An Ultimate Guide to Launch An SEC Compliant ICO

An Ultimate Guide TO Launch an SEC Compliant ICO

Corey A. Washington

Jennifer M. Greenlee

FORWARD BY Ernesto Lee

securedestate.io

Copyright

Copyright © 2018 by Corey A. Washington and Jennifer M. Greenlee. All rights reserved.

Published by Consultants Network Publishing, United States.

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ISBN 978-1-942864-46-2 (print book)

ISBN 978-1-942864-47-9 (ebook)

Printed in the United States of America

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This book is for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Purchase of this book, access to the Secured Estate website (www.securedestate.io) or any of the e-mail links contained within the site do not create an attorney-client relationship between Washington Law PLLC (washingtonpllc.com) and the reader or browser. The opinions expressed at or through this book are the opinions of the individual author and may not reflect the opinions of the firm or any individual attorney.

FOREWORD

Blockchain technologies are a combination of nascent technologies that require a new way of thinking. Blockchain is not just about computers, computer security, and applications. It is also about the legal protections that are associated with the Blockchain benefits. Blockchain is a composite field involving computer science, mathematics, database and network management, user training, and legal and policy issues. While the former topics have received wide interest and coverage, the legal and policy issues surrounding Blockchain are effectively a new landscape. A common objective in Blockchain based projects is to tokenize an asset and utilize the Blockchain benefits of immutability, decentralization, safe and secure records and data, disintermediation and transactional trust. While Blockchain makes these benefits a reality, there are critical questions that are only now beginning to be answered: what is the asset? Is it money? Is it currency? Is it legal tender? Most importantly, is it a security from the perspective of the SEC? These critical questions require deep legal analysis by the minds of Corey Washington and Jennifer Greenlee.

Consider the explosion of the Internet, social media, smart phones and tablet computers. They have been playing a larger role in our daily lives. Most of this technology is connected together by standard protocols. It has become so common place that we have lost the wonder of what it means to be interconnected. Knowledge has been commoditized and made available to all. Combine this technological explosion with the fact that money is now viewed in the light of cryptoeconomics. This combination foreshadows the next generation of technologies in which interconnected networks stand alone and execute transactions that may or may not involve legal tender. Entrepreneurs as well as large and small companies are racing to build networks that are both hyper focused on a business solution and that execute purely on the transactions of goods and services through a private internet. People are beginning to comprehend the true potential power of Blockchain in which one wonders what the world would look like to not simply build an application on the internet but to quite literally build a private internet. Existing networks are operated by governments and commercial organizations—and are vulnerable to attacks and misuse through their internet connections. Blockchain technologies are not only prepared for such events. They include defenses into the protocols themselves making them economically unviable to hack. This system has a built-in reward mechanism – tokens. As a result, token analysis is a very important concern for entrepreneurs, businesses, and governments. Not only do we need to be aware of how these systems are built, but we also need to learn how the systems fit into the legal framework of the United States.

This book provides a valuable window on Blockchain tokens and covers the necessary analysis required to successfully navigate the SEC. This book is just technical enough and just legal enough to seamlessly weave together Blockchain technology in a legal context. Because of its uniqueness, and newness, Blockchain is rapidly becoming the tool of choice for disruptive applications. It has exploded so quickly that the legal community has often struggled to keep pace. The SEC is only now providing guidance for cryptocurrency based projects. This book serves as a sunstone to help navigate the waters. Technology and legal concerns are closely related. When developing an ICO, we need to consider how the token is viewed by government regulators. We must also consider the impact on privacy and combine security risk assessment techniques with privacy risk assessment techniques. Risk assessment is a critical process for defining both the probability and impact of undesired events. Its objective is not to eliminate the risk, but to provide the policy and methodology by which risks could be managed.

These challenges are both difficult and interesting. People are working on them with enthusiasm, tenacity, and dedication in order to develop new methods of analysis and provide new solutions to keep up with the ever-changing legal threats and technological opportunities. In this new age of global interconnectivity and decentralization, it is necessary to provide anyone involved in an ICO with state-of-the art knowledge on the frontiers of Blockchain including the legal aspects. This book is an excellent step in that direction.

