
- JD Anderson v. Binance, 1:20-cv-2803 (ALC) (S.D.N.Y. Mar. 31, 2022)“Plaintiffs are investors who bought certain digital tokens-EOS, QSP, KNC, TRX, FUN, ICX, OMG, LEND, and ELF-on Defendant Binance, a digital exchange. Digital tokens may operate as “utility tokens, ” which permit the holder of the token to participate in projects associated with the token, or as “security tokens, ” which function similarly to a traditional security and are classified as securities under federal and state law. Accordingly, issuers of security tokens must file registration statements with the U.S. Securities and Exchange Commission (“SEC”) and a platform where security tokens are traded must register with the SEC as an exchange.””Issuers would sell tokens to investors in an initial coin offering (“ICO”), listing the token on Binance.””Investors were only apprised of the tokens’ status as securities on April 3, 2019, when the SEC issued a report, “The Framework for ‘Investment Contract’ Analysis of Digital Assets” (“Framework”), which categorized the tokens as securities under Section 2 of the Securities Act of 1933 (“Securities Act”) and Section 3 of the Securities Exchange Act of 1934 (“Exchange Act”).”
- Sec. & Exch. Comm’n v. Telegram Grp. Inc., 448 F. Supp. 3d 352 (S.D.N.Y. 2020)“The Securities and Exchange Commission (“SEC”) seeks to enjoin Telegram Group Inc. and TON Issuer Inc. (collectively “Telegram”) from engaging in a plan to distribute “Grams,” a new cryptocurrency, in what it considers to be an unregistered offering of securities. In early 2018, Telegram received $1.7 billion from 175 sophisticated entities and high net-worth individuals in exchange for a promise to deliver 2.9 billion Grams.””Cryptocurrencies (sometimes called tokens or digital assets) are a lawful means of storing or transferring value and may fluctuate in value as any commodity would. In the abstract, an investment of money in a cryptocurrency utilized by members of a decentralized community connected via blockchain technology, which itself is administered by this community of users rather than by a common enterprise, is not likely to be deemed a security under the familiar test laid out in S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298–99, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946). The SEC, for example, does not contend that Bitcoins transferred on the Bitcoin blockchain are securities.”
Statutes:
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This statute is relevant to the research request because it specifically addresses the regulation of digital tokens, which may include ICOs, in Colorado. However, it is not clear from the excerpt whether the statute applies to all types of ICOs or only those with a “primarily consumptive purpose.”“(1)Short title. The short title of this section is the “Colorado Digital Token Act”. (2)Legislative declaration. The general assembly: (a) Finds that: (I) Cryptoeconomic systems, which are protocols that govern the production, distribution, and consumption of goods and services in a decentralized digital economy, can be an important component of blockchain technology; (II) Blockchain technology has the potential to create new forms of decentralized “Web 3.0″ platforms and applications that have advantages over the current centralized internet platforms and applications; (III) Colorado has become a hub for companies and entrepreneurs that seek to utilize cryptoeconomic systems to power blockchain technology-based business models; (IV) Companies that seek to utilize cryptoeconomic systems face regulatory uncertainty that the issuance, sale, and purchase of digital tokens that have a primarily consumptive purpose may be prohibited under this article 51; (V) Crowdfunding consumer goods platforms provide a means for companies and entrepreneurs to acquire growth capital and customers by preselling the right to receive consumer goods before the goods are ready to be sold or used, in addition to providing a marketplace for the purchase and sale of consumer goods that are ready for use; (VI) Companies using cryptoeconomic systems that seek to acquire growth capital and customers by preselling digital tokens that have a primarily consumptive purpose face regulatory uncertainty that the offer, sale, or transfer of digital tokens may be prohibited under this article 51; and (VII) Companies that seek to create a marketplace to effect the purchase, sale, or transfer of digital tokens that have a primarily consumptive purpose face regulatory uncertainty that effecting or attempting to effect the purchase, sale, or transfer of a digital token may be prohibited under this article 51; (b) Determines that: (I) The costs and complexities of state securities registration can outweigh the benefits to Colorado businesses using cryptoeconomic systems that seek to raise growth capital and create new decentralized internet platforms and applications by offering the sale or transfer of digital tokens that have a primarily consumptive purpose; (II) Companies that seek to issue or effect the purchase, sale, or transfer of digital tokens that have a primarily consumptive purpose face regulatory uncertainty under Colorado’s securities laws; and (III)”
