What’s next for the ICO? Reflections on Securities Law and the Future of Initial Coin Offerings


To date, fundraising has been blockchain’s killer app.

In 2017, Initial Coin Offering (ICO) fundraising eclipsed that of traditional venture capital, and in 2018, ICOs have already raised nearly $3 billion in non-dilutive funding. This new form of early-stage financing is incredibly promising, at least in theory. For one, it can be more than “dumb money,” as tokens can enable platform participation and allow post-ICO startups to bootstrap network effects. Even better, ICOs promise decentralization; from a technological perspective, there are no formal barriers to ICO fundraising.

From a practical perspective, however, Initial Coin Offerings are far more complicated; the barriers to legal fundraising via ICO are quite high. The U.S. Securities and Exchange Commission (SEC) has been outspoken in their opinion that ICOs have been drastically “under-regulated” – which is a nice way to say that many founders and investors may have unwittingly broken securities law.

Such opinions began to surface in mid-2017 after The DAO – then the largest crowdfunding campaign in history – was hacked and initially lost around 4% of all existing Ether to theft by a rogue actor. In the wake of that attack, the SEC declared that “DAO Tokens are securities under the Securities Act of 1933 (‘Securities Act’) and the Securities Exchange Act of 1934 (‘Exchange Act’).” And, even more recently, SEC Chairman Jay Clayton doubled down by stating directly, “every ICO I’ve seen is a security.”

The immediate reaction to such comments by the broader cryptocurrency community was intense, immediate, and almost exclusively alarmist. Pundits declared the ICO “dead” and the “death knell” sounded; sober, alternative opinions in the intervening weeks have been hard to come by.

In the remainder of this piece, we will assess the likely impact of the SEC’s statements and attempt to answer three questions: How should we feel? How should we respond? And, ultimately, what does the future hold for Initial Coin Offerings?

[clickToTweet tweet=”What does the future hold for Initial Coin Offerings? #ICOs” quote=”What does the future hold for Initial Coin Offerings? #ICOs”]

How should we feel?

The road ahead for ICOs is certainly more complicated than many community members may have initially expected.

First, this judgment may signal the death of the cypherpunk dream of radically open, borderless, and authority-free fundraising in the US. If token sales are indeed securities offerings, an imposing set of  potential compliance activities may be necessary, including Know Your Customer and Anti-Money Laundering (KYC/AML) laws, which mandate collection of personal information from prospective buyers, accredited investor checks, and more. Compliance with these laws can be difficult for the unacquainted, so it’s reasonable to fear that ICO regulation may stifle innovation from blockchain entrepreneurs by raising barriers to entry.

[clickToTweet tweet=”it’s reasonable to fear that #ICO regulation may stifle innovation from #blockchain entrepreneurs by raising barriers to entry” quote=”it’s reasonable to fear that #ICO regulation may stifle innovation from #blockchain entrepreneurs by raising barriers to entry”]

Similarly, these SEC judgments pose significant challenges for founders who have completed ICOs: in cases of an illegally sold security (i.e. not registered with the SEC or not relying on an appropriate exemption), investors have rescission rights (to receive their money back); issuers may be precluded from using certain exemptions to raise capital in the future; plaintiffs may attract class action attorneys to bring potentially firm-ending lawsuits; and, last but certainly not least, government sanctions, fines, and jail time for issuers are not off of the table.

Despite this ex-ante and ex-post negativity, however, history may prove these SEC judgments to be a blessing in disguise – or at least a less catastrophic development than they are popularly understood.

We expect that the SEC’s declarations may:

Remove Uncertainty

For better or worse, the community is no longer in limbo: the SEC has provided a clearer position, which allows founders to act with conviction. With the knowledge that token offerings are nearly always securities, entrepreneurs can structure their fundraising efforts accordingly.

Clear Out Bad Actors

Many prominent figures within the blockchain community — including Brad Garlinghouse and Joseph Lubin — have argued that many ICOs to date have been fraudulent, an unfortunate feature of the current ICO landscape. This round of enforcement and investigation should curb that kind of behavior. In the long run, this culling of the community may strengthen the perceived legitimacy of blockchain and cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud.

