The blockchain movement has inspired lots of talented people to get creative. In the last few years, we’ve seen decentralized ledger technology applied in innovative and imaginative ways that the mysterious Bitcoin founder and blockchain pioneer Satoshi Nakamoto probably never even dreamed of. Unfortunately, we’ve also seen blockchain inspire another group of people to get creative in a greedy and sinister way, piggybacking on the technology to try and get rich quick.
Most of these attempts have revolved around shady Initial Coin Offerings (ICOs). While ICOs are an effective model for launching a thriving blockchain network, many scammers co-opted the model, stripping away useful blockchain functionality in an attempt to issue useless (and worthless) tokens.
In general, most schemes boiled down to something along the lines of creating a token with no real purpose, build hype around the token, try to sell the token to as many people as possible and then run off with the money you made from the sale. Selling something useless by itself normally isn’t illegal, but these scammers often promised token holders that their purchases would be tradable on exchanges and increase in value. More legitimate businesses sought to use token sales as a fundraising method but failed to come up with viable use cases for their tokens and were essentially issuing thinly veiled stocks.
Regulatory bodies like the U.S. Securities and Exchange Commission (SEC) were quick to catch on, deem many tokens as unregistered securities and intervene. Obviously, selling unregistered securities is illegal and the SEC is not to be trifled with. Nearly every country has its own set of securities laws pertaining to issuance, investor protection, and promotion, meaning people running noncompliant ICOs could face hefty fines or even jail time in many jurisdictions. At first, shady ICOs just hoped to beat regulation due to the nascent nature of the model, but as soon as regulators began to crack down, a mad scramble occurred to dodge regulations and at least appear compliant.
At ICOBox, our clients’ business models are thoroughly examined and they have the luxury of both an expert legal team, versed in securities laws, and highly-skilled blockchain developers. Using this wealth of knowledge, we are able to craft the perfect, compliant token sale and blockchain business model, without having to cut corners or step into regulatory gray areas. Many other ICO projects can’t say the same and have resorted to some truly “creative” strategies to try and issue tokens while dodging regulators. We’ve selected the top three worst strategies we’ve seen illegitimate ICOs use to try and sidestep securities laws.
- Surveys – Many ICOs have claimed that they are selling utility tokens to try and hurdle securities regulations when they are essentially selling stocks not backed by equity. Utility tokens require clear and established use cases, which most of these ventures lack.
Since they don’t have a concrete business plan in place and are using the tokens solely as a fundraising tool, these ICOs try to weasel their way out of regulators’ grasps by requiring token purchasers to fill out surveys.
While the contents of these surveys vary, there is always a (leading) question asking if the buyer was treating the token as an investment or wanting to become part of the network. If a buyer checks the “investment” option, the ICO will not sell them any tokens (until they refresh the page and select another option). This strategy employs a lot of “wink, wink, nudge, nudge… if I don’t say it’s a security, then it can’t be…”
In the U.S., whether something is a security is determined by the Howey Test and not by questions that fake naivety or ulterior motive. Some carefully crafted surveys are legitimate and pass legal scrutiny, but relying on a survey to prove you aren’t selling unregistered securities can be a great way to have the SEC lawyers and a federal judge laugh in your face.
- Airdrops – One of the most popular means to issue tokens is by using the “airdrop” method, where the token recipients receive “free” tokens for signing up for a blockchain network. Recipients are often required to promote the ICO, refer friends or at least give the ICO their contact information.
While this may seem like a novel new way to grow a user base, companies tried similar tactics in the late 1990s issuing “free stock,” in exchange for promotion. The SEC did not take kindly to this, quickly flagging the move as illegal. No cash was being exchanged, but the company was gaining advertisement, and stockholders hoped to profit off increased valuation.
Airdrops are new only in name and already on the SEC’s no-no list
- Goods for Tokens – Several companies have rolled out “goods for tokens” model where they sell you an item, like a t-shirt, and then refund you the costs in what they believe to be the equivalent amount of their tokens. Once again, this method attempts to tiptoe around regulation by not technically selling you a token. The token issuer can claim they were “simply selling a t-shirt,” however, all they are doing is complicating the token sale transaction.
Selling someone a good and refunding them in tokens might as well just be selling them tokens, and if those tokens are deemed unregistered security, then you’re out of luck again.
The entire blockchain industry needs to stop dodging regulators and trying to get off on technicalities, and meet securities laws head-on. If blockchain is ever going to reach its full potential, startups need to get to work, consult experts and look for compliant ways to advance the sector, not just get rich quick.
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