No U.S. Investors Need Apply for Some Digital Coin Offerings

By Andrew Ramonas

What do the world’s largest aquarium and female entrepreneurs in Brazil have in common?

In both cases, potential U.S. investors were discouraged from buying digital tokens to back the ventures amid concerns about the reach of U.S. securities laws.

The fundraising mechanism known as an initial coin offering is increasingly off limits to U.S. investors looking to enter the red-hot market of token sales. Businesses with ICOs reportedly rake in millions of dollars on a regular basis without undertaking an initial public offering.

Uncertainty about U.S. securities laws in the emerging digital asset world has left Americans excluded from a number of ICOs, people who study and run businesses using cryptocurrency told Bloomberg BNA. One of the earliest recognized ICOs was held in 2013, according to crypto-finance research firm Smith + Crown. Halfway through 2017, there were 80 token sales that each raised more than $25,000 after only 69 secured that sum in 2016, the firm said. At least five ICOs have pulled in a minimum of $15.8 million since March. One secured $148.1 million.

The Securities and Exchange Commission this summer issued what’s known as a Section 21(a) report of investigation to clarify its authority over the sales. Federal securities laws may cover the offering, selling, and trading of digital assets by organizations using the distributed ledger technology known as blockchain, the agency said. The record-keeping tool is the foundation for bitcoin, ether, and other virtual currencies.

Although the SEC stopped short of taking enforcement action, the report “didn’t quite ease any fears” businesses using ICOs may have had about the commission, Smith + Crown research director Matt Chwierut told Bloomberg BNA. New ICOs prohibiting U.S. investor participation started to become more prevalent this year and have grown increasingly common in recent months, he said.

“Many token sales are barring U.S. persons from participating because of concerns around the U.S. SEC,” Chwierut said. “The potential of SEC enforcement understandably makes both the entrepreneurs wary and their off-chain backers uncomfortable.”

‘Way, Way Easier’

Aquarium enterprise PAquarium and banking services provider Moeda are two startups using ICOs that don’t accept U.S. investors.

Moeda, intended to help Brazilian women with small businesses, is expected to raise $5 million through its public digital token sale, none of it from Americans, co-founder and chief technology officer Brad Chun told Bloomberg BNA.

The startup enlisted brokers and platforms that perform know-your-customer and anti-money-laundering due diligence to verify the identification and residency of interested investors, he said. Moeda made available 5 million tokens pegged at $1 apiece for screened investors for the ICO, which started Aug. 28. Another 15 million tokens were available to investors through pre- and private sales.

The tokens can be traded on cryptocurrency exchanges and will change value based on market demand after the ICO.

Chun, who also runs a New York hedge fund that invests in digital assets, said that to Moeda, convertible notes and other more traditional ways of raising capital aren’t as attractive as an ICO.

“With other ventures in the past, I’ve done traditional financing,” Chun said. “If that’s the only option on the table, that’s great. But raising it through tokens or rewards-based crowdfunding, like donation-based crowdfunding, is way, way easier for a new company.”

U.S. Investor Bars

PAquarium, which wants to build an aquarium that makes the Guinness World Records, hoped to raise $120 million through its ICO, its business plan showed.

The Estonia-based startup offered for sale to prospective non-U.S. investors 1.2 billion PAquarium tokens valued at 10 cents apiece, according to its website. The ICO ran earlier this summer. As of Aug. 30, it wasn’t clear if the aquarium hit its $1 million “minimum milestone” to choose a location for the facility, promote it, and create a software application for a game.

PAquarium plans to let token holders trade their coins on exchanges. The startup also intends to give them annual dividend payouts and, with the purchase of at least 1,080 tokens, a lifetime entrance ticket.

Although PAquarium bars U.S investors from its ICO, it’s possible Americans still might have participated.

“We cannot be sure that every new upcoming transaction is outside the U.S.,” chief executive officer Ingus Staltmanis told Bloomberg BNA in an emailed statement.

‘Walking on Eggshells’

Sterling, Va.-based Loci Inc. has a different approach to avoiding ICO problems with U.S. regulators: Work with the SEC.

The technology startup hired lawyers to create a “Simple Agreement for Future Tokens” intended to satisfy SEC regulations during its pre-ICO and facilitate investments by U.S. persons in its patent search tool, CEO John Wise told Bloomberg BNA. Loci’s SAFT is akin to the “Simple Agreement for Future Equity,” a convertible note alternative in securities-based crowdfunding, he said.

The SAFT and the SAFE—pioneered by Silicon Valley startup incubator Y Combinator—are available to wealthy individuals known as accredited investors, according to company documents. Under federal law, these investors can take part in some offerings of unregistered securities, which may be riskier than those registered with the commission. Anyone, however, can participate in Loci’s public ICO, which the company is working on with the SEC in an effort to ensure compliance, Wise said.

Agency staff members are “very fair and reasonable people” who are trying to protect investors, he said.

“They just want to make sure that people that can’t afford it don’t get screwed out of their money, and for very good reason,” Wise said.

An SEC spokesman declined to comment for this story.

Loci’s pre-ICO, which began Aug. 14 and ends Aug. 31, could raise up to $11.205 million in exchange for 5 million LOCIcoins, according to the company. The price per token is pegged at the $2.49 equivalent in ether. The public ICO, which will start in October, could bring in as much as $74.7 million through its sale of 30 million tokens, the company said. LOCIcoin holders then can trade the tokens on exchanges or use them to buy Loci’s products or services.

The ICO process is “very efficient and fast,” Wise said. Loci has spent about $170,000 on lawyers and consultants in an effort to avoid problems with the SEC, he said.

“With so much uncertainty in the regulation, you’re walking on eggshells all the time, and you’re spending a lot of money to walk on eggshells,” Wise said.

SEC Probe

The SEC’s report of investigation, released in July, stated that tokens from the DAO, a decentralized autonomous organization, were securities, subjecting them to applicable U.S. laws. The virtual entity used its token sale in 2016 to raise about $150 million, roughly $50 million of which was stolen by a hacker, according to the SEC.

The DAO wouldn’t have qualified for a Regulation Crowdfunding exemption that would have relieved it of SEC registration, the agency’s Enforcement Division said. The unit decided against bringing charges in the matter, however.

The commission said it sought to caution investors and entities behind ICOs that issuers and sellers of securities aren’t immune from U.S. securities laws even if they are a virtual organization, deal in digital currencies, or use blockchain.

‘Rattlesnake Den’ in U.S. for ICOs?

ICOs were a hot topic at a financial technology conference that drew crypto-promoters from around the world to New York in August.

Several of them pitched projects, ranging from a real estate platform to software for businesses looking to use blockchain. Some said they excluded Americans from their token sales.

“Do you want to walk through a rattlesnake den or go to another neighborhood?” Nick Spanos, founder of cryptocurrency education organization Bitcoin Center NYC, asked Bloomberg BNA at the gathering.

The SEC is trying to “foster innovative and beneficial ways to raise capital, while ensuring—first and foremost—that investors and our markets are protected,” commission Chairman Jay Clayton said in a July statement about the DAO investigation.

U.S. regulators are “trying very hard” to understand the crypto-space, Dana Syracuse, a New York-based Perkins Coie LLP senior counsel who focuses on fintech, said at the conference. Entrepreneurs in the area should interact with the government and explain their business models, he said.

“When you’re talking to young companies, it’s dangerous to instruct them to turn a blind eye to regulation,” Syracuse said.

To contact the reporter on this story: Andrew Ramonas in Washington at aramonas@bna.com

To contact the editor responsible for this story: Phyllis Diamond at pdiamond@bna.com

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