Although blockchain technology was envisioned by ‘Satoshi Nakamoto’, Bitcoin’s anonymous creator, almost a decade ago, the use of Initial Coin Offerings (ICOs) seems to be a relatively recent phenomenon.
This method of raising funds is favoured by many cryptocurrency start-ups, who typically publish a white paper detailing their goals on a roadmap, the issues their currency will solve, and how they plan to allocate funds acquired in the ICO. During a crowdsale, the company will sell a percentage of their tokens to support ongoing development. Notable examples of such projects include Civic, an identity verification platform (tokens are used to purchase various services on the network) or Golem, which will allow users to rent out their computing power in exchange for the Golem token.
The ICO route has become highly popular among entrepreneurs who wish to circumvent the traditional and considerably more difficult methods of acquiring capital. With upwards of 1.3 billion dollars raised in 2017 alone, governments of the world have decided to put an end to what is characterised by many as a digital Wild West, with China outright banning Initial Coin Offerings altogether.
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The Securities and Exchange Commission in the US, however, returned a ruling that surprised many: the last significant piece of legislation released pertaining to cryptocurrency was the introduction of the BitLicense in New York, which resulted in many businesses simply relocating outside of the jurisdiction of the heavy regulation imposed.
A new ruling returned by the SEC took a different approach — a less heavy-handed decision that tokens may be considered securities (and thus, subject to the Commission’s regulations) in certain cases. The report revolved around the DAO, a virtual organisation built on the Ethereum network — most likely investigated following the high profile breach in June 2016 where a hacker exploited a loophole to siphon more than three million ‘Ethers’ from the organisation. The DAO was an investment fund of sorts, where participants could vote on proposals that would stipulate how the organisation’s pooled funding would be invested (the dividends would then be redistributed to the participants).
The SEC’s investigation found the DAO to be responsible for the distribution of securities (in the form of DAO tokens) under the test set out in SEC v Howey Co. The Howey test has been the standard for ascertaining whether something is (or is not) an “investment contract”, and looks at four factors:
1. Whether there has been an investment of money…
2. With an expectation of profit.
3. The investment of money is a common enterprise.
4. The profit comes solely from the efforts of the seller or a third party.
The SEC is applying a relatively lenient approach, choosing not to enforce the test retroactively (the DAO will escape any sanctions). It has wasted no time, though, in making its position known to parties planning ICOs in the future, as evidenced by Protostarr’s shutdown following a call from the Commission.
The reception of this ruling has been mixed. Some see it as a declaration of war on the free market by an oppressive government, while others see it as a measure to prevent the propagation of scam coins or vaporware. Legitimate coins that provide an actual function (beyond just storing value) are exempt from regulation, so as to not hinder innovation in the blockchain field.
The main takeaway here is that the SEC is tuned into the rapidly evolving blockchain ecosystem. Whether this news is a breath of fresh air that reflects a relaxed stance on the ICO phenomenon, or the start of a crackdown on virtual tokens, remains to be seen.
Matthew Breen is a final year law student at the University of Dundee, aiming to pursue a career exploring the relationship between the law and the digital realm.
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