Initial coin offering (ICO)
An initial coin offering (ICO) is a method in which companies can raise money by issuing new tokens or coins to purchasers who deposit cryptocurrencies with the issuer.
These tokens offer investors access to a product or service offered by the company and the sale of the coin or token is meant to help the issuer further develop the service. The coins and tokens can fluctuate in value.
Typically, an ICO includes a new digital currency at a discount that is to be used later on the issuer's platform. If that cryptocurrency increases in value, the investor can make a profit. The tokens, however, do not grant the investor any stake or ownership in a company like a stock.
The early issuers of ICOs generally asserted that the coins and tokens are not subject to investment laws and regulation like those which govern initial public offerings.
The first known ICO was held in July 2013 by a firm called Mastercoin, later renamed Omni, owned by J.R. Willett. Willett, a software engineer, published a white paper in January 2012 called "The Second Bitcoin Whitepaper" which outlined the concept. In it, he posited the idea that "new currency layers" and "new protocol layers" could raise funds for services. Ethereum, the cryptocurrency, held an ICO in 2014.
In the first nine months of 2017, ICOs raised more than $2 billion in token sales in about 140 ICOs. Through the first three quarters of 2018, ICO's raised $18 billion, according to Coinschedule.com.
U.S. legal issues
In late 2017, the Securities and Exchange Commission (SEC) set about clarifying its views about oversight of the ICO market. In November 2017, SEC Chairman Jay Clayton said during a speech at the Institute on Securities Regulation in New York "I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security." In February 2018, Clayton said "I believe every ICO I've seen is a security." during a US Senate hearing. Such comments pushed the SEC into the ICO space along with a series of cases that established its authority.
In December 2017, the SEC got involved with its first two ICO cases. The first case was against PlexCorps, which raised $15 million on an ICO with a promised 13-fold return in less than a month. The other SEC case effectively forced California-based Munchee Inc. to halt its ICO in December 2017. The SEC found that Munchee's ICO "constituted unregistered securities offers and sales." In that case, Munchee, an online food review platform, sought to grow its network and eventually pay users for reviews with tokens. The SEC said Munchee emphasized that investors could expect the value of the tokens to rise, and it would support a secondary market for them, leading investors to believe they could generate a return on investments. Munchee halted its ICO quickly and returned any proceeds to investors.
In 2018 the SEC began issuing subpoenas and information requests in an investigation of the multibillion-dollar U.S. initial coin offering market, following a series of warning shots suggesting that many token sales might be violating securities laws. The SEC has also warned investors about scams involving ICOs.
In July 2018, a study published by ICO advisory firm Satis Group concluded that approximately 78% of ICOs in 2017 were scams.
In September 2018, a federal judge ruled the SEC's oversight does cover initial coin offerings. The case, the first for a U.S. federal court, revolved around charges brought by the Department of Justice against Maksim Zaslavskiy for illegal unregistered securities offerings and fraudulent conduct related to two ICOs, one involving REcoin Group Foundation LLC and another called DRC World Inc. The SEC said Zaslavskiy misrepresented the amount of money REcoion could raise, saying it could generate $2 million to $4 million, when the actual amount was about $300,000. Zaslavskiy also claimed the ICO tokens were backed by real estate and diamonds, and argued that the investments were not securities but currencies, which are outside SEC jurisdiction. The judge ruled, however, that "simply labeling an investment as a virtual currency or cryptocurrency does not transform an investment contract - a security - into a currency." The judge also ruled that Zaslavskiy would stand trial on SEC fraud charges related to the ICOs.  
Later that year, in December, the Wall Street Journal published its report on research conducted on 3,291 ICOs. The report said that 513, or 16% of the whitepapers studied contained evidence of plagiarism, identity theft, and promises of improbable returns. Many whitepapers had language that appeared to have been directly lifted from other published documents. Some included fake executive employee profiles on their websites, which used photos taken from people online without their knowledge or consent. Beyond this, over 2,000 of the reports examined included misleading or overly-promising language such as "guaranteed profit" or "no risk.”
Security vs. utility tokens
Typically, ICOs feature one of two types of tokens: security tokens and utility tokens. Being able to tell which is difficult to discern on an individual basis, making regulation complicated. Security tokens are digital assets that pass the Howey Test, while utility tokens tend to be used similar to preorders, discounts on the company's goods or services, or other functions that are not directly related to the growth of the company.
"The DAO Report"
In July 2017, the SEC released a statement that came to be known as "The DAO Report." The report was a breakdown of the recent attack on The DAO during its ICO, which resulted in hackers successfully stealing over a third of the DAO's tokens. The report highlighted the need for investor protection for ICOs, including but not limited to government regulation. It also specified that some ICOs may technically fall under the SEC's legal definitions for securities, making them subject to SEC regulations, as under such legal statutes, "the investment of 'money' need not take the form of cash."
On November 17, 2018, the SEC announced that it had settled cases against two issuers of ICOs, Airfox and Paragon. The firms had raised $15 million and $12 million, respectively, to fund blockchain-based commercial projects. In these cases, for the first time in ICO matters, the SEC did not allege fraud. It did require the defendants to pay significant fines, promise full restitution to investors and to register any securities that they issue.
Unfortunately for the Paragon ICO participants, the husband and wife founders of the company, fled the U.S. before paying either the whole fine or the amount to be refunded to the investors, ideally about $12 million. In April 2021, the SEC set up a fund of about $175,000 from the penalties paid by Paragon to the agency in order to compensate the investors.
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