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SEC initial coin offering (ICO) report

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The US Securities and Exchange Commission (SEC) has just issued a report warning that Initial Coin Offerings (ICOs) may be deemed to be securities, making them subject to United States’ securities laws. This will depend on the economic realities of the transaction (is it an investment transaction for capital raising purposes), regardless of the terminology or technology used in implementing the transaction.

The report comes off the back of an investigation into the legality of tokens issued by virtual organisation The DAO.  DAO is an acronym for digital autonomous organisation.  The DAO itself was a decentralised venture capital type fund that raised crypto currency (Ether) to invest in blockchain and other projects. Unfortunately, vulnerabilities in The DAO’s code were attacked, putting The DAO’s funds at risk.  This ultimately led to unwinding of The DAO (at least as it was originally conceived).

The SEC was tasked with considering whether The DAO had violated United States securities laws, which hinged on the question of whether The DAO tokens were securities under US law.  The SEC found that The DAO tokens were securities.  They decided not to pursue enforcement action, but considered it to be in the public interest to warn those who use ICOs or other blockchain technologies to raise capital in the United States to ensure compliance with US securities laws.  Interestingly, as well as firing a warning shot across the bows of issuers and promoters of ICOs, the SEC also said that investors have a greater responsibility to look out for ICO red flags.

What does this mean for the current wave of ICO activity?

  • In the short term, probably a migration of companies planning ICOs to countries with favourable regulatory regimes.  We hear blockchain/crypto startups mention Singapore often for this reason.
  • In the medium term, if ICOs are going to crack the mainstream, they will need to square up to regulatory compliance in the United States as this is by far the world’s biggest capital market (and we can’t see crypto or blockchain changing that).  At the same time, we expect that the SEC will need to move to accommodate the industry to some degree, as the American startup ecosystem, not to mention financial markets, will not wish to miss this movement in its entirety.

As far as we are aware, New Zealand’s equivalent of the SEC, the Financial Market’s Authority (FMA), has not given any detailed consideration to the regulation of crypto currencies/ICO’s in this country.  Since New Zealand’s securities laws have their original genesis in the United States Securities Exchange Act 1933, and the regulators at the FMA have a pretty similar consumer protection focus to the SEC, we’d expect them to reach similar conclusions to those in the SEC’s The Dao report.  Meaning that New Zealand’s fledgling blockchain and crypto sector will need to work with regulators and officials to achieve a workable regulatory position, if it is to grow into a major industry in this country.

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