ICO (Initial Coin Offerings) FAQ

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ICO (Initial Coin Offerings) FAQ 2018-02-25T17:16:34+00:00

ICO (Initial Coin Offering) FAQ

 

What Is An ICO?

An Initial Coin Offering (ICO) is a relatively unregulated way to raise capital with the use of crowdfunding your company by using cryptocurrency.

In an ICO campaign, a percentage of a newly created cryptocurrency or token/smart contract for a particular project is sold to early backers of the project in exchange for legal tender or other cryptocurrencies, such as Bitcoin.

ICOs use blockchain technology to bridge the gap between crowdfunding and investment.

Think of an ICO as similar to an IPO (“Initial Public Offering”) to raise capital, yet without having to offer equity (“ownership”) of your company.

 

What is a virtual currency, virtual token or coin?

A virtual currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, unit of account or store of value.  Virtual tokens or coins may represent other rights as well.  Accordingly, in certain cases, the tokens or coins will be securities and may not be lawfully sold without registration with the U.S. Securities and Exchange Commission or pursuant to an exemption from registration.

 

What is a virtual currency exchange?

A virtual currency exchange is a person or entity that exchanges virtual currency for fiat currency, funds, or other forms of virtual currency.  Virtual currency exchanges typically charge fees for these services.  Secondary market trading of virtual tokens or coins may also occur on an exchange.  These exchanges may not be registered securities exchanges or alternative trading systems regulated under the U.S. federal securities laws.  Accordingly, in purchasing and selling virtual coins and tokens, you may not have the same protections that would apply in the case of stocks listed on an exchange.

 

Who issues virtual tokens or coins?

Virtual tokens or coins may be issued by a virtual organization or other capital raising entity.  A virtual organization is an organization embodied in computer code and executed on a distributed ledger or blockchain.  The code, often called a “smart contract,” serves to automate certain functions of the organization, which may include the issuance of certain virtual coins or tokens.  The DAO, which was a decentralized autonomous organization, is an example of a virtual organization.

 

What is a blockchain?

A blockchain is an electronic distributed ledger or list of entries – much like a stock ledger – that is maintained by various participants in a network of computers.  Blockchains use cryptography to process and verify transactions on the ledger, providing comfort to users and potential users of the blockchain that entries are secure.  Some examples of blockchain are the Bitcoin and Ethereum blockchains, which are used to create and track transactions in bitcoin and ether, respectively.

 

Are ICOs legal?

The simple answer is maybe. It depends on how the ICO is structured.

ICOs have been relatively unregulated. Some compared the landscape similar to the Wild West. They are subject to laws of their local jurisdiction.

On July 25, 2017, the U.S. Securities and Exchange Commission issued an investor bulletin on initial coin offerings.

In essence, a particular ICO may be ruled as a security and regulated by federal securities laws.

As a rule of thumb, you cannot sell stock or share profits in your company with an ICO, or it will most likely be defined as a security.

Some companies may choose to operate their business and launch ICOs outside of SEC jurisdiction. In those cases, ICOs are not allowed to solicit U.S. citizens without proper registration with the SEC.

Looking forward, we anticipate additional compliance procedures and laws as the ICO market continues to evolve.

 

What are some key points to consider when determining whether or not to participate in an ICO?

If you are thinking about participating in an ICO, here are some things you should consider.

  • Depending on the facts and circumstances, the offering may involve the offer and sale of securities.  If that is the case, the offer and sale of virtual coins or tokens must itself be registered with the SEC, or be performed pursuant to an exemption from registration.  Before investing in an ICO, ask whether the virtual tokens or coins are securities and whether the persons selling them registered the offering with the SEC.  A few things to keep in mind about registration:
    • If an offering is registered, you can find information (such as a registration statement or “Form S-1”) on SEC.gov through EDGAR.
    • If a promoter states that an offering is exempt from registration, and you are not an accredited investor, you should be very careful – most exemptions have net worth or income requirements.
    • Although ICOs are sometimes described as crowdfunding contracts, it is possible that they are not being offered and sold in compliance with the requirements of Regulation Crowdfunding or with the federal securities laws generally.
  • Ask what your money will be used for and what rights the virtual coin or token provides to you.  The promoter should have a clear business plan that you can read and that you understand.  The rights the token or coin entitles you to should be clearly laid out, often in a white paper or development roadmap.  You should specifically ask about how and when you can get your money back in the event you wish to do so.  For example, do you have a right to give the token or coin back to the company or to receive a refund? Or can you resell the coin or token? Are there any limitations on your ability to resell the coin or token?
  • If the virtual token or coin is a security, federal and state securities laws require investment professionals and their firms who offer, transact in, or advise on investments to be licensed or registered.  You can visit Investor.gov to check the registration status and background of these investment professionals.
  • Ask whether the blockchain is open and public, whether the code has been published, and whether there has been an independent cybersecurity audit.
  • Fraudsters often use innovations and new technologies to perpetrate fraudulent investment schemes.  Fraudsters may entice investors by touting an ICO investment “opportunity” as a way to get into this cutting-edge space, promising or guaranteeing high investment returns.  Investors should always be suspicious of jargon-laden pitches, hard sells, and promises of outsized returns.  Also, it is relatively easy for anyone to use blockchain technology to create an ICO that looks impressive, even though it might actually be a scam.
  • Virtual currency exchanges and other entities holding virtual currencies, virtual tokens or coins may be susceptible to fraud, technical glitches, hacks, or malware.  Virtual tokens or virtual currency may be stolen by hackers.