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“The emergence of decentralized, secure blockchain technology allows security token offerings to be used for capital financing; (II) A security token offering is a capital financing method in which security tokens, which are digital, liquid contracts made verifiable and secure through the use of blockchain technology that establish a token owner’s right to a fraction of a financial asset, are sold to investors; (III) If the general assembly, after a study by the state treasurer of the feasibility of using security token offerings for state capital financing, authorizes the state to use this new and innovative method of capital financing, the state could substantially reduce its capital financing costs by: (A) Allowing a much broader range of investors, including ordinary individuals, to invest in underlying financial assets such as certificates of participation issued in connection with financed purchase of an asset or certificate of participation agreements by purchasing security tokens that evidence their investments, thereby increasing investor demand for the underlying financial assets and reducing the rate of interest that the state must pay to investors; and (B) Reducing the state’s dependence on commercial banks, institutional investors, mutual funds, and pension funds when obtaining capital financing and the high underwriting fees, interest, and other transactional costs that result from that dependence; (IV) In addition to reducing costs, if authorized by the general assembly, the state’s use of security token offerings for capital financing will allow ordinary Coloradans, who as taxpayers collectively own state-owned capital assets, to also share in the ownership of leased state capital assets until the state has paid all of its lease obligations and obtained ownership of the assets; and (V) Because the state has not previously used security token offerings for capital financing and the state treasurer has substantial experience and institutional expertise in capital financing and provides centralized capital financing management on behalf of many state agencies, it is necessary and appropriate to: (A) Require the state treasurer to study the feasibility of using security token offerings for state capital financing; and (B) Authorize the state treasurer to recommend to the general assembly that the general assembly enact legislation to authorize the use of security token offerings for state capital financing if, after completing the feasibility study, the state treasurer determines such use to be in the best interest of the state.”
Analyses:
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Virtual Currencies, ICOs and the SEC
“The SEC’s Mission and Jurisdiction.”
“The SEC Looks at ICOs. An Initial Coin Offering (ICO) is a fundraising activity whereby new ventures sell a “coin” (often referred to as a “token”) often in exchange for virtual currency (like Ether) and in some cases fiat currency as well. A token offering may resemble a traditional offering of securities, depending on how the tokens are structured and marketed and what rights the tokens represent. Some ICOs are offered to limited numbers of accredited investors in “private placements” that are exempt from SEC registration requirements, while others are offered publicly. Utility Tokens?”
“In a March 7, 2018 “spotlight” announcement, the SEC staff outlined several concerns about ICOs, and articulated a substance-over-form review: “ICOs, or more specifically tokens, can be called a variety of names, but merely calling a token a ’utility’ token or structuring it to provide some utility does not prevent the token from being a security.””
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Offering Exemptions Available to Companies Issuing ICOs
“HIGHLIGHTS: Issuing an initial coin offering (ICO) is a new and innovative way for companies to infuse capital into their enterprise. However, several regulatory agencies have increased their scrutiny of ICOs, including the U.S. Securities and Exchange Commission (SEC).”
“According to recent statements by the SEC, most “tokens” or “coins” issued through an ICO are securities and companies issuing ICOs must consider how these offerings implicate the securities registration requirements of the federal securities laws.”
“Depending on a company’s goals and tolerance for associated regulatory burdens, the company may have a strong preference for a certain form of exempt offering. These offering exemptions provide a “middle ground” for a company looking to raise capital when compared to other capital raising initiatives, such as offerings to private equity firms, venture capital firms and public offerings under the federal securities laws.
