ICOS, CRYPTOS, BLOCKCHAIN, OH MY! A PRIMER ON ICOs.

• Author: Shulman, Jacob Gregory
• Position: Initial coin offerings

1. Introduction 54 II. Brief U.S. Regulatory History 59 A. ICOS AND THE BLOCKCHAIN MARKET 61 B. U.S. Federal Response 64 C. From "Can a Token be a Security?" to "This is Howl doit." 68 III. State Responses 72 A. Massachusetts Takes Action 73 B. New Jersey 74 C. New York 75 IV. International 75 A. European Union 76 B.Russia 77 C.Israel 78 D. Other Jurisdictions Taking Crypto Friendly Actioi 80 1. China 81 2. Japan 82 3. North and South Korea 82 4 Australia 83 5. United Kingdom 84 6. India 85 V. Business Risks, Considerations, and Alternatives 86 I. INTRODUCTION

   In 2017, Initial Coin Offerings ("ICOs") of cryptocurrencies ("cryptos" or "cryptoassets" or "tokens" or "coins" or "convertible virtual currencies" or "crypto assets" or "digital assets") (1) raised more money than early stage venture capital funding. (2) The United States Securities and Exchange Commission, which is the primary securities regulator in the United States, in a law suit filed on June 4, 2019, defined ICOs as a "fundraising event in which an entity offers participants a unique digital asset - often described as a 'coin' or 'token' - in exchange for consideration (most commonly Bitcoin, Ether, U.S. dollars, or other fiat currency). (3) The tokens are issued and distributed on a 'blockchain' or cryptographically secured ledger." (4)

   By August 2017, approximately $1.25 billion was raised by ICOs; (5) and by October 2017, close to $2 billion. (6) In total, around $3.7 billion was raised by ICOs in 2017. (7) However, according to Ernest & Young, over ten (10) percent of those funds raised by ICOs in 2017 were stolen. (8) In the first 5 months of 2019, according to PwC and the Crypto Valley Association, 250 token offerings raised $3.3 billion. (9) There is an issue as to whether or not ICOs are considered securities, and more generally as to how to regulate cryptocurrencies. (10) Therefore, the issue with ICOs, in addition to fraud and theft, is that issuers are not registering with the SEC. Their failure to register limits consumer protection. The SEC and other agencies continue to provide guidance on this issue. This paper will review international, federal, and state actions, and recommend how to proceed going forward.

   Of the 372 ICOs analyzed, roughly $400 million of the total $3.7 billion funds raised have been stolen." Phishing was the most widely used "hacking" technique, (12) with stolen proceeds around $1.5 million. (13) Due largely to the compromise of data through social engineering, "hacking," and other associated risks, less than twenty-five (25) percent of ICOs reached their target in November 2017, compared to ninety (90) percent reaching their target in June 2017. (14) Nonetheless, some of the shortest lasting ICOs attracted an average of $300,000 per second. (15)

   In general, ICO funding has not entirely surpassed all venture capital investments. (16) In 2016, venture capital investments totaled $127 billion, whereas in 2015, crowdfunding platform investments were $34 billion. (17) As of August 2017, Tezos had the largest of such offerings with $232 million. Comparatively, Bancor had a $150 million offering. (18) Additionally, as ICO funding subsided, other, even more convoluted funding opportunities arose, namely Securities Token Offerings ("STO"), (19) Initial Exchange Offerings ("IEO"), (20) Decentralized Exchange Offerings ("DEO"), and Utility Tokens. (21)

   However, according to Deloitte's 2019 global survey, more than half of companies surveyed believe blockchain "will be critical, [and is] in [their] top five strategic priorities." (22) The "most significant advantages of blockchain over existing systems," from the provided list, were "new business models and value chains," "greater security/lower risk," "greater speed compared to existing system," and "greater transparency." (23) However, respondents cited "some barriers to greater adoption [of] blockchain technology," the top five being: regulatory issues, "implementation: replacing or adapting existing legacy systems," "potential security threats," "uncertain return on investment (ROI)," and "lack of in-house capabilities (skill and understanding)." (24)

   The North American Securities Administrators Association ("NASAA") represents states' securities regulators in all fifty (50) states, as well as Canada, Mexico, and other North American territories. According to the 2018 President of NASAA, unlike an Initial Public Offering ("IPO"), when a company sells stocks in order to raise capital, an ICO sells 'tokens' in order to fund a project, usually related to the blockchain. The token likely has no value at the time of purchase. Some tokens constitute or may be exchangeable for a new cryptocurrency to be launched by the project, while others entitle investors to a discount, or early rights to a product or service proposed to be offered by the project. (25)

