Taking the cautious approach to ICOs

(Photo: Shutterstock)

(Photo: Shutterstock)

One of the misconceptions surrounding blockchain technology is that it is the same as Bitcoin. Blockchain and Bitcoin are not the same thing – it is the blockchain that cryptocurrencies such as Bitcoin are traded upon. Still, the confusion remains. And now we have something called initial coin offerings (ICOs), which use cryptocurrencies to raise money. Sometimes called token sales or TGEs, they are becoming a popular way for companies, especially startups, to raise funds.

They may seem like a sure-fire way to raise money, but they come with significant risk, according to Austin Mills, chair of blockchain & cryptocurrency practice at law firm Morris, Manning & Martin. According to Mills, as recently as this past spring, there was about one ICO per month, but that has increased to about 5 per day.

ICOs can raise massive amounts of money for businesses. For instance, Storj, a cloud-storage solutions provider, raised $130 million in an ICO.

What is an ICO? “In an ICO campaign, a percentage of the cryptocurrency is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, but usually for Bitcoin” or some other cryptocurrency, explains Investopedia.

In general, people who buy into an ICO or token sale would invest money and may get cryptocurrency, or in some cases access to a physical product or service, in return. Early efforts at ICOs saw many investors lose a lot of money.

“All of a sudden, two guys with a white paper could raise millions of dollars,” Mills explained to members of the Blockchain in Transport Alliance (BiTA) during the group’s initial meeting in Atlanta earlier this month. “As the market gets more saturated, you are seeing less appetite for two guys and a white paper. It is looking for [more developed projects].”

In some instances, U.S. individuals and companies are barred from participating in ICOs – either investing or using one to raise funds. The reason is the complexity of the law. According to Mills, the Securities and Exchange Commission views nearly 90% of all ICOs to be securities (the remainder would be considered “utility tokens”), and therefore subject to SEC regulations. That is one reason why most ICOs originate overseas.

“Depending on the facts and circumstances, the offering may involve the offer and sale of securities,” the SEC wrote in an advisory this summer. “If that is the case, the offer and sale of virtual coins or tokens must itself be registered with the SEC, or be performed pursuant to an exemption from registration.  Before investing in an ICO, ask whether the virtual tokens or coins are securities and whether the persons selling them registered the offering with the SEC.”

If you treat or ICOs as securities, you will be on the right side of the law, Mills advised.

So, if you want to get involved in an ICO, how do you do that? Start by answering a simple question: “You have to be able to answer what value that token will have,” Mills said. It could be a price increase or a physical good or service. “If you are trying to do an ICO, they are buying a token, but they are not going to buy that token for $5 if it’s going to be worth $5 [in the future].”

An ICO starts with the planning phase and includes a white paper. It must also include a development plan (smart contract); marketing plan; a legal/tax structure; documentation; a presale or initial raise (this is for insiders); a crowdsale; security audit and then the token issuance.

One consideration Mills noted is that if you raise money through an ICO, it is generally considered deferred revenue for tax purposes.

Presales have become an increasingly important part of ICOs, Mills advised, giving companies a way to raise money from insiders to build out a product or service. “So that when the ICO sale takes place, it is less likely to be considered a security,” he said.

Mills concluded by noting that anyone interested in an ICO should consider securities laws, tax consequences, money transmission regulations, jurisdictional bans and sale documentation before making the leap.

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