SEC Asserts Authority: Some ICOs Are Legal, Some Are Not

Cryptocurrencies and initial coin offerings (“ICOs”) are subject to numerous federal and state laws. Dickinson Law has previously covered efforts by federal regulators to assert control over cryptocurrencies and ICOs under existing federal law. The SEC continues to assert its authority to regulate ICOs and cryptocurrencies as securities. 

July 10, 2019, the SEC qualified a Tier 2 Regulation A offering by blockchain company Blockstack PBC, the first such initial coin offering ("ICO") in compliance with securities laws. An ICO is a type of fundraising in which investors receive cryptocurrency tokens. Tokens can either serve a purpose in the company's provided service or simply represent investor equity.  In this particular ICO, investors would purchase Stacks Tokens in the general offering, which would operate as currency for inter-platform transactions such as uploading digital assets to the platform or  executing smart contracts.  The Blockstack platform is designed as a decentralized computing network, an alternative to traditional cloud computing.

Section 5 of the Securities Act of 1933 requires that an offering of securities either be registered with the Securities and Exchange Commission ("SEC") or be exempt from registration as provided in the 1933 Act or its attendant rules as issued by the SEC. Regulation A is one such exemption from registration. Regulation A is described as a limited public offering and operates on two Tiers. A Tier 1 offering is limited to $20 million in any 12-month period, while a Tier 2 offering is limited to $50 million and imposes investment limits on non-accredited investors.

In 2017, Blockstack issued tokens in an ICO exempt from registration under Regulation D, raising over $5 million in an offering which for compliance purposes was limited to Accredited Investors. Accredited Investors are those entities or individuals who meet the thresholds of net worth or income as defined in Rule 501 of Regulation D. The benefit of the Regulation A offering is that it is not so limited. In an effort to widen the investor pool, Blockstack invested approximately $2.8 million dollars in legal fees, accounting fees, investor verification services, marketing expenses, etc. to prototype a process for ICO securities compliance. The 2019 Blockstack ICO was the first SEC-qualified token offering, a new paradigm for token offerings in the US.

The ICO was open to investors from July 11, 2019 to September 9, 2019, with more than 75% of the round subscribed by September 5, 2019. In total, over 4,500 investors participated, investing more than $23 million. On October 18, 2019, there was a hard fork in the Blockstack network to accommodate issuance of the Stacks Tokens. A hard fork is a fundamental change in the blockchain protocol.

Concurrently with Blockstack's ongoing offering, the SEC issued an enforcement action against Telegram Group Inc. for failing to register their ICO, seeking, among other penalties, disgorgement with prejudgment interest of the more than $1.7 billion raised in the ICO. Currently, the SEC is engaged in efforts in the Southern District of New York Court seeking injunctive relief to prevent the distribution of “Grams,” the digital asset sold in the Telegram ICO. The SEC is arguing that as securities, the offering,  issuance and distribution of “Grams” requires compliance with Section 5, under which the offering would need to either be registered or exempt. A key component of the arguments presented will be whether or not the digital asset is in fact a security. The SEC has not moved from their opinion that these digital assets are generally securities, and is not expected to do so. However, the option for a compliant limited public offering under Regulation A is a step toward integrating blockchain technology into the securities regulatory framework.

Entrepreneurs interested in utilizing blockchain, cryptocurrencies, or ICOs as part of their startup need to be aware of the SEC’s recent activity in this area. This means consulting with knowledgeable counsel about whether a particular product may fall within the SEC’s jurisdiction.