   A "cryptocurrency," also known as a virtual currency, is: a digital representation of value that can be digitally traded and functions as: (1) a medium of exchange; and/or (2) a unit of account; and/or (3) a store of value, but does not have legal tender status (i.e., when tendered to a creditor, is a valid and legal offer of payment) in any jurisdiction. It is not issued or guaranteed by any jurisdiction, and fulfills the above functions only by agreement within the community of users of the virtual currency. Virtual currency is distinguished from fiat currency (a.k.a. 'real currency,' 'real money,' or 'national currency'), which is the coin and paper money of a country that is designated as its legal tender; circulates; and is customarily used and accepted as a medium of exchange in the issuing country. It is distinct from e-money, which is a digital representation of fiat currency used to electronically transfer value denominated in fiat currency. (26)

   NASAA released a statement with the "common cryptocurrency concerns" (27) and "common red flags of fraud," including minimal regulatory oversight and too good to be true claims. (28)

   This paper will argue that ICOs emerged due to the rising cost of raising working capital, evolving technology, and the stagnant nature of securities regulations. (29) This paper will also discuss the author's views on the regulatory nature surrounding ICOs and options for regulators, like the SEC's Cyber Unit within the Division of Enforcement and Strategic Hub for Innovation and Financial Technology ("FinHub").

2. BRIEF U.S. REGULATORY HISTORY

   Coinbase, a digital currency exchange and platform, (30) has more user accounts than Charles Schwab Corp., the number 2 brokerage firm. (31) Coinbase also has had, by far, the most consumer complaints filed against a blockchain related company. (32) Mark Zuckerberg, CEO of Facebook, Inc., referred to cryptocurrencies and other decentralized technologies as something he would be studying in 2018. (33) However, shortly thereafter, Facebook Inc., announced that it will be banning ads on its social network that promote cryptocurrencies, ICOs, and binary options, saying they're "frequently associated with misleading or deceptive promotional practices." (34) The policy was "intentionally broad" while Facebook worked to understand which ads were deceptive or misleading, from companies "not currently operating in good faith," reported the company via blog post in January of 2018. (35) Thereafter, Facebook participated in the release of their own Calibra and The Libra Association's release of Libra. The goal was to have Libra become a global currency to be used through Facebook's wallet, Calibra. The Libra Association was comprised of some of the largest institutions in the world, including Visa, MasterCard, PayPal, eBay, Uber, Vodafone, Spotify, and Facebook (Visa, eBay and Mastercard subsequently abandoned the effort). (36) Almost immediately, the French finance minister decried Libra "must not happen" (37) and the United States House Financial Services Committee scheduled hearings and demanded Libra be halted in the interim. The wild west of cryptocurrency is now more mainstream than previously thought and regulators are taking notice.

   1. ICOs and the Blockchain Market

      While regulatory scrutiny is increasing, the ICO market is evolving and the blockchain and bitcoin markets are not slowing down. (38) Regulatory scrutiny has come from The White House and President of the United States of America, The Secretary of the United States Treasury, the Chairman of the Board of Governors of the Federal Reserve, among others domestically and internationally. On July 11, 2019, President Trump tweeted, "I am not a fan of Bitcoin and other Cryptocurrencies, which are not money, and whose value is highly volatile and based on thin air. Unregulated Crypto Assets can facilitate unlawful behavior, including drug trade and other illegal activity.. ,." (39) For example, as regulatory scrutiny over ICOs increased, the markets evolved and transferred "the hype" to IEOs, or initial exchange offerings. However, these capital raising ventures have not been without problems or concern. Charles Hoskinson, a co-founder of Ethereum, one of the largest cryptocurrencies by market share, believes ICOs are "a ticking time bomb." (40) Moreover, Mr. Hoskinson believes "[t]here's an overtokenization of things as companies are issuing tokens when the same tasks can be achieved with existing blockchains. People are blinded by fast and easy money." (41)

      For example, Brad Garlinghouse, CEO of Ripple, which is a money-transfer company utilizing blockchain technology, believes "ICOs operating in the wild west of finance isn't sustainable[.]. . . If it talks like a duck and walks like a duck, the SEC will say it's a duck." (42) An example of legal troubles for ICOs can be depicted by the Tezos's offering for "tezzies," which resulted in private class action securities litigation. (43)

      But what exactly is an ICO, and why do issuers favor them? ICOs are a method of capital raising utilized...