Ernesto Lee

CTO, Blockchain Training Alliance

EXECUTIVE SUMMARY

In the past year we have witnessed the cryptocurrency market surge to heights beyond what even the most enthusiastic and optimistic investors could have imagined. Bitcoin, Ethereum, and other cryptocurrencies have soared in value as a result of cryptocurrency frenzy. There are already countless new cryptos known as altcoins emerging on a near daily basis, catering to several applications of Blockchain flooding the market.

One new development that has arisen from this cryptocurrency craze is a phenomenon that has gripped the tech world. The Initial Coin Offering (ICO) is revolutionizing the way startups raise funds, shifting away from traditional Initial Public Offerings (IPOs), in favor of crowdfunding or leveraging the help and influence of venture capitalists (VCs).

Since the first successful ICO in 2013, a flood of ICOs have been launching every other day. In 2017 alone, 235 ICOs were launched raising close to $3,700,000,000 with Filecoin (257,000,000) and Tezos ($232,319,985) being frontrunners.

If you’re reading this book, you are probably considering launching your own ICO to develop a crypto-based project(s). There will be many tales of rags-to-crypto-riches swirling around. And perhaps, you could be one of them.

But don’t be silly.

Invest not to be duped.

The fact is that a myriad of shrewd entrepreneurs have been conned in this game simply because they were imprudent. A recent study commissioned by Bloomberg found that only one out of ten tokens issued in ICO is actually in use following the sale. The study identified regulatory clarities and legal concerns as the key challenges facing those wanting to launch successful ICOs.

As is the case with the majority of buzz-worthy trends, once the dust settles on ICOs, you may start asking, Is it really worth it? Even if you are a savvy investor, plenty of misinformation is swirling around about ICOs. This can make things confusing from a legal perspective. Before you rush off and jump on the ICO bandwagon, it is vital that you become familiar with what an ICO is, its underlying technology, and relevant legal perspectives.

ICOs and cryptocurrencies are incredibly complex, and most people who talk about them really don’t understand the intricacies at all. This book is here to help you understand all the abstract ICO information you need in order to help you launch successful ICOs that are security compliant.

Welcome.

CHAPTER 1: INTRODUCTION TO CRYPTOCURRENCIES, BLOCKCHAIN, AND ICOs

Cryptocurrencies are the latest sensation in the financial world. The first virtual currency, Bitcoin, was conceived in 2009. Now the market has over 1300 different cryptocurrencies and assets with a cumulative market capitalization exceeding $615B. ICOs (Initial Coin Offerings) are one of the most popular mediums through which virtual currencies are entering the market.

This chapter will walk you through the basics of cryptocurrencies, ICOs, their history, advantages, and risks along with insights into the emerging regulations and the future of ICOs.

Cryptocurrency 101

Before we dive into our explanation of cryptocurrencies, let’s first define money. We will also explain how to correlate conventional (fiat) money and cryptocurrencies?

What is money?

This is one of the easiest questions to answer, after all, money is the main thing that we use in an economy—and surely, we must know what it is. At the outset, money is just a means of exchange. It is a medium that allows a person to trade in whatever he or she has for what he or she wants. For instance, if you wanted to buy a pair of shoes, you would use money as a means of exchanging the pair of the shoes between you and the seller.

Money can also be used to measure value. For example, by working hard at your job you may have created value in the form of life savings. You may have developed a business empire or built a house. Obviously, when you dispose of these assets, the only thing that can measure their value (worth) is money.

The best form of money is one that allows people—the free market—to decide what they really want to use as currency. History has shown that people will cultivate trust in money they are using if it has the following characteristics:

It is scarce: Its supply cannot be manipulated.

It is durable: It is not perishable and can act as a store of value.

It is fungible and divisible.

It is portable: The high concentration of value should allow people to carry it and store it in significant volumes.

To understand money as both a means of exchange and a store of value, we must look back to the first methods of trade. Before conventional money was invented people engaged in direct barter. For example, if you were a farmer producing beans and wanted a pair of shoes for your family, you would have to find someone who had a pair of shoes and wanted beans.