 

How can I recover funds in the event of investing in a fraudulent ICO?

Investing in an ICO may limit your recovery in the event of fraud or theft.  While you may have rights under the federal securities laws, your ability to recover may be significantly limited.

If fraud or theft results in you or the organization that issued the virtual tokens or coins losing virtual tokens, virtual currency, or fiat currency, you may have limited recovery options. Third-party wallet services, payment processors, and virtual currency exchanges that play important roles in the use of virtual currencies may be located overseas or be operating unlawfully.

Law enforcement officials may face particular challenges when investigating ICOs and, as a result, investor remedies may be limited. These challenges include:

  • Tracing money.  Traditional financial institutions (such as banks) often are not involved with ICOs or virtual currency transactions, making it more difficult to follow the flow of money.
  • International scope.  ICOs and virtual currency transactions and users span the globe. Although the SEC regularly obtains information from abroad (such as through cross-border agreements), there may be restrictions on how the SEC can use the information and it may take more time to get the information.  In some cases, the SEC may be unable to obtain information from persons or entities located overseas.
  • No central authority.  As there is no central authority that collects virtual currency user information, the SEC generally must rely on other sources for this type of information.
  • Freezing or securing virtual currency.  Law enforcement officials may have difficulty freezing or securing investor funds that are held in a virtual currency.  Virtual currency wallets are encrypted and unlike money held in a bank or brokerage account, virtual currencies may not be held by a third-party custodian.

 

What are potential warning signs of investment fraud?

  • “Guaranteed” high investment returns.  There is no such thing as guaranteed high investment returns.  Be wary of anyone who promises that you will receive a high rate of return on your investment, with little or no risk.
  • Unsolicited offers.  An unsolicited sales pitch may be part of a fraudulent investment scheme.  Exercise extreme caution if you receive an unsolicited communication—meaning you didn’t ask for it and don’t know the sender—about an investment opportunity.
  • Sounds too good to be true.  If the investment sounds too good to be true, it probably is. Remember that investments providing higher returns typically involve more risk.
  • Pressure to buy RIGHT NOW.  Fraudsters may try to create a false sense of urgency to get in on the investment.  Take your time researching an investment opportunity before handing over your money.
  • Unlicensed sellers.  Many fraudulent investment schemes involve unlicensed individuals or unregistered firms.  Check license and registration status on Investor.gov.
  • No net worth or income requirements.  The federal securities laws require securities offerings to be registered with the SEC unless an exemption from registration applies. Many registration exemptions require that investors are accredited investors; some others have investment limits.  Be highly suspicious of private (i.e., unregistered) investment opportunities that do not ask about your net worth or income or whether investment limits apply.

 

What is the legal definition of an accredited investor?

The following is the legal definition of an accredited investor.

An accredited investor shall mean any person who comes within any of the following categories, or who the issuer reasonably believes comes within any of the following categories, at the time of the sale of the securities to that person:

(1) Any bank as defined in section 3(a)(2) of the Act, or any savings and loan association or other institution as defined in section 3(a)(5)(A) of the Act whether acting in its individual or fiduciary capacity; any broker or dealer registered pursuant to section 15 of the Securities Exchange Act of 1934; any insurance company as defined in section 2(a)(13) of the Act; any investment company registered under the Investment Company Act of 1940 or a business development company as defined in section 2(a)(48) of that Act; any Small Business Investment Company licensed by the U.S. Small Business Administration under section 301(c) or (d) of the Small Business Investment Act of 1958; any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality of a state or its political subdivisions, for the benefit of its employees, if such plan has total assets in excess of $5,000,000; any employee benefit plan within the meaning of the Employee Retirement Income Security Act of 1974 if the investment decision is made by a plan fiduciary, as defined in section 3(21) of such act, which is either a bank, savings and loan association, insurance company, or registered investment adviser, or if the employee benefit plan has total assets in excess of $5,000,000 or, if a self-directed plan, with investment decisions made solely by persons that are accredited investors;

(2) Any private business development company as defined in section 202(a)(22) of the Investment Advisers Act of 1940;

(3) Any organization described in section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust, or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5,000,000;

(4) Any director, executive officer, or general partner of the issuer of the securities being offered or sold, or any director, executive officer, or general partner of a general partner of that issuer;

(5) Any natural person whose individual net worth, or joint net worth with that person’s spouse, exceeds $1,000,000.

(i) Except as provided in paragraph (a)(5)(ii) of this section, for purposes of calculating net worth under this paragraph (a)(5):

(A) The person’s primary residence shall not be included as an asset;

(B) Indebtedness that is secured by the person’s primary residence, up to the estimated fair market value of the primary residence at the time of the sale of securities, shall not be included as a liability (except that if the amount of such indebtedness outstanding at the time of sale of securities exceeds the amount outstanding 60 days before such time, other than as a result of the acquisition of the primary residence, the amount of such excess shall be included as a liability); and

(C) Indebtedness that is secured by the person’s primary residence in excess of the estimated fair market value of the primary residence at the time of the sale of securities shall be included as a liability;

(ii) Paragraph (a)(5)(i) of this section will not apply to any calculation of a person’s net worth made in connection with a purchase of securities in accordance with a right to purchase such securities, provided that:

(A) Such right was held by the person on July 20, 2010;

(B) The person qualified as an accredited investor on the basis of net worth at the time the person acquired such right; and

(C) The person held securities of the same issuer, other than such right, on July 20, 2010.

(6) Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year;

(7) Any trust, with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a sophisticated person as described in §230.506(b)(2)(ii); and

(8) Any entity in which all of the equity owners are accredited investors.

 

What is KYC?

KYC (“Know your customer”) is the process of a business identifying and verifying the identity of its clients. The term is also used to refer to the bank and anti-money laundering regulations which govern these activities.

Know your customer processes are also employed by companies of all sizes for the purpose of ensuring their proposed agents, consultants, or distributors are anti-bribery compliant. Banks, insurers, and export creditors are increasingly demanding that customers provide detailed anti-corruption due diligence information.

Depending on the jurisdiction, an ICO may be subject to the KYC rule.

 

What is AML?

AML (Anti-money laundering) is a term mainly used in the financial and legal industries to describe the legal controls that require financial institutions and other regulated entities to prevent, detect, and report money laundering activities. Anti-money laundering guidelines came into prominence globally as a result of the formation of the Financial Action Task Force (FATF) and the promulgation of an international framework of anti-money laundering standards. These standards began to have more relevance in 2000 and 2001 after FATF began a process to publicly identify countries that were deficient in their anti-money laundering laws and international cooperation, a process colloquially known as “name and shame”.

An effective AML program requires a jurisdiction to criminalize money laundering, giving the relevant regulators and police the powers and tools to investigate; be able to share information with other countries as appropriate; and require financial institutions to identify their customers, establish risk-based controls, keep records, and report suspicious activities.

In theory, electronic money should provide as easy a method of transferring value without revealing identity as untracked banknotes, especially wire transfers involving anonymity-protecting numbered bank accounts. In practice, however, the record-keeping capabilities of Internet service providers and other network resource maintainers tend to frustrate that intention.

While some cryptocurrencies under recent development have aimed to provide for more possibilities of transaction anonymity for various reasons, the degree to which they succeed—and, in consequence, the degree to which they offer benefits for money laundering efforts—is controversial.

Depending on the jurisdiction, an ICO may be subject to the AML rule.

 

I want to launch my own ICO. How do I make sure my ICO is completely legal?

Contact a legal professional in your jurisdiction.

If you want to Launch Your Own ICO and need assistance, our team of professionals can help you.

 

What is the typical timeframe to launch my own ICO?

Several factors that determine the timeline for an ICO completion.

Some factors include:

  • Are you making your ICO offer available to U.S. investors? If so, you may be required to register your offering with the SEC, which can add as many as 90 days for approval.
  • The complexity of the programming for your “smart contract.” Some are more complex than others.
  • Your marketing budget. If you have a minimal budget, you may be forced to employ more of guerrilla marketing tactics, which may take longer to see results.

Companies take anywhere from 4-6 months from start to completion.

 

What are a few successfully funded ICOs?

Here is a sample of the many successfully funded ICOs:

NAME STARTUP IDEA TIME TO
RAISE FUNDS
AMOUNT RAISED (US$)
FileCoin Blockchain data storage 60 minutes 252,000,000
Tezos Create a new Blockchain 13 days 230,000,000
Bancor Unclear 3 hours 153,000,000
The DAO Autonomous corporate investment vehicle 25 days 150,000,000
TenX Digital currency payment platform 48 hours 83,000,000
Brave New browser for advertising 30 seconds 35,000,000
Stor Cloud storage 7 days 30,000,000
Aeternity Smart contract platform 7 days 24,000,000
Ethereum New Blockchain 45 days 18,000,000
InsureX Insurance services on the Blockchain 3 days 17,000,000
Mysterium VPN reselling services 45 minutes 14,000,000
Patientory Medical data stored on Blockchain 3 days 7,200,000
Quantum Resistant Ledger Blockchain to resist quantum computers 24 days 4,100,000

 

What are the typical costs to start an ICO?

To provide a better understanding, of the expenses, you should know the steps that are involved in the ICO process.

  1. Product Development & Advisory
  2. Platform & Technology Development
  3. Legal & Compliance Advisory
  4. Whitepaper Writing
  5. Smart Contract & ICO Coin Development
  6. Digital Marketing
  7. ICO Pre-Sales Management
  8. ICO Community & Investor Relations
  9. Escrow & Custodial Advisory
  10. Distribution & Treasury Management
  11. Security Audits

Some of these steps are more costly than others, based on skill sets needed.

As an example, the cost of the programming depends on the complexity of the smart contract. Also, the cost of auditing the smart contact reflects its complexity.

In the end, the success of an ICO great depends on a successful digital marketing and PR campaign.

As with anything, you can have the greatest mousetrap in the world, yet if no one knows about it, you will easily be lost in the noise.

Based on all of these necessary steps, initial costs can go anywhere from $150,000 – $500,000 with $300,000 being the average. Plus, it’s not uncommon for ICO companies to receive a small portion of the amount raised, which is how they will earn a majority of their profits and have a vested interest in the success of your project.

If the SEC may possibly consider your ICO as a “security” and you desire to make your ICO available to U.S. investors, the average cost increases to about $400,000, due to the increased fees in security attorneys and fees with the SEC.

Current prices will fluctuate as the market continues to evolve.

Yes, launching an ICO can get pricey. Nonetheless, if your ICO is a great idea that raises millions of dollars, it may make sense to consider an ICO.

 

How much money can and ICO raise?

If you plan to solicit U.S. investors, there may be limits due to your security filings with the SEC. Otherwise, there are no limits on the amount of money that you can raise.

Keep in mind that there is no guarantee of any particular dollar amount that will be raised. Any company that claims a guaranteed dollar amount raise should be considered questionable unless the offering is underwritten, which is rare in the ICO space.

 

ICO Glossary

ICO (An initial coin offering) –a way to raise funds from the public.  A company creates a new bitcoin-like cryptocurrency and offers it for sale to the public.  Sometimes ICOs are described as a cross between traditional public offerings and crowdfunding. In 2017, more than 70 startups raised money this way.

Token – is a form of a crypto currency in other words a digital coupon that is sold for fiat currency (USD, EUR) or crypto currency of liquid value (Bitcoin or Ethereum). Tokens can have various functions, for example, they can give access to services of the company, but not the ownership rights to it.

Blockchain –  is a history of transactions that uses cryptography to link timestamped batches of events together in order to make it evident if tampering has occurred. Blockchain facilitates direct exchange of value between parties, without the need for a trusted intermediary. For example it means that in block chain digital code confirms transactions, while in traditional economy centralized authority validates a contract between two parties. It is important that data written to a blockchain can never be changed and is visible to everyone. Blockchain runs on an entire network of computers, meaning there is no single system that can fail or be compromised. But it is suited to storing small transaction records only.

Fork – is a technical event in a block chain, when two miners find a block at the same time. In result subsequent blocks are added to one block, while the other block gets abandoned by the network.

Hash function –is a cryptographic function that takes any text as input, then chops it up and returns a string of characters of a set length as output.  For bitcoin mining, a specific hash function is used called SHA-256.  The input can be any set of characters – from simple “hello world” to a Shakespeare sonnet.  The output will always be a string of letters and digits 64 characters long that looks like this: e3b0c44298fc1c149afbf4c8996fb92427ae41e4649b934ca495991b7852b855

SHA stands for Secure Hash Algorithm.  It was designed by the United States National Security Agency, but currently is in public domain.

