TRANSCRIPT FROM JULY 20TH AMA (ASK ME ANYTHING) / BY ROD TURNER
Hi to all,
Please know that I am not an attorney! I have learned a great deal by working closely with some of the best securities attorneys, but that's the extent of it. I am happy to answer your questions.
Please make use of the Search feature on Manhattan Street Capital, top right of our home page. We have a great deal of compliant ICO and Reg A+, Reg D and Reg S information, including cost and schedule guides.
Here is our Compliant ICO program. The page is about to get a proper design treatment to make it look beautiful, but the content is relevant and good.
I hope you gain knowledge from the questions and answers generated during the recent AMA.
Q: Many people are curious about cryptocurrencies, but they are usually explained in technical terms and a large portion of the population is left out because they do not understand it. Can you please explain in simple terms about cryptocurrencies and how they are a great asset to invest in, including by investing in ICOs?
Upfront disclaimer: What I describe is not yet being delivered completely. The speeds, efficiencies, costs, and security of cryptocurrencies and the Blockchain are being rapidly enhanced and more needs to be done and is being done.
Cryptocurrencies like Bitcoin are built on a new technology called Blockchain. They co-exist with Tokens, which provide many more features than currency and are used for many different purposes than cryptocurrencies. Tokens also are built using the Blockchain.
Bitcoin is most famous because it was the first cryptocurrency and the first Blockchain created. It has been in existence since 2008.
Bitcoin is a new type of currency/money that is intelligent. In many ways, it is the opposite of cash. When you pay someone in cash, they can deny that you paid them. When you pay someone with Bitcoin, the Blockchain makes a permanent record that you paid them, automatically, without the need for human beings to be involved.
I think of Bitcoins as intelligent digital coins that know where they are stored, how they got there, who owns them and their history.
Because Bitcoin is not the currency of any single nation, the price of Bitcoin is independent of central banks and interest rates and inflation -- on a country by country basis. The price of Bitcoin is primarily the result of changes in demand for it and supply of it.
The reason that the Blockchain matters and that it will add value beyond the status quo is that it adds these new capabilities:
1) A secure record of transactions. For example, when an accountant makes a mistake and corrects it, the Blockchain records both the mistake and the correction permanently.
2) The Blockchain distributes its records around the world in an innovative way so it is far more difficult for bad actors to corrupt or manipulate.
3) The Blockchain makes it possible to build token and coin systems that have no person or entity in charge. This is already true of Bitcoin, and the fact that there is no person or entity to target makes it much more independent than say Google or Facebook when a government wants to force them to release private member information or to control what is done/said on the system.
4) The Smart Contract software used in the Blockchain automates, restricts and controls what is allowed on any particular coin or token system automatically, 7 days, 24 hours a day.
When the above new capabilities are used in new innovative ways, then cryptocurrencies are just the beginning of the useful products and services that can be brought to market.
Low-cost money transfers anywhere in the world instantly made, securely and at very low cost.
Tracking food from the original source will enable rapid and precise identification of which field on what farm caused a salmonella outbreak.
Similarly, tracking individual car components from the initial manufacturer will enable precise and efficient fixes to component failures.
Using tokens as a way to own and trade micro slices of assets like real estate or of commodities, profit streams in new medicines and giving control to individual consumers over the uses of their own information for medical, marketing use and more, will open up more efficient deployment of capital, improve the efficiency of payments for work by removing the need for middlemen, and provide more individuals income and control over their personal information.
And this is just the start!
Q: Is using Blockchain technology necessary and advantageous? Why or why not?
In some cases yes, in others no. This is a long topic that I cannot do justice to here. ICOs that make superficial use of Blockchain do not resonate with investors and have a harder time raising capital, as one would expect.
Q: Is there an ICO that was successful enough to start a company that has been able to generate value for a sustained period?
Pretty much the only ICO that has been around long enough to pass your test is Ethereum. It was the first ICO, and it is a real business today, which of course is no guarantee that it will prosper in the future, although if the management team does a good job they are well situated to do well medium term. Which is not the same thing as saying that their investors will do well from the Ethereum coin increasing in value. Ether has appreciated greatly for the early investors, so if they sold now they will have done well. See chart. They are related but separate variables.
