Initial Coin Offerings
In addition to its Report and statement of the Divisions of Corporation Finance and Enforcement, on July 25, 2017, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin on Initial Coin Offerings (ICO’s). The Investor Bulletin is written in a simple format and helps to inform the public on the basics of ICO’s.
As noted throughout this blog, virtual coins or tokens are created using DLT or blockchain and can be sold in exchange for other virtual coins (such as Bitcoin or Ethereum) or for fiat currency such as U.S. dollars. Generally tokens sold entitle the purchaser to some return on investment or participation in a project and also may be resold or traded on secondary markets, such as virtual currency exchanges. The Investor Bulletin informs the public that these virtual coin or token offerings can invoke the federal securities laws.
The Investor Bulletin provides some basic information on blockchain and virtual currencies. In particular, taken from the Investor Bulletin:
What is a blockchain?
A blockchain is an electronic distributed ledger or list of entries – much like a stock ledger – that is maintained by various participants in a network of computers. Blockchains use cryptography to process and verify transactions on the ledger, providing comfort to users and potential users of the blockchain that entries are secure. Some examples of blockchain are the Bitcoin and Ethereum blockchains, which are used to create and track transactions in Bitcoin and Ether, respectively.
What is a virtual currency or virtual token or coin?
A virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, unit of account, or store of value. Virtual tokens or coins may represent other rights, as well. Accordingly, in certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the SEC or pursuant to an exemption from registration.
What is a virtual currency exchange?
A virtual currency exchange is a person or entity that exchanges virtual currency for fiat currency, funds, or other forms of virtual currency. Virtual currency exchanges typically charge fees for these services. Secondary market trading of virtual tokens or coins may also occur on an exchange. These exchanges may not be registered securities exchanges or alternative trading systems regulated under the federal securities laws. Accordingly, in purchasing and selling virtual coins and tokens, you may not have the same protections that would apply in the case of stocks listed on an exchange.
Who issues virtual tokens or coins?
Virtual tokens or coins may be issued by a virtual organization or other capital-raising entity. A virtual organization is an organization embodied in computer code and executed on a distributed ledger or blockchain. The code, often called a “smart contract,” serves to automate certain functions of the organization, which may include the issuance of certain virtual coins or tokens. The DAO, which was a decentralized autonomous organization, is an example of a virtual organization.
The Investor Bulletin continues with warnings to potential investors, including to be aware that the federal securities laws require either registration or an exemption from registration for an offer and sale of securities. The Investor Bulletin points potential investors to the EDGAR database to find registration statements, and reminds investors that exemptions usually are limited to accredited investors.
Further, the Investor Bulletin discusses disclosure obligations and sets forth key information that an investor should be informed of, such as use of proceeds, management and business plans.
The Investor Bulletin points out that even if there has been a fraud or theft, their rights may be limited do to the nature of ICO’s in general, including that they can be autonomous, the inability to trace money, the international scope of offerings, that there is no central controlling authority and that there is no method to freeze or secure virtual currency. Finally, the Investor Bulletin points to the usual red flags, including “guaranteed” high returns or low risk, unsolicited offers, sounds too good to be true, buying pressure, no net worth or other investor requirements and unlicensed sellers.
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