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Cryptocurrency 2018: When The Law Catches Up With Game-Changing Technology
“Legal Issues in Cryptocurrency A critical distinction will be whether cryptocurrency coins or tokens are securities that should be regulated by the Securities and Exchange Commission (the “SEC”). This issue has received exposure in recent months due to the growing use of cryptocurrency in Initial Coin Offerings (“ICOs”).”
“If cryptocurrency tokens are considered securities (a hotly debated topic), then they must be offered and sold in the U.S. or to U.S. investors in accordance with U.S. securities laws. The SEC’s Investigative DAO Report And Latest Guidance In July 2017, the SEC released its investigative report on the Decentralized Anonymous Organization’s (the “DAO”) coin offering.[2] The SEC concluded that the facts and circumstances of a particular ICO determine if it is a security. The SEC analyzed whether tokens issued by the DAO constituted “investment contracts” under the United States Supreme Court’s long-established standard in SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946).”
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ICOs Involving Non-Issued Cryptocurrency May Be Prosecuted Under Federal Securities Laws
“This week, a federal district court in New York was the first to decide that federal securities laws may be used to prosecute fraud involving cryptocurrencies. In United States v. Zaslavskiy, Eastern District Judge Raymond Dearie held that the Securities Exchange Act of 1933 (“Exchange Act”) and Securities Act of 1933 (“Securities Act”) are broad enough to cover representations made in connection with virtual currency investment schemes and related Initial Coin Offerings (“ICOs”).”
“Under the Supreme Court’s Howey test, an “investment contract” exists when there is a contract, transaction or scheme whereby a person (i) invests his money (ii) in a common enterprise and (iii) is led to expect profits from the efforts of the promoter or third party. Judge Dearie applied that test and found that facts alleged in the indictment, if proved, would be sufficient to meet each element.”
“The court concluded that, since the indictment was facially sufficient, prosecutors should have the chance to prove their case at trial.”
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Federal Judge Rules Securities Laws May Cover ICOs
“U.S. District Judge Raymond Dearie of the Eastern District of New York has ruled that initial coin offerings (ICOs) may be subject to securities law. The ruling came in the court’s denial of defendant Maksim Zaslavkiy’s motion to dismiss an indictment that alleges that he committed securities fraud for selling tokens that he claimed represented shares in a real estate venture and a separate diamond business.”
“The definitions of “security” in the relevant securities laws includes “investment contracts,” and whether the investment schemes at issue in this case are investment contracts is a question reserved for the ultimate fact-finder, which will be required to conduct an independent Howey analysis based on the evidence presented at trial.”
“Judge Dearie’s denial of the motion to dismiss means that the case will proceed to trial, where Zaslavskiy is free to argue that, under the Howey test, the relevant tokens were not investment contracts. We will provide updates on this case as it moves to trial. [View source.]”
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Recent ICO Guidelines in France and Switzerland
“After our recent client alert summarizing recent U.S. regulatory developments in the crypto-world, the House of Representatives of the State of Wyoming passed HB 70, referred to as the “Utility Token Bill” and HB 19, known as the “Bitcoin Bill.” While these bills are intended to create a separate regulatory apparatus for cryptocurrencies and initial coin offerings (“ICOs”)[1], the Wyoming bills, if passed by the Wyoming State Senate, would have limited efficacy since they would only apply to virtual currencies developed and sold exclusively within the State of Wyoming. European market authorities have also been seeking to find a way to regulate ICOs.”
“I. FINMA’s Guidelines for Inquiries Regarding the Regulatory Framework for ICOs FINMA stated in its press release that the ICO guidelines it published set out how it intends to apply financial market legislation and principles when handling inquiries and responding to ICO sponsors. It is therefore clear that the Swiss regulator’s guidelines shed some light on its principles-based approach but hardly constitute a definitive legal framework for ICOs.”