There are numerous companies that have completed ICOs and have promise, but it is too early to say they are winners. The huge surge in ICOs began in 2017. It's a very new phenomenon.
Most ICOs raise money before they have built the tokens/coins and infrastructure. This is inherently more risky than investing after proof of the model has been delivered.
Q: Where can one find existing or upcoming ICOs? Would you recommend for one to invest in an already existing ICO that could cost more rather than invest in an upcoming one which carries a higher risk of the unknown?
If you Google "Active ICOs" or "ICO Lists," you will find many. Ideally, if you have the time and the skill, researching those that are at an early stage might get the best returns when you find a winner. However, it's easier to identify those that are showing success post-ICO, so that has merit too. But this is not foolproof because with low trading volumes trading prices can be boosted by marketing and announcements that may not really have much relationship to how the fundamentals of the business are building. Basically, be careful and don't let emotions cause you to take risks you might regret later.
Q: How does an ICO work?
A company sells coins (or more often tokens) that are created in a platform like Ethereum, and smart contracts that govern the ways that the tokens or coins can be used, the rights of the owners and a lot more.
The company markets their ICO to potential investors to raise the capital to build the tokens, smart contract and other parts of their system, or in an existing business, to expand.
Investors are able to invest before the tokens and smart contract have been built, and the ICO company typically gives lower prices for the tokens that are bought in the early stages, and progressively reduces their discounts (thereby raising the price per token) as time goes on. When the tokens and smart contracts have been developed/completed, they are delivered to the investors.
For ICOs to raise capital in some countries, the process is regulated to protect investors; the US is the best example of this.
A whitepaper is written that describes the plan, in detail. For ICOs that raise capital in some countries, particularly the US, more legal documents/contracts are required than just the whitepaper.
I recommend that you read the whitepapers of a few ICOs and you will learn a great deal more than I am saying here.
Q: How can an Initial Coin Offering be profitable?
I am not saying that any particular ICO will be.
But they can be profitable to the token owners through appreciation of the token price over time, and as more sophisticated ICOs are introduced, some will include equity style ownership of the company; some will provide dividend payments and profit sharing.
The companies themselves and token owners can also be profitable from earnings generated by active use of a vibrant Blockchain network where payments are made for services.
In my view many hugely over-funded ICOs will fail in time because the company culture often focuses on hiring, scaling up and spending while losing sight of the real goals of generating customer traction, revenues and profits.
This happened many times in the Internet Bubble.
Q: Where can one find some Initial Coin Offerings to support?
I suggest that you search for ICO listings and similar. There are many sites listing ICOs that are live for investing, some of which have basic editorial or ratings. The challenge is to identify the good ones, and that takes time and effort.
Q: What are the risks of contributing to an ICO?
That you will lose all your investment. In more detail:
Weak or unreal team;
No demand for what they do;
Well-funded competitors overrun them;
Trends or regulations evolve that work against the business;
It's a marginally appealing ICO that raises too little money to prosper;
Internal founder disputes kill the business;
Key players leave;
And many more.
If the tokens are to be provided to enable US people to participate in the token system for the features that your Blockchain provides, not as a way to raise capital, then you are not making an investment offering and the tokens can be simply provided free or sold for a nominal cost. This would not be a Securities transaction, so it would not require an SEC regulation or exemption to take place. Other regulations might apply.
Q: What does a European ICO issuer need to do to be able to offer its utility tokens to US investors?
If the tokens are to be provided to enable US people to participate in the token system for the features that your Blockchain provides, not as a way to raise capital, then you are not making an investment offering and the tokens can be simply provided free or sold for a nominal cost. This would not be a Securities transaction so it would not require an SEC Regulation or exemption to take place. Other regulations might apply for commodities or money exchange. It's still necessary to tread carefully to make sure that you don't accidentally step into the security offering zone.
If your objective is to raise capital by selling the tokens to investors that buy them anticipating to make a profit (see the Howey test) then the transaction will be viewed by the SEC as a Securities offering that must be done using Reg D for US investors. For non-US companies you can follow the regulations of your home country for non-US investors whilst accepting investments from US investors via Reg D. You must make sure that US investors are not shown the non-US investment terms.
