The cryptocurrency world is breathing a sigh of relief after U.S. regulators finally weighed in on initial coin offerings, saying that companies which raise money through the sale of digital assets must adhere to federal securities laws.
Prices of many of the more than $1 billion in digital coins already sold this year were little changed as issuers, analysts and attorneys said the Securities and Exchange Commission guidance late yesterday provides some long-sought clarity.
“It’s a step in the right direction for the industry as before yesterday’s announcement, it was common knowledge that ICOs have been enveloped in a regulatory gray area,” said Ron Chernesky, who is in the process of issuing tokens to be used in his trading platform InvestFeed Inc. “One of the most telling pieces in the SEC announcement was an acknowledgment that some ICOs are completely fair investments, and some are not.”
Here’s what some other industry participants and observers say may happen next.
What Tokens May Be Considered Securities?
It depends on the facts and circumstances of each transaction. What’s clear though, is that being a “virtual” organization, selling securities based on a distributed ledger, or the blockchain technology, in exchange for other digital currencies, doesn’t exempt it from securities laws. Steve Obie, a partner at the law firm Jones Day, said the legal standard called the Howey Test is the way to define whether tokens are securities.
“The SEC was straightforward in saying that each ICO has to be evaluated,” said Obie, a former top enforcement lawyer at the Commodity Futures Trading Commission. “Each part of the Howey Test has to be evaluated independently, there’s not one sign that defines whether a token is a security, rather all the factors have to be looked at globally.”
In the specific case of a startup known as DAO, the tokens that spurred the investigation, the SEC didn’t consider it a crowdfunding contract because among other things, it was not a broker-dealer or a funding portal registered with the SEC and the Financial Industry Regulatory Authority.
Who Can Be Liable?
Basically, everyone involved. The SEC said issuers of unregistered blockchain-based securities, those participating in unregistered offerings, and securities exchanges trading these securities are all liable for violations of the securities laws.
The consequence is that ICO participants should be more cautious, Obie said.
“Investors or people buying the ICOs will have to ensure that whatever they purchase will be compliant with U.S. securities laws, and potentially you’ll have more ICOs outside the us that will not take us investors,” Obie said.
What Happens to Past ICOs?
It’s unclear, but the SEC signaled it wants to caution and have a dialogue with issuers instead of bringing charges forward.
Matt Kluchenek, partner and global head of derivatives and hedge funds at law firm Baker McKenzie LLP, said there will likely be flexibility with founders who have already issued tokens.
“What happened in the past is probably safe activity but if they want to continue to fund raise with tokens they will need to reconsider whether that fundraising complies with federal securities laws,” Kluchenek said.
For Obie, issuers are at risk if they don’t make sure they’re following SEC requirements.
“There are no easy answers for those who feel that they may have overstepped,” Obie said. “They should be looking for good counsel so that appropriate steps including dialogue with the SEC can be taken.”
What’s Next for Markets?
We might see a more restrained U.S. ICO market as compliance with SEC rules in some cases requires greater disclosure from companies and for participants to be accredited investors.
That won’t necessarily mean fewer cryptocurrencies, as even more ICOs might be done outside the U.S. Blockchain companies in the U.S. might go to more traditional funding mechanisms, such as venture capital and private placements, Kluchenek said.
“If participants choose to call an ICO a security and market it as a private placement, they could still avoid a lot of securities laws; that’s still a viable route,” Kluchenek said. “There would be transfer restrictions so they wouldn’t be trading in secondary markets, but keep in mind many ICOs were avoiding U.S. markets altogether, so the choice now becomes do I want to avoid U.S. investors or do I want to take money from U.S. investors subject to the requirements that apply.”