Many crypto companies try to raise money first and worry about consequences later. But, like Maury Povich confronting a runaway dad, it’s only a matter of time before the Securities and Exchange Commission tracks the deadbeat to a bar in Thailand and sentences him to eighteen years of repayments.
However, there are several forms of protection for a regulator-friendly initial coin offering. It’s not as much fun as an all-night fundraiser with anonymous investors, but it will keep you out of jail.
Crypto Briefing has swiped right through some of the hottest offerings to find out how token creators are keeping safe. Or should be.
Option 0: Don’t do it in the U.S.
Abstinence is the default choice. Although you miss out on US investors, there’s plenty of ICO money in the rest of the world.
Option 1: Don’t be a Security (see Option 0)
There has been some good news for Bitcoin and Litecoin, which are currently regulated as commodities rather than securities. Despite its origins, Ethereum also appears to be in the clear, after a senior official publicly stated that there was “no advantage” in treating it as a security.
But most cryptos are still in the crosshairs. Forget about calling it a “utility token.” In investment terms, that’s about as effective as the rhythm method, as Munchee learned last Fall. The token sale ended on its second day, after what must have been a very frosty phone call.
Most initial coin offerings are issued by centralized companies, and seem unlikely to escape the net. For XRP, the Howey test is almost in, and if there’s anything we’ve learned from reality TV, it’s that it’s a fair bet Ripple IS the daddy.
Option 2: Option D
Some offerings escape the full rigor of federal securities law regulations, but these exceptions mostly apply to small and local businesses.
The most used get-out-of-jail card is Regulation D. There are a few different variations, but fundraising is mostly limited to “accredited” (wealthy) investors. Several high-profile companies, notably Telegram, have gone this route, and we’ve already reported on SharesPost‘s platform for Regulation D-compliant offerings.
Manhattan Street Capital estimates that it takes at least 60 days to launch a Form D ICO, with costs starting around $220,000. That includes “$30k – $60k” for legal fees and a $130,000 marketing budget, plus line items like verifying investors and AML compliance. Not to mention MSC’s monthly advisory fee of “$10k/mth plus $10k of tokens/mth.”
The catch? Form D securities are “restricted” which means they can’t be traded. Considering that crypto’s advantage comes from mobility, it doesn’t make much sense to make a token that can’t be resold.
Option 3: Do It Online
There is one more promising exemption: Regulation CF, which allows companies to raise up to a million dollars through an SEC-approved, online portal. We’ve already covered Republic, a crowdfunding service whose cookie-cutter model has launched several budget cryptos.
Crowdfunding platform Indiegogo is also now getting in on the act: right now, as an accredited investor with at least $10,000 to was… spend… you can purchase “an indirect fragmented equity ownership stake” in the St. Regis Aspen resort, which entitles you to “…no free perks attached to Aspen Coins in regards to free hotel room or free hotel accommodations at the St. Regis Aspen or any St. Regis hotel.”
(Interestingly, the Aspen Times reported in December that the owners of the property originally intended to file for an IPO and list on the stock exchange, raising $33.5M. Having downgraded to Indiegogo and an $18M raise, we don’t know exactly what kind of dividends they intend to pay, but suspect that the view from East Dean Street is probably worth more. Facing towards the bus depot at Rubey Park, that is.)
Option 3: Register As A Security (The Nuclear Option)
To date there are only a few companies which have openly attempted to register coins as securities, but there may have been confidential filings as well.
Praetorian Group was the first applicant, although one Law blog said their S-1 was “so sloppy in its drafting that if the SEC bothered to review it, it may set some sort of record for number of comments in a comment letter.” The company got the point, and filed an amendment on July 2.
Monster Products, better known for its overpriced audio cables, filed its S-1 back in May. The company hopes to raise up to $300 million from sales of its MMNY token, which customers can use “to purchase Monster products or pay for services.” If the ICO fails, the tokens may be traded for Monster common stock at a rate of 4:1.
One would expect Monster to do their homework before spending $37,350, but they got shut down even harder than Praetorian: regulators refused to review their application due to its “serious deficiencies.”
So how hard is it? According to Praetorian’s Chief Strategy Officer, between lawyers, accountants and third-party auditors, the entire process costs starts around $100,000. That number’s not as big as it sounds. “If your idea can’t raise a hundred thousand dollars,” said CSO Louis Adimando in a phone call, “you’re going to have a problem existing as a company.”
After filing, the SEC typically responds with detailed comments, which must be addressed in further amendments. The process typically repeats a few more times until the regulators are satisfied.
Option Infinity: Persuade The SEC To Put Regulation on the Blockchain
These rules sound draconian, but they exist to stop exit scamming or lying to investors. Considering recent crypto history, it’s not hard to understand why the SEC insists.
But what if those tedious regulations could be could be handled automatically? That’s one idea which has been floated by none other than the SEC’s new crypto chief. “It will be relatively easy to program these rules into smart contracts and DLT technology, “ Mrs. Szczepanik told a forum in New York, “but technologists need to talk to regulatory attorneys.”
For example, a well-written smart contract could restrict its tokens to the verified addresses of accredited investors, or to people in a specific state, or limit how many tokens they buy. You could even restrict their trade to SEC-approved exchanges.
That sounds like a distant future, at least while the standard tech for KYC is the human eyeball. But several companies, like Civic or TheKey, are already working on blockchain-based ID systems to automate the KYC process.
If successful, they might make your next investment just a little bit more easier.
The author is invested in Bitcoin, Ethereum and XRP.