Imagine the hurdles involved in finding that perfect match of a trader who had exactly what you wanted and wanted exactly what you had to offer. Challenges like the rarity of a perfect trading partner gave rise to indirect barter. Continuing with the aforementioned example, let’s assume that you found someone selling a pair of shoes but he or she didn’t want beans. Perhaps, he wanted sugar.

While having a chat at the local bar a friend of yours might have overheard someone next to him saying he wanted beans in exchange for sugar. Obviously, you would have to sell your beans for sugar and go back to the shoemaker to trade the sugar for shoes. In this instance, you would have conducted an indirect barter by using sugar as a means of exchange.

Historically, different commodities were used as a means of exchange but the hurdles of durability and marketability created obstacles. Food became a necessary and highly exchangeable commodity. But the primary issue with food was that it was perishable. You had to use it immediately or trade in it before it went bad.

Over time, precious metals such as gold and silver became standard means of exchange. Because these metals didn’t rust, they were ideal economic commodities and were widely utilized as a means of exchange. Nevertheless, precious metals were ultimately replaced by government-supplanted paper currency as a result of deceit and laziness on the part of goldsmiths.

Gold miners would take gold to goldsmiths for minting. In turn, the smith would give the miners a receipt to be redeemed when minting was completed. Miners could instantly trade the receipt as though it were gold and return to the mines without waiting for the gold to be minted.

Over time, goldsmiths realized that the receipts they were issuing were being used as a means of exchange. To increase their purchasing power, miners began to use fraudulent receipts which had no gold backing. This gave rise to a significant number of outstanding receipts which led to inflation and diluted the value of all other outstanding receipts.

Eventually, governments introduced paper currency. Paper currencies such as the U.S. dollar have value because governments grant them the legal tender status and only accept taxes that are paid through them. But central banks have increasingly marred the issuance of the fiat currencies the same way the miners did with precious metals.

Many central banks in different jurisdictions have issued more receipts—paper money—than they had for precious metals to back them. The results have been disastrous on a global scale. We can see a prime example of why cryptocurrencies are increasingly being adopted by looking at the relationship between Bitcoin prices and government regulation in Zimbabwe.

Zimbabwe has long been known for hyperinflation. Whenever the market prospects look poor, the Bitcoin prices soar. What is the reason for this correlation? Savvy wealthy investors understand how undependable the local currency can be. These knowledgeable investors turn to Bitcoin as a means of safely moving their wealth out of the country.

The spike in Bitcoin prices in Zimbabwe and other countries provides a sneak preview of what will likely occur in the future when faith in regulatory institutions and government agencies wane. Historically, governmental control of factors of currency supply and demand have proven disastrous.

In fact, entire governments have been completely toppled as a result of the problems that often face fiat currencies. Due to government errors, frailties and weakness, the popularity of fiat money has been waning. Now cryptocurrencies are stepping up to fill this gap.

So, what is a cryptocurrency?

A cryptocurrency is a form of digital or virtual money designed to work as a means of exchange. Cryptocurrencies use cryptography to verify and secure transactions as well as to control and manage the creation of new units of a given cryptocurrency. Essentially, these currencies are just limited entries in a database which no person can change unless specific conditions have been met.

Cryptocurrencies emerged as a result of the 2008 financial crisis. Previous central bank policies along with decades of regulatory oversights inspired resentment of the financial industry. Consider the illustration below:

Alice lives in the US. She wants to send some money to Bob who lives in the UK. Alice informs her local bank that she wants to wire the money to Bob. Alice’s bank contacts the local Reserve Bank—which in this case is the Federal Reserve—to notify them of the transfer and the Federal Reserve quietly informs the IRS, FBI, DEA, NSA or even the CIA.

If these agencies approve the transfer, the Federal Reserve contacts the central bank of Bob’s country which in this case is the Bank of England. The Bank of England then contacts Bob’s local bank. Finally, Bob withdraws the money from his local ATM branch in the UK.

Now, to illustrate why financial resentments have been building over time, let us break down what has just happened:

There are 6 discrete steps that have just occurred in the above scenario and at each step there is the potential for human error. In addition, each step carries with it a transaction cost that makes the entire process expensive.

Alice