Initial Coin Offerings Worries for Startups and Investors

For Startups, ICOs are Becoming More Attractive, But Buyer and Seller Beware

 

An ICO, or initial coin offering, is the sale of virtual coins or tokens to raise capital by startup companies involved in blockchain technology.

Depending on the terms of the offering, purchasers may use virtual currencies (such as Bitcoin or Ether) or fiat currency to purchase the coins or tokens.

ICOs, token pre-sales, and similar sales of blockchain-based coins and tokens are quickly becoming an important fundraising option for many early-stage companies.

Cryptocurrencies. That’s How!

 

Initial coin offerings are the creation of a new cryptocurrency that people buy using the more common and established Bitcoin and Ethereum. Cryptocurrencies like are digital currencies created by encryption techniques. Tools solve the encryption code to unlock the cash, which can then be used to buy and sell goods and services or is exchanged for U.S. dollars or any other fiat currency. Bitcoin and Ethereum are the biggest currencies currently circulating.

Here’s the typical three-step process to launch an ICO

First, the startups that want to launch an ICO works with a smart group of attorneys and services that will generate your blockchain token. Most startups set a minimum goal for the fundraise and a period of time to reach that goal.

Second, the startups build their startup to an early stage, announce the token sale, and publish a white paper about what they intend to create, how they intend to do it, and how much money they need to make it happen. It’s not much of a disclosure, but some serious companies are pretty detailed in their white papers.

Third, individuals that believe that the tokens will have value either in and of themselves as currency (e.g., Bitcoin) or because the tokens will have value on the platform to be created (e.g., Ethereum) will purchase those tokens. If the fundraising goals are met, then the tokens are distributed and can be used for the purchase and use of certain products developed by the start-up. Though not actually currency, “investors” seem to be simply hoping for a jump in the price of the new currency, much as we’ve seen from Bitcoin and Ethereum, the two established players. If you bought $100 of Bitcoin on January 1, 2011, it would be worth over $1.7M today.

I know someone who turned a few bucks into $3MM on Ethereum over a couple years.

Here’s the rub, laws might be broken.

Section 5 of the Exchange Act makes it unlawful for any exchange to effect a transaction in a security unless the exchange is registered with the SEC or exempt from registration. On July 25,2017, the securities regulatory agency the (SEC) issued its Report of Investigation of an offering of digital tokens by “The DAO.”

Here’s the gist:

  • An ICO that does not meet the requirements of an exemption from registration would likely be an illegal offering and the issuer or individual responsible for promoting it could face civil or criminal liability.
  • The purchasers of the securities also have the right under the Securities Act to force the seller to rescind the transaction and repurchase the securities at their original purchase price, plus interest.
  • If securities are offered, the activities of exchanges and other intermediaries would also come under scrutiny.

Conclusion: Buyer and Seller Beware

Anyone thinking about buying or selling tokens via ICOs should proceed with caution. In particular, established market participants should consult with experienced securities counsel in considering transactions involving tokens and other virtual currency.

 


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