[clickToTweet tweet=”this culling of the community may strengthen the perceived legitimacy of #blockchain and #cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud #ICO” quote=”this culling of the community may strengthen the perceived legitimacy of #blockchain and #cryptocurrencies and help it shed its unfortunate associations with the sin economy and fraud #ICO”]

Incentivize Education

These provocative headlines and the attention they attract may prompt the general public to better understand the blockchain ecosystem and the regulatory regime in which it operates. This rising tide of consumer attention may raise all ships, for if token issuers truly want to build network effects via ICO, they will benefit from educated, meaningful investment far more than speculative investment by “greater fools.”

Spark Legitimate Industry

Once bad actors are eliminated, remaining industry participants will have been tried by fire and validated by survival. New entrants, then, may be able to rely on such stalwarts, building on their successes to recreate the energy seen in this first wave of decentralized fundraising.

How should we respond?

Realizing such a solution will require a deliberate focus on compliance, the seemingly inevitable conclusion of the SEC’s statements to date is just this: innovative as it may be, the ICO structure didn’t supersede nearly 100 years of legal precedent. While blockchain technology is certainly novel, the way that innovators finance blockchain projects need not be. We identify three complementary strategies that prospective token founders should consider: shape the definition of “utility tokens,” hold compliant Initial Coin Offerings, and develop technology solutions to help others do the same.

[clickToTweet tweet=”Innovative as it may be, the #ICO structure didn’t supersede nearly 100 years of legal precedent” quote=”Innovative as it may be, the #ICO structure didn’t supersede nearly 100 years of legal precedent”]

(1) Shape the Definition of “Utility Tokens”

An important, but as yet undefined, distinction may exist between normal securities tokens and utility tokens. In theory, the latter would fail to meet at least one of the criteria of the Howey Test and would thereby not be subject to securities law.

The name “utility token” comes from the belief that tokens with utility – i.e., concrete use, like the ability to bid in a decentralized prediction market – do not qualify as securities under the Howey Test. The SEC clarified that the Howie test has gradations to each factor in determining if a token is a security, however, when it stated in a cease-and-desist letter to ICO-issuer Munchee (MUN):

“Even if MUN tokens had a practical use at the time of the offering, it would not preclude the token from being a security. Determining whether a transaction involves a security does not turn on labelling – such as characterizing an ICO as involving a ‘utility token’ – but instead requires an assessment of ‘the economic realities underlying a transaction.’”

Clearly, further definition is needed. Technologists, founders, investors, and, yes, even government officials should work to have their voices heard as these standards take shape. One such influencer, Albert Wegner of Union Square Ventures, publicly advocated for an ICO “Safe Harbor”:

A Safe Harbor for initial token sales and issuance could impose requirements on investors that are along the lines of Rule 144 governing Restricted Securities, such as imposing holding periods and information requirements prior to sales. Token distributions via faucets or crowd sales with small dollar amounts per buyer should be exempted from this requirement.

Such statements of advocacy are laudable, and we expect others to follow Wegner’s lead and fight for greater regulatory clarity.

(2) Hold Compliant Initial Coin Offerings

The safest strategy in the near term is to treat all ICOs as securities offerings. Token issuers, then, have two possible courses of action: register the ICO with the SEC and conduct an initial public offering, or find an exemption.

In the remainder of this section, we will define five such exemptions: Regulation D Rule 506(c), Regulation S,  Regulation CF, Regulation A+, and Rule 147.

Regulation D

Most token sales to date have used Rule 506(c) of Regulation D, which covers the general solicitation of securities. This option is a popular choice because it allows for general solicitation and has no cap on the amount of money that can be raised. In addition, this rule preempts state securities laws; state-by-state registration and pre-launch disclosure filings are not necessary.

The drawback to this option is that tokens or token-based securities can only be sold to accredited investors, and issuers must verify this status by receiving certain personal information from those investors – which may significantly limit participation in the sale. (Accredited investors make up just 7% of the US population.) Tokens or token-based securities sold pursuant to this exemption also generally have a one-year holding period before they can be freely traded.

Regulation S

Regulation S concerns securities offerings that take place outside of the United States, and can apply as long as the issuers conducting an offshore transaction make no “direct selling efforts” in the United States. Regulation S offerings are categorized by the likelihood that securities will flow back into the United States, and face variable restrictions on holding periods, information requirements, and the like depending on that categorization. A Regulation S deal can be run simultaneously with a Regulation D deal in order to solicit both US and foreign investors where investor qualifications differ from those in the US (assuming compliance with local laws).

