Initial Coin Offerings, or ICOs, have generated a lot of buzz recently as a new method by which companies can raise capital to fund their businesses. At the same time, the SEC has been cracking down on ICOs that involved the offer or sale of a security that was not registered or structured to comply with an exemption from registration. For example, the SEC announced last week that it halted a $600 million ICO by AriseBank, which allegedly involved the offering of a coin that was a security without properly registering the transaction. Despite the apparent scrutiny of ICO transactions by the SEC, there’s much uncertainty in the space as to when securities laws may or may not apply to a specific ICO transaction.
Currently, we are seeing two primary types of ICOs – those that involve the sale of a “security token” and that are intended to be offerings of a security and those that involve the sale of a so-called “utility token,” which do not involve the offer or sale of a security. The primary difference between these two types of tokens is that a utility token is designed such that it has some intrinsic value that is not based upon prospective price appreciation. For example, a cloud computing company might sell utility tokens that are redeemable with the issuer for storage space on the issuer’s servers. In this sense utility tokens are not unlike gift cards where a purchaser is acquiring something that can be redeemed for products or services from the issuer in the future. Like gift cards, an incentive to purchase a utility token could be that the token offers a discount to the normal price for the issuer’s goods and services. While a secondary market for the utility token might develop, just like there are secondary markets for the purchase and sale gift cards, issuers usually intend for these tokens to fail the Howey test, which is the test that is used to determine whether something constitutes an “investment contract” (which would be a security) for federal securities law purposes. Continue Reading Is your Initial Coin Offering a securities offering?