SEC puts ICOs on notice: tokens are technically securities

REUTERS/Benoit Tessier/File Photo

(Reuters) – Wall Street’s main regulator, the Securities and Exchange Commission (SEC), said on Tuesday that initial coin offerings (ICOs), a means of crowdfunding for blockchain technology companies, should be subject to the same safeguards required in traditional securities sales.

ICOs have become a bonanza for digital currency entrepreneurs, allowing them to raise millions quickly by creating and selling digital “tokens” with no regulatory oversight.

But the SEC has said that the tokens can be considered securities, and therefore, may need to be registered unless a valid exemption applies.

“The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets,” said Stephanie Avakian, the co-director of the SEC’s enforcement division.

The decision reminds blockchain startups that they cannot ignore investor protections, and could make some potentially more cautious about fundraising via coin sales in the United States.

By mid-July, tech firms raised about $1.1 billion in 89 coin sales this year, roughly ten times more than that in the whole of 2016, according to data compiled for Reuters by crypto-currency research firm Smith + Crown.

And this year alone, there are 110 upcoming ICOS, according to tokendat.io, a website that tracks token sales.

“This is a shot across the bow for many of these ICOs,” said Preston Byrne, a technology attorney who specializes in virtual currencies. “I think it ruins the party in the US for sure.”

Some ICOs have drawn criticism because they failed to accurately disclose token distribution, such as what proportion of tokens would be held by founders or whether the offering would be capped.

As many of these tokens are then listed and traded on virtual currency exchanges, large holders could in theory have the firepower to control the price.

Critics have also warned that projects often lack realistic business plans or are being led by individuals who do not have enough experience.

The SEC’s decision was released in an investigative report into a virtual organization known as The DAO. The DAO was created in April 2016 by a blockchain company called Slock.it.

A blockchain is an online ledger of transactions maintained by a network of computers, which gained prominence as the technology that underpinned digital currencies such as bitcoin.

The DAO was designed as a decentralized crowdfunding model in which anyone could contribute ethereum tokens to be a voting member and have an equity stake in the organization. Ethereum is another cryptocurrency.

Although it raised $150 million as of late May last year, an anonymous hacker later funneled $60 million of the tokens into a separate account.

The SEC said in its report it has decided not to bring civil charges at the end of its probe into The DAO, but instead use the case as a cautionary tale for the market.

(Reporting by Gertrude Chavez-Dreyfuss and Anna Irrera in New York, writing by Sarah N. Lynch; editing by Richard Chang, Carmel Crimmins and Bernard Orr)

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