Bitcoin, Ether, Litecoin! What are these superhero-sounding currencies? And, what, exactly, are initial coin offerings? Let’s get to it (in plain English).
What are cryptocurrencies?
(Crypto-whaaaa!?) Cryptocurrency platforms are decentralized peer-to-peer payment networks. Unlike national — a.k.a., fiat — currencies (i.e., Dollar, Yen, Ruble) cryptocurrencies aren’t tied to a particular country; nor are they physically circulated via “cash.”
Bitcoin was the first significant cryptocurrency to hit the market.
What Is The Main Difference Between Cryptocurrencies and Traditional Banks?
Cryptocurrencies, like Bitcoin, are built with blockchain technology, allowing for decentralization and superior security. Blockchain-based systems produce ongoing public ledgers of all transactions executed on a given platform. Moreover, once something is “recorded,” it can’t be undone. Traditional banks, on the other hand, are centralized and only allow account holders to see transactions in a statement.
How are cryptocurrencies generated?
Millions of calculations must be completed, daily, for cryptocurrency systems to function. Computers that solve these calculations earn tokens. The process is called mining, and it’s how digital currencies, like Bitcoin, are generated.
Think of it this way: Back in the day, prospectors mined gold; today’s prospectors use their computers to mine Bitcoin and other cryptocurrencies. Some miners even combine their resources into “mining pools,” which some folks claim is the most efficient way to earn tokens.
What are Altcoins?
In the cryptocurrency world there is Bitcoin, and Not-Bitcoin. Anything that isn’t Bitcoin is considered an “altcoin.”
Who can create a cryptocurrency?
Anybody. That’s right; you and nearly everyone you know can create a cryptocurrency. A lot of startups use Ethereum’s smart contract platform to launch ICO’s, which we will discuss more below.
What is an ICO?
ICO stands for Initial Coin Offering. Similar to IPOs (Initial Public Offerings), startups solicit funding by selling unique tokens. The tokens are integral to the project, but can also be traded on exchanges. How does it typically work? Let’s look at how some ICO’s use Ethereum’s platform.
- One: A startup creates a unique token — a.k.a., altcoin — using Ethereum’s platform.
- Two: The startup holds an initial coin offering where the public can buy the altcoin using Bitcoin or another established virtual currency, like Ether.
- Three: The startup exchanges the Bitcoin or Ether it raