Is the ICO party over?
The original version of this post appeared in the November 20th, 2018 edition of Messari’s “Unqualified Opinions”.
The question on everyone’s mind this week after Friday’s SEC statement: are ICOs dead? Yes and no. Gone are the days where anything goes and token offerings operate in the "wild wild west” of regulatory uncertainty. (Which, honestly, was not very uncertain at all in the past year and a half.) The problem has always lied in the way the tokens were structured and sold. There is still space for compliant token sales, but it won’t be an easy path back to 2017 activity.
The SEC’s big year in crypto regulations: are ICOs dead?
(Reminder before reading another word, that I am not an attorney, and most definitely not your attorney.)
The SEC has had an active month. It kicked off November with an enforcement action against the founder of a decentralized exchange, EtherDelta, and followed up on Friday with two more jabs against Airfox and Paragon, two tokens who completed sales in late 2017 “after the SEC’s DAO report.” And then the final upper cut dropped: a statement on digital asset securities issuance and trading.
The details of what happened in those cases are well covered online by many legal commentators in the crypto space (some good ones here, here, and here), but the gist is that Airfox and Paragon conducted ICOs in which they a) sold tokens b) at a discount to early private investors, c) to fund the build-out of their products, and d) which had no use at the time of sales. And the companies did not register those token sales as securities with the SEC.
Nothing super surprising. Both token sales pushed the securities law envelope hard.
It was the SEC’s full statement and takeaways later in the day, however, that are worth spending time dissecting.
The skinny: if you're dealing with what the SEC deems to be a security, security laws will apply to you. In the SEC’s eyes, there’s nothing “retroactive” about that treatment, as securities issuers should be knowledgeable of existing law. As should investment advisers, broker-dealers, exchanges, alternative trading systems, or any other entity that touches securities and is subject to the giant umbrella of securities law.
Regulators — since they do not make laws— know how to make existing frameworks work even with new paradigms of fundraising like token sales.
I’m not sure that regulatory uncertainty has even particularly ambiguous in the past year, many teams and their lawyers simply ignored SEC guidance and precedent. I went and looked up all of the public statements, speeches, orders, releases, and actions by the SEC in the past year and a half, and there’s a consistent narrative.
With the DAO investigative report, the SEC charged onto the crypto scene in July 2017 rather aggressively and issued a report and two investor guideline/ bulletins around how and when ICOs would likely be deemed securities. This is also when we all started hearing about the “Howey Test,” which I’m sure you may recite by heart. (An a) investment of money in b) a common enterprise with c) a reasonable expectation of profit, from d) the work of others is a security.)
Since that first report, the SEC has put out numerous statements warning i) they are paying attention; ii) the way that most token sales have been structured to date are in fact securities (even if they are domiciled overseas); and iii) they intend to regulate the ICO space by applying securities law frameworks.
Anecdotally, I have friends at law firms who have been approached in 2017 and 2018 by various token issuers to write legal opinions stating that those token offerings are not securities. Those law firms and lawyers who stood their grounds and turned away easy clients and profits are today largely vindicated. Those who played fast and loose with the law and had a role in facilitating egregious activity may face financial penalties.
So is the ICO party really all over?
Yes and no.
Perhaps the most significant component to Friday’s actions? Enforcement actions are no longer reserved for the most egregious actors. Neither the Paragon nor Airfox orders had fraud components to them. Rather, the SEC went after them on purely civil grounds, because neither project registered their token sales as securities.
Now we wait to see where the next shoe will drop, and whether there will be an exodus of projects to friendlier climates than the U.S.
This doesn’t spell the end for tokens or cryptonetworks. Just sloppily constructed ones. And that is, by and large, a good thing.
In the meantime? Stop getting your legal advice from twitter and call up real securities law lawyers to handle issues that you’re facing.
Can’t get enough SEC action? I have been collecting a timeline of all of the SEC actions/ orders/ statements/ speeches/ announcements in the crypto space thus far which you can review here.