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Rise of Blockchain and ICOs Brings Regulatory Scrutiny
“Adoption of blockchain technology is expected to continue to rise in 2018, and the growing popularity of both the technology and ICOs is likely to bring with it continued legislative and regulatory scrutiny, especially with respect to U.S. securities and anti-money laundering laws.”
“Two key factors will drive the pace and extent of increased adoption: the regulatory environment and the legal treatment of so-called smart contracts.”
“ICOs ICOs have become a significant source of funding for companies raising capital to build out blockchain applications and platforms.”
“Securities Laws Although other jurisdictions have taken drastic steps to curb the pace of ICOs — including China’s flat ban on the sale of blockchain tokens — the U.S. Securities and Exchange Commission (SEC) has yet to develop an ICO-specific regulatory framework.
“On December 11, 2017, SEC Chairman Jay Clayton issued a “Statement on Cryptocurrencies and Initial Coin Offerings,” in which he drew a distinction between true cryptocurrencies that have inherent value (similar to cash or gold) and those blockchain tokens that resemble securities.”
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SEC: Bitcoin Is Not Governed By Securities Laws
“In an important development for the cryptocurrency industry, the U.S. Securities and Exchange Commission has declared that Bitcoin, Etherium and other coins operating on truly decentralized platforms are not securities. The agency’s reasoning was revealed in remarks by William Hinman, Director of the SEC’s Divison of Corporate Finance, at the Yahoo Finance“All Markets Summit: Crypto” on June 14. (See transcript below) Hinman explained that, since the value of cryptocurrency is not based on the expectation of profits resulting from the success or failure of the issuer, it does not compare to a typical security.”
“This allows the tokens and the coins to be structured and offered in a way where it’s then more evident that the purchasers are not making an investment in the development of an enterprise.”
“The digital asset, again, is itself simply code, but the way in which it’s sold as part of an investment to non-users by promoters to develop an enterprise can be and, to that extent, most often is, a security, because its evidences an investment contract. And regulating these transactions as securities transactions makes sense.”
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Metamorphosis: Digital Assets and the U.S. Securities Laws
“[co-author: Kimmi H. Pham] “When Gregor Samsa woke up one morning from unsettling dreams, he found himself changed in his bed into a monstrous vermin.” – Franz Kafka, The Metamorphosis In the past year, the U.S. Securities Exchange Commission (“SEC”) and Chairman Jay Clayton have repeatedly cautioned the cryptocurrency and initial coin offering (“ICO”) industries about the securities law implications for digital assets. On February 6, 2018, in testimony before the Senate Banking Committee, Chairman Clayton notably asserted that “[e]very ICO I’ve seen is ‘a security.’” [1] Such guidance and statements have led many industry participants to ask whether Ether — the second most prominent cryptocurrency after Bitcoin — might be a security in light of the Ethereum Foundation’s initial fundraising and promotional efforts in creating Ether, as well as their ongoing curation activities. [2]The question has been of great importance to many participants in the cryptocurrency and ICO markets in the last several months. On June 14, 2018, William Hinman, the SEC’s Director of the Division of Corporation Finance, delivered a speech entitledDigital Asset Transactions: When Howey Met Gary (Plastic) (the “Hinman Speech”), in which he stated that, putting aside the fundraising that accompanied the creation of Ether, “current offers and sales of Ether are not securities transactions.” (emphasis added).”
“The Hinman Speech also provides guidance for how the Division of Corporation Finance might evaluate whether a given digital asset constitutes a security. This article discusses the context and implications for Director Hinman’s conclusions surrounding Ether.”
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NJ Regulators Stop Digital Asset Firm BlockFi From Offering Interest-Bearing Cryptocurrency Accounts
“Between July 20-22, 2021, state securities regulators in New Jersey, Texas, and Alabama took aim at BlockFi — a cryptocurrency-based platform that has raised $14.7 billion from investors — related to the company’s interest-bearing crypto accounts.”