Mining – is mining means searching for new blocks to continue the chain of bitcoin transactions. A chain of completed transactions is a block chain. Blocks are hard to produce. Miners have to compute a cryptographic hash of the block that meets certain criteria; typically a valid block must start with a certain number of zeros:

000000000000002e9067f1cf7252333f7aeb619c89d220985a70ac0e015248e0

Many cryptographic hashes need to be computed before the right one is found. Miners run computer programs on specialized hardware that automates the process of securing the network. For each block of transactions validated, the successful miner receives bitcoin reward.

Blockchain scaling – reducing the time of operation needed for every transaction. Each transaction in a block chain is shared with every member of the network. This makes the transaction process transparent, but slow and uncompetitive with VISA or SWIFT. The problem lies in a parameter called the “the block size limit”.  Its increase would lead to centralization of Bitcoin since only big company’s would be able to afford the storage space and computing power. This is contrary to Bitcoin’s idea and philosophy.

Smart contracts – digital contracts, blockchain contracts, also called self-executing contracts – computerized transaction protocols that execute terms of a contract. These contracts are converted to computer code, stored and replicated on the system and supervised by the network of computers that run the block chain. In other words, the system of smart contracts automates the process of legal interaction between the two parties: upon completion of the terms of the agreement automatically transacts the payment. Smart contracts are needed for avoiding third parties, cost reduction, cutting legal red tape and time needed for each transaction.

Crypto currency – is a digital or virtual currency, an alternative to fiat currencies and centralized electronic money. The underlying technical scheme for crypto currency production is based on hash functions – mathematical operations run on digital data. Thus, each unit of crypto currency is an encrypted code. Crypto currency helps to secure transactions and it’s a cheaper way to produce money. Anyone can buy crypto currency on specialized sites after creating a wallet in the internet. The first crypto currency to appear was Bitcoin.

Altcoin – Any crypto currency except Bitcoin, which is positioned to be better than Bitcoin and is aimed at replacing it. There are hundreds of altcoins, some use the same hashing algorithm as Bitcoins (Namecoin), others use scrypt algorithm like the popular Litecoin. There are crypto currencies using innovative hashing algorithms – Ethereum is Bitcoin’s biggest rival.

SCAM (“con”,“MLM”, “hack”) – A fraudulent or deceptive company that is using an ICO model to raise funds with no intention to proceed with the project development.

ANN (announcement on the announcement board) – is the first message to appear about an altcoin to be launched.

Whitepaper – is an official document released by the company that is planning to launch an ICO. The document provides potential investors with information about the project, the market and potential risks. The white paper is needed to pursue investors in funding the project and normally answers why the product needs a token, which services will be available for tokens, why the demand of these services will grow in the future.

Escrow wallet or escrow account – a financial arrangement where a third party holds payment of the funds required for two parties involved in the transaction. It’s a transparent procedure of returning funds to investors. Escrow wallets hold funds until the terms of the agreement are completed, after that the payment becomes available (e.g. new altcoins become available for sale and exchange).

 

ICO Timeline

History of the question in milestones

2008 – a software developer Satoshi Nakamoto proposed an electronic payment system based on mathematical proof. He called it Bitcoin and suggested it to be a new digital currency that is produced thanks to mathematical formulas and specific software programs. Nakamoto argued that Bitcoin allows to avoid digital currency to be spent in two places. With Bitcoin one entity could confidently transact value directly with another entity without relying on a third party.

2012/2013 – Blockchain 2.0 appeared as developers understood that underlying Bitcoin technology can be used for all kinds of other cooperation.

2013 – Mastercoin launches its crowdfunding campaign on Bitcointalk forums. It was one of the first projects to use an ICO. Mastercoin was also one of the first attempts to suggest altcoins  and use a meta-protocol written above Bitcoin blockchain with an aim to provide additional features to Bitcoin.

2015 – a second-generation block chain system called Ethereum is launched. Ethereum’s innovation is based on smart contracts and enables to validate deals, payments and contracts without using traditional legal procedures with the help of blockchains.

2017 – the crypto currency market is facing two main problems: legal regulation and block chain scaling process development. The resolution of the latter is crucial for the future of crypto currency in the face of Bitcoin centralization.

 

Can you help me conduct my own ICO?

Whether you are starting from scratch or have an existing ICO, we can help you!