The Committee of Financial Services met with Congress this week to examine the economic efficiencies of Cryptocurrency and ICO Markets.
From these discussions, Congress will be tasked with balancing the needs of investor protection, efficient markets, and technological innovation as they propose new regulations to guard this new area of capital formation. As Congress determines whether to regulate and classify ICO’s as a security (under the SEC) versus a commodity (under the CFTC), their discussion of the Cryptocurrency and ICO Markets raised the immediate concerns of adequate disclosure, transparency, and accountability for issuers of ICO and Cryptocurrency.
Although there is no currently recognized framework for ICO “offering documents”, the conservative approach is to treat ICO’s as a private placement of securities (however, that raises the additional issue of whether tokens can be freely exchanged since most private placements are for restricted securities, which is a completely separate topic).
As the Committee tries to understand and put structure around the ICO/Cryptocurrency Markets, it was proposed that the following disclosures be addressed and raised to potential investors and buyers of ICO’s:
- Promoter and Management Location. The origin of the issuer is important, not only for accountability, but also the jurisdiction of law in determining investor rights.
- Technology Proposition: The investor needs to understand the basic problem (and market) that technology is solving, and the panel proposed the following measures to protect investors: (i) Plain English Description of the Technology (without hyperbole); (ii) Third Party Validation and Technology Audit to allow investors to determine the strength of the technology; and (iii) Public Code Repository so that investors can perform their own Due Diligence.
- Identification of Forward Looking Statements. Investors need to distinguish between historical facts and milestones accomplished by the issuer versus the future endeavors of the issuer.
- Intellectual Property Ownership of the Token. If Tokens are open-source, that raises the underlying issue of whether technology asset is owned and controlled by the issuer, thereby triggering the valuation of the token/issuer.
- Access to Post ICO Financials. The investor should be informed of whether they will be provided to the issuer’s financials after the ICO so that they can monitor performance of the project.
- Token Description. Investors should understand why the token is unique and differentiated from all other types of Altcoins.
- Blockchain Governance. As a distributed ledger and community verification are critical to the success of cryptocurrencies, investors should be informed on how the blockchain will be regulated and monitored.
- Legal Rights of Token Holders. Investors should understand their property and contractual rights when owning a token, as well as the mechanism for handling disputes.
- How Tokens will be Traded and the System of Exchange. Trading rules specific to the platform must be addressed and made known to the investor.
- Risk Factors to the Issuer, Tokens and Industry. To protect the issuer, they should be transparent on the many ways an investor can lose all of their money. One risk factor unique to Cryptocurrency is technology obsolescence and continuous support to make sure the platform is sufficiently functional within the particular technological environment.
To show good faith by the issuer to comply with regulators, I recommend following this framework in preparing their ICO documents.
In the end, I am optimistic that the majority of Congress is open-minded to Blockchain and Cryptocurrencies, but it appears that Congress, itself, is still trying to understand the technology powering this new frontier. As such, there may not be any additional regulatory clarity in the upcoming months to serve as guidance as various competing interests must be weighed in order to produce an efficient market without stifling any technological progress.
Click here for more about this week’s Congressional Meeting on the Examination of Cryptocurrencies and ICO Markets.
Aaron Woo, Partner | McCullough Sudan, PLLC
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