Reg D investors have a one year holding period before they can sell their tokens. They must be Accredited investors.
The SEC allows you to conduct the US and non-US offerings on different schedules, so you can start in Europe first, and then go live to US investors when you are ready.
Q: What is the difference between an ICO and an ITO?
ITO refers to an initial token offering while ICO refers to the Coin variant. Because of the very high awareness of the ICO term, it is often used in a somewhat inaccurate way to describe token offerings that are clearly not launching a new currency/coin like Bitcoin -- which is the origin of the ICO label. Tokens are used for many different purposes. STO is a Security Token Offering, meaning that the ICO is conducted in a Securities rule compliant manner.
Q: What country has the most restrictions on ICO and which has the least?
China probably has the most restrictive environment, but they keep contradicting themselves. The US is really the most restrictive.
Least restrictive would be The Bahamas and a changing list. Switzerland made more restrictions and is now softening them because they are losing too many people in the Blockchain business who are going elsewhere.
Q: What country do you think will take the first step to improve its legislation for Blockchain?
I expect that Singapore, Hong Kong, and Switzerland will take the lead in making regulations that remove ambiguity. Clearly, the US leads the way in the regulation of securities offerings, commodity trading and more.
Q: What in your opinion is the most valuable COIN now?
Your question implies future value versus current value. Probably Ether because it is leveraged by all the new ICOs that build on it. Bitcoin might get interesting when all the mining capacity is used up.
Q: What is the most valuable space in your opinion in terms of ICO investment?
I feel that we have a long way to go to reach a functional Blockchain that can deliver on the promise. So to me, some of the best areas are in improving the Blockchain: security, speed, scaling. These are examples. Invest at your own risk!
Q: How do you do your accredited investor verifications for Reg D? Is it in-house or are you partnering with a provider?
We use a third-party service that is integrated into our platform. Accreditation verification is a requirement of Reg 506c, which is the method best used for non-US companies to raise capital from US investors. Reg A+ is better for liquidity because it is not limited to accredited investors, but only companies that have their HQ in the US or Canada can use Reg A+.
Q: If I file a Reg. CF (crowdfunding) for a small fund, raising less than $1,070,000 in any 12-month period, but having over 1,000 small shareholders, do I have to file the fund under the 1940 Act?
Only if you are acting as an equity investment fund -- then yes, I believe so.
Q: Are STOs only available for accredited investors?
That is true when Reg D is the vehicle that is used. When Reg A+ is used, the investors can be of any wealth level. Check Manhattan Street Capital for more on Reg A+ using the search box -- top right on the homepage.
Q: How do I know if an ICO is worth investing in?
There is no way I can advise you in a useful way on that.
The below are not sufficient but they are a start:
A strong and seasoned team of real people?
Vesting ownership for founders?
Genuine need for what they are doing?
And so much more.
Q: How does one know if an ICO falls within SEC jurisdiction and it's compliant?
If an ICO is offered to US investors, it falls within the SEC's jurisdiction. It is challenging to determine if an ICO is compliant, even for me, because a lot of what it takes is under the surface. The smart contracts and token software must be developed so they enforce the SEC regulations where needed. Verifying this early on is difficult since for many ICOs if they have not yet been developed. At the surface level, make sure that they are enforcing "know your customer," Anti Money Laundering and if relevant, accreditation verification professionally.
Q: Could you name the common mistakes to avoid when preparing an ICO?
Over-optimism is the biggest risk; both for the usual reasons, but more critically for regulatory ones.
"My token is a utility anyway" is very risky and likely the wrong conclusion.
Some people are too idealistic and think that any company can call the SEC and get the rules changed because to some, they seem too difficult.
Doing things like gifting tokens to all token investors and not realizing that the gifted tokens are then securities.
International ICO CEOs have a much easier time raising capital outside the US because they are often allowed to raise capital by paying commissions to people who bring in investors. So they tend to assume the same method will work in the US, which is not the case at all. Therefore, the idea of having to pay a marketing agency to drum up demand is hard for them to buy into.
Forgetting to do the post-ICO raise filings with the needed authorities.