“New Jersey’s Bureau of Securities Cease and Desist Order On July 20, 2021, the New Jersey Bureau of Securities (part of the New Jersey attorney general’s office) ordered BlockFi to stop selling BIAs because BIAs are unregistered securities. The bureau’s press release noted that the order was issued “amid rising concerns over the proliferation of … financial platforms [seeking] to reinvent traditional financial systems.””
“A Sign of Future Enforcement This year, according to Google Trends, search terms for “bitcoin,” the largest cryptocurrency by market capitalization, went from a value of just six in December 2020 to a whopping 91 by May 2021.”
“It is also an example of the issues that arise when states and the federal government fail to comprehensively regulate a new product.”
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The SEC’s Shutdown of the Munchee ICO
“Commission’s action shows the limited utility of the utility token-security token distinction. Takeaways Regulator finds that sellers of blockchain-based digital coins cannot dodge securities law by calling the coins “utility tokens.” It is still possible to carry out an initial coin offering in compliance with the Securities Act by relying on the Act’s Rule 506(c) or Regulation A provisions.”
“These features, of course, align with the core elements of the Howey test—namely “the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.””
“Rule 506(c) of Regulation D and Regulation A+ under the Securities Act are particularly well-suited for ICOs.”
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The SEC Begins Regulation of Cryptocurrency Interest Account Offerings
“On June 29, 2021, a major cryptocurrency exchange (the “Crypto Exchange”) announced a new program called “Lend” in which it proposed offering customers a 4% interest rate on cryptocurrency tied to USD. But on September 7, 2021, the Crypto Exchange announced that the U.S. Securities and Exchange Commission (the “SEC”) had issued a Wells notice, a formal notice that the agency was planning to sue them for offering the program.”
“The Crypto Exchange’s Lend program was advertised as a “high-yield alternative to traditional savings accounts” and offered 4% interest on a USD Coin (“USDC”), which was a “stablecoin that [could] always be redeemed one-to-one for USD $1.00.””
The SEC accused the Crypto Exchange’s Lend program of offering an unregistered sale of securities thereby violating registration requirements.
“In order to provide more guidance, the Court established “the family resemblance test” to determine whether a note is a security.”
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SEC Charges Do Kwon in Violation of Federal Securities Laws
“Yesterday, the Securities and Exchange Commission the Securities (the “SEC”) brought charges against Terraform Labs PTE Ltd and Do Hyeong Kwon (the “Defendants”), both based in Singapore, for orchestrating a multi-billion dollar crypto asset securities fraud. The scheme involved an “algorithmic” stablecoin and other crypto asset securities.”
“Summary of the Violations Alleged by the SEC The defendants are accused of violating federal securities laws by selling crypto asset securities without registering them with the SEC, which was required under Section 5(a) and 5(c) of the Securities Act of 1933.”
“Sections 5(a) and 5(c) of the Securities Act oblige issuers like Terraform to register offers and sales of securities with the SEC.”
“While the definition of crypto asset may vary, it generally includes assets such as “cryptocurrencies,” “digital assets,” “virtual currencies,” “digital coins,” and “digital tokens.””
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Global Regulatory Update for Cryptocurrency and Initial Coin Offerings
“This client alert provides selected examples of countries that have recently 1) addressed the regulation of ICOs, 2) warned investors of certain risks related to ICOs, or 3) announced new laws providing for the regulation of cryptocurrency. The rapid proliferation of technological advancements in global financial markets has caused regulators in several countries to increase their scrutiny of investments in, and implications of, cryptocurrencies.”
“Notably, recent statements by the U.S. Securities and Exchange Commission (SEC) express their view that such offerings implicate federal securities laws.”
“Canada: In March 2018, the Ontario Securities Commission (OSC) published its Statement of Priorities, which includes the identification of “regulatory gaps arising from cryptocurrency, initial coin and similar offerings.””
“However, the FinTech law does not provide specific regulation for ICOs.”
