US SEC Rules on ICOs and Token Sales

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Last year, the blockchain world, and Ethereum in particular, was rocked by the news that approximately $80 million (dropping to $50 million as the effects became known and the value of Ether dropped) had been effectively stolen by a malicious move from an unknown person who exploited a loophole in the coding of the DAO to drain funds from investment that had been made during its token sale.

Since then, there have been many token sales and ICOs, raising over $1.3 billion of investment for the blockchain community in 2017 alone. Whilst many of these have been entirely legitimate, there has been almost no regulation in this space and investors have largely undertaken investments at their own peril. However, the incident with the DAO elicited a response from the US, with a ruling being made by the Securities and Exchange Commission at the end of July 2017.

After examining the case of the DAO, the SEC has decided that the various investment methods which have been employed by blockchain-based projects – such as Initial Coin Offerings or Token Sales - will be treated as a sale of securities. In its investigative report, the SEC warned that participants in this nature of activity will be subject to the requirements of federal securities laws – whether participants use cryptocurrencies or fiat currency.

The impact of this decision is huge for blockchain-based start-ups in the US, but also affects all start-ups on a global scale. Registration will now be required for US-based start-ups seeking investment, but will also be needed to invest in start-ups located in the US. Without finding methods to circumvent the ruling – by using alternative accounts or the pseudo-anonymity of cryptocurrencies – people will have no option but to register, which some would say goes against the nature of a public blockchain and the ideals it seeks to promote, in addition to making it harder to rise funds as a start-up.

This decision may result in crypto-based development moving out of the US to other countries which have shown a willingness to encourage blockchain development and ICOs, but it may also lead to the rate of development of these new technologies decreasing. Whether a slowing down of blockchain development would be a good thing or a bad thing is a matter for debate.

Despite the possible negative views, many people are heralding the decision as a positive one. Before this ruling, there was little-to-no protection for investors against fraudulent or other criminal activity, and this change will go some way to prevent negative associations of blockchain technology with criminals. With this ruling, companies may feel secure in investing in new technology using ICOs and token sales.

The SEC now requires such activity to be registered unless exempted. People who take part in unregistered offerings will need to be wary as they risk violating securities laws. This ruling also affects exchanges which participate in these events, unless an exemption applies to them as well.

Although this ruling has been made, the SEC has decided not to bring charges against anyone involved with the DAO, but rather has cautioned the industry and participants that in the US, token sales, ICOs or funding of such nature will now be treated as a sale of securities and will be considered under federal securities laws. Alongside this announcement, the SEC's Office of Investor Education and Advocacy provided information to investors in ICOs, raising awareness of disclosure requirements and the dangers of fraud which potential investors should be aware of.

Jaron Lukasiewicz, CEO of WRKFLOW, commented: “The SEC had the ability to decimate the entire ICO market, and it has fortunately has provided open possibilities. I hope the commission takes the ‘facts and circumstances’ approach outlined in its report so that blockchain companies can thrive in the US. I don’t think it’s a coincidence that the SEC chose to target a German company in its investigation. The agency is signalling that its rules will apply even to non-US token issuers. Given the wide array of token functionalities, I wish the SEC had been more clear about what types of tokens might not be viewed as a security by the agency.”

It remains to be seen whether other countries will follow this decision and tighten regulation around funding, but some countries have taken a ‘hands-off’ approach to blockchain-based developments and show no signs of changing.