Regulation CF

Regulation CF, in contrast to Regulation D, allows anyone (including non accredited investors) to invest but limits the fundraise to just over $1 million in a 12-month period. Each investor is also limited to a certain investment amount, usually around $2,000. (Considering the size of many ICOs and ICO investments to date, these limitations may seem particularly onerous.)  This transaction can, however, be combined with a Regulation D transaction mentioned above to increase the amount raised and allow for non-accredited investor participation.

Regulation CF brings its own regulatory obligations, like the need to use a registered crowdfunding platform and to file certain documentation with the SEC prior to launching the deal and on an ongoing basis. This exemption also preempts most state securities laws and requires a mandatory one-year holding period prior to trading.

Regulation A+

Regulation A+ allows token developers to raise up to $50 million from unaccredited investors, increases the possible investment amount to roughly 10% of an investor’s income or net worth, and allows tokens and token-based securities to be freely tradeable once issued.

This regulation necessitates an arduous SEC qualification process, however, that requires communication with the SEC in advance of the token offering. Regulation A+ also mandates the provision of audited financial statements and continued reporting once the offering has concluded. The security types that can be issued in these offerings are limited, and state securities laws are again preempted.

Rule 147

Rule 147 allows for intrastate offerings so long as such sales comply with that state’s securities regulations. In order to qualify for this exemption, the issuer must have some “nexus” (business operations, employees, customers, assets, etc.)  within the applicable state and can only raise funds from residents within that state. Investors do not need to be accredited investors, and after a six-month holding period the securities are freely tradeable (prior to the holding period they can be resold within the state).

(3) Technology Solutions for ICO Compliance

Where there is pain, there is opportunity, and it strikes us that a technology solution to manage and comply with ICO regulations is a necessity.

Compliance with securities law – and its many, varied exemptions – is far from simple, but the SEC seems to have little sympathy for would-be issuers. SEC Chairman Jay Clayton said recently that “Many ICOs are being conducted illegally. Their promoters and other participants are not following our security laws. Some people say that’s because the law isn’t clear. I do not buy that for a moment.”

Clayton also reportedly isolated the importance of compliance with the “spirit of the law” and “the professional obligations of the U.S. securities bar.” These broad concerns, when paired with the immense scale at which some of these ICOs operate, compound potential compliance issues.

This is a real, present problem for individuals trying to raise collectively billions of dollars. To us, that feels like a prime opportunity for technology innovation.

What’s the future of the ICO?

Looking forward, we appear to be entering a new era of distributed fundraising. The cypherpunk dream of radically decentralized fundraising may be lost, but there is still reason for tentative optimism: regulatory uncertainty is largely gone, fraud is likely to decrease, and the crypto community may be bolstered by additional education and public awareness.

In the end, well-intentioned founders still have a path to raise vast sums of money and develop the next generation of blockchain technology. Despite the challenges of compliance, the outlook for ICOs is bright. We hope that this rational, measured optimism can nudge the community towards fighting for regulatory clarity, and cashing in on the legitimacy that increased consumer protections may  bring to the blockchain ecosystem.

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Andy Bromberg is the CEO of CoinList, a platform for token sales which emerged as an independent company from AngelList and Protocol Labs’ collaboration. Bromberg is the co-founder and former CEO of Sidewire. He attended Stanford University studying Mathematics and Computer Science. Bromberg co-founded the Stanford Bitcoin Group while studying there.




Georgia P. Quinn is a Senior Contributor for Crowdfund Insider. Quinn is a prominent securities attorney and is current General Counsel for CoinList. She is also the co-founder of iDisclose, an adaptive web-based application that enables entrepreneurs to prepare customized institutional grade private placement documents.


Regan Bozman is Business Operations Lead at CoinList. He previously worked at AngelList where he led the growth for AngelList’s last fund. He is a graduate of Harvard University.






https://www.cnbc.com/2017/11/17/many-icos-are-fraud-according-to-ethereum-co-founder-and-ripple-ceo.html; https://www.wsj.com/articles/sec-launches-cryptocurrency-probe-1519856266?mod=searchresults&page=1&pos=2
SEC v. Howey Co., 328 U.S. 293 (1946)
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