The regulatory frameworks underpinning Initial Coin Offering’s (ICO) are rapidly evolving as more and more Fintech Startups look to leverage crowdfunding on the blockchain. This blog post will outline the recent remarks made by the Securities and Exchange Commission (SEC) with regard to the legal status of ICO’s as a security or utility token.

In a recent interview, the director of corporate finance at the SEC William Hinman made some significant statements regarding their stance on Ethereum as a non-security. Mr. Hinman, who is largely considered as the SEC’s point man on cryptocurrencies and Initial Coin Offerings recently stated that Bitcoin and Ether are not considered securities. In giving this determination, Mr. Hinman laid out some key elements that are central to determining whether a security is being sold through a digital asset. These rules ultimately serve as a guideline for how forthcoming ICO tokens should be issued, distributed and sold with respect to U.S. Securities Laws.

Promoters and Reasonable Expectation of Purchasers

A primary factor in determining the legal status of an ICO is assessing the role of any centralised promoter or person that raises money to develop the network on which the digital asset will operate and often sell their token or coin. Generally speaking, popular promoters of well established tokens have shown a propensity to tout their ability to create innovative applications of blockchain technology. However, these ostentatious claims are typically made at the outset of the development of an application, where its viability is still relatively uncertain.

As such, given that there is generally no working product during ICO, the purchaser has no choice but to rely on the statements made by the respective promoter. This relationship then establishes a sentiment that the purchase of the token is a bet on the success of the enterprise, as opposed to the purchase of a token used for the exchange of goods or services on a network. This conduct stifles the impetus of the Securities Act, which is ultimately in place to remove any asymmetry between investor and purchaser.

Application to ICO Entrepreneurs

The fundamental prerequisite to avoid being represented as a security or investment contract for the purposes of the SEC is to be sufficiently decentralised. This would result in an environment or network where the efforts of a third party are no longer a key factor for determining the enterprise’s success. Such a network becomes truly decentralised when the ability to identify an issuer or promoter to make requisite material disclosures becomes difficult and increasingly less meaningful.

It is pertinent to also emphasise that the analysis of whether something is a security is not completely static. For example, Mr. Hinman noted that in spite of the fundraising that accompanied the creation of Ethereum, its network is currently sufficiently decentralised enough in its structure to not constitute a securities transaction. This may indicate that as technological advances occur and enterprise adoption for automation becomes easier over time, your respective token can take ongoing steps to increase its decentralisation to achieve compliance.

Contact our Experts

Should you require further analysis or assistance with regard to these updates, please do not hesitate to contact one of our ICO specialists at Salerno Law today!