• More Blockchain Developments for Initial Coin Offerings
  • November 24, 2017 | Authors: Andrew Keith Wichmann; Michele Bresnick Walsh
  • Law Firm: Gordon Feinblatt LLC - Baltimore Office
  • In our October 2017 Maryland Legal Alert, we noted recent developments concerning virtual currency initial coin offerings (ICOs) and the United States Securities and Exchange Commission’s (SEC) view that ICOs constituted the offer of securities. On October 24, 2017, a subsidiary of Overstock.com, announced details about a proposed initial coin offering (ICO) to raise funds to support further development of the company’s alternative trading system. The trading system is intended to enable SEC compliant trading of virtual currencies or “tokens.” In the ICO, rather than directly offering tokens, the company proposes to offer a standardized investment contract for the future delivery of tokens known as a Simple Agreement for Future Tokens (SAFT). Many ICOs offer a type of token known as a “utility token” that is intended to function through a network of distributed ledgers developed by the seller to provide the buyer goods or services. For example, utility tokens can function as cryptographic coupons to be exchanged for goods, act as currencies like bitcoin, or evidence membership or access to commercial services. ICOs for utility tokens frequently take place before a seller has established a functional network for the tokens offered (Utility Token Presales). The proceeds from such Utility Token Presales are then used by the seller to further develop its network and the accompanying utility tokens. Under current law, an instrument is an “investment contract” and thus a security subject to United States securities laws when it constitutes an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others. Although the SEC has not ruled on the categorization of utility tokens, there is an argument that the direct sale of utility tokens that are functional on the seller’s network when sold are not likely securities, since the utility tokens predominantly derive their value immediately from their functionality on the seller’s network rather than the future efforts of others. However, the sale of to-be-developed utility tokens in Utility Token Presales may constitute the sale of securities because the purchase is in expectation of value to be derived predominantly from the efforts of others (the seller’s future efforts in developing their network upon which the utility tokens function). As a result, many Utility Token Presales may run afoul of securities laws. The motivation for SAFTs is to enable SEC compliant investment in Utility Token Presales. SAFTs are intended to be investment contract securities to be offered in SEC compliant private placements to accredited investors. In such an offering, the investors provide funding under the SAFT in exchange for the future delivery of utility tokens on a functioning network. Once the network is launched, the utility tokens can be delivered to the investors under the SAFT. The seller and the investors may then also offer utility tokens directly to the public with lower risk of violating securities laws since the utility tokens are delivered on a functioning network. The use of SAFTs or similar documents in conjunction with ICOs is likely the first of many steps in the evolution and formalization of token-based investment. We will continue to provide updates as this space evolves.