Mixing US investment terms with non-US investment terms is a big no-no, and few ICOs are aware of the SEC regulations that apply.
Q: What is the future evolution of SEC compliant ICOs?
They will tend to normalize. More equity ownership. More conventional investors and credibility. Things like vesting for founders will become normal. The size of raises will trend towards what is actually needed vs. whatever can be raised. More clarity in regulation will take place, and the regulators will become more comfortable with what they are and on what is needed from them. More will use Reg A+ -- particularly via a convertible note tied to the Reg A+ for the liquidity benefits combined with bringing in early capital at discounted prices.
Q: What are the characteristics of the people who invest in ICOs?
The people who typically make up the majority of investors in ICOs at the level of 80 to 90% are what I call the Bitcoin wealthy. Young people who are technically savvy and got involved in Bitcoin and the Blockchain very early and made a fortune, many times unintentionally.
They are motivated by positive disruptive change on a large scale. They like democratic access, participation, and very large scale concepts which can build a huge token Network. They are generally less interested in profits, equity ownership and dividends, unlike conventional investors.
Q: What regulations apply when a company with a launched product wants to create a token economy by issuing utility tokens without doing an ICO?
If the utility is not launched as a way to raise capital as an investment, then the SEC regulations do not apply. Others may, like commodities and money exchange regs. This is a great way to go for many situations.
Q: How did you learn about Blockchain technology and what did you find intriguing about it?
I learned about it from friends and articles. In my view, the application of the Blockchain will add to productivity, security, economic growth and democratic access in a very big way. This time reminds me of the early internet days. I see huge potential.
It's intriguing for reasons I stated above and because my company has been in the business of helping companies raise capital via the same regulations, especially Reg A+, so it's a natural extension of our expertise and business.
Q: If I do an "STO" for a "hedge fund" in the US with a Reg. C filing, am I subject to registration under the Investment Company Act of 1940?
Assuming that, if you limit the number of investors to less than 100, I think you must mean a "Reg D"? Then no, you don’t. If you exceed 100, then you can operate as a lending fund where at least 60% of assets are held in simple debt instruments and no more than 40% can be in equity instruments. Not measured on each deal you do. Otherwise, you are required to adhere to the Act.
Q: What’s your take on ICOs for start-ups? Is this a viable financing source for early-stage firms?
Yes, better than one might expect. Many ICOs make a continuous offering that is analogous to conventional seed, series A, B, C and liquidity rounds, all in a short time.
Q: What are some other problem areas that you think you will see for ICOs in 2018?
If cryptocurrencies continue to trend down in price, the easy money from the suddenly wealthy crypto owners will be reduced, making it much more difficult to raise capital.
Another one is companies making strap-on ICOs where they aren't aware of the ways you make a highly appealing token model work. These will have a lower success rate.
Q: What are some of the legalities that could affect crypto adoption? Are there currently any laws in place that could make it difficult for companies to pay their employees in cryptocurrency if they chose to receive it as such?
Commodity regulation, SEC investment regulations, exchange of money regs from FinCen, and more. Some vary according to the specific business.
The key is to find the relevant ones to a given ICO and do what's needed to be legitimate.
This will get clearer with time.
Q: What's the viewpoint of the SEC on ICOs?
The SEC views about 99.9% of ICOs to be security transactions that they regulate.
Q: How can crypto startups decide if their token is a security or a utility?
Beyond the Howey test, the keys that I see are:
If people buy tokens to profit from owning them, it's a security offering.
If the price is fixed forever, it's a utility.
If the ICO is decentralized so that no one controls it or profits from it through ownership of it, then it might be a utility.
Q: With some of these dark scenarios out of the way, do you see any bright or hopeful spots for Blockchain or crypto within the United States and in the eyes of the SEC?
I do see the freeze is starting to thaw now. I believe the SEC wants to see a thriving Blockchain sector in the US and as they gain clarity on it, they will enable it.
My company has a strong pipeline of compliant ICOs, many for sizable established companies. Many of them are waiting for the smoke to clear and then they will launch.
Q: The legal side of Blockchain is still controversial. When you hear people telling you how opposed they are towards Blockchain, what do you tell them?
If they are open, then I explain the fundamental merits of the Blockchain and how there are great companies making ICOs in a regulated manner that are very different from the excesses of the past. If not, I wish them well and move on.
Q: What are the legal implications of an already operating crypto to be later declared a security? How would those results differ for a cryptocurrency project that is based in the US, and for one that is based in another country?
The implications are very severe if this takes place in the US. The company would probably have to refund all investors and start again. The situation is different for a non-US ICO that has not taken investment from US investors. In this case, it may be possible for the company to make a regulated offering to US investors while retaining the non-US progress they have made.
Q: What’s the most exciting part about being in the Blockchain and Cryptocurrency space?
In my view, the application of the Blockchain will add to productivity, security, economic growth and democratic access in a very big way. This time reminds me of the early internet days. I see huge potential.
Q: What is going to be the future evolution of SEC compliant ICOs?
In my view, SEC compliant ICO's will evolve to normalize over the coming years. More conventional investors will engage with them and the mix of investors will be far less dominated by the Bitcoin wealthy. We will see a trend towards more conventional ownership where Equity ownership and token participation will be combined. Investors will demand this. I also expect the regulatory environment to gradually become more clear. I expect the SEC will adjust the regulations in the medium and long-term as well the CFTC and FinCen and other regulators so that the US climate for the Blockchain will become more receptive. We will see increased use of Reg A+ as more ICO's recognize the liquidity benefits and advantages of legitimately approaching non-accredited investors.
Q: How will a non-American ICO work with the SEC regulations?
Non-American ICOs can work with the SEC regulations by using Reg S, which was written especially for non-US companies to raise capital outside the US while complying with SEC regulations, and by using Reg D for US investors. See our International ICO program. Non-US ICOs can also use the regulations of their non-US home country for investors outside of the US while using Reg D for US investors.
Q: What do you think about ICO regulation from governments, as more than half of ICOs are currently reported to be scams?
More regulation is needed, and I hope it will be implemented in a balanced manner.
Q: If a company was thinking about embarking on an ICO, what advice would you give them?
For companies thinking about making an ICO, the first and most important issue is to identify a genuine market and one that appeals to the people who are actually investing in ICO's, which are primarily the Bitcoin wealthy.
It's important to avoid making an ICO which is inherently very limited in scope. An example is a company that may have 2,000 customers and 1,000 vendors and the potential to multiply those by 10. While token/Blockchain systems may add a great deal of value to the company, this is unlikely to appeal to the people that invest in ICO's because the scale of the token economy is limited or at least appears so.
Then, of course, the next issue is to align with the best service providers such as my company! The three most important ingredients after having defined the tokens and Blockchain system are: tremendous securities attorney advice, marketing expertise that is delivered cost-effectively by experienced agencies, and a functional and easy-to-use investment platform that makes it convenient for investors to invest even if they don't have a wallet ready, and of course satisfies the regulations.
Thoroughly defining the token system and the way the Blockchain works and how the number of tokens will be managed is a key. Also, demonstrating commitment to the company by tying the owners and key management to vesting of income and ownership is critical. Investors want reassurance that the team will be dedicated long-term to the success of the business.
There's a lot more to say here but limited time, so I will stop at this point!
Q: Why does the VC community want to align with Bitcoin? How do you think ICOs will impact venture capitalists going forward?
I am not sure they do. VCs are already adapting and investing in Blockchain companies at an early stage. Those VCs which do not adapt will likely lose share and momentum with time. I find it kind of funny how VCs have for a long time only invested in startups that have already magically raised capital and reached the "proof it works" stage. The whole ICO phenomenon has forced them to become genuine seed investors -- what we wanted and needed for years!
Q: A Utility token with no monetary value is given away for free to users of a platform. The token then begins trading for Bitcoin on worldwide digital exchanges. The token issuing platform then trades their token reserve for Bitcoin on these exchanges. Are they breaching USA law by trading their token reserve on a secondary market without legally registering with regulatory agencies?
I think that in this case, they would probably be in the clear. It would depend on what was stated at the time the tokens were first distributed. My sense is that if done carefully this would be OK. FinCen registration is probably needed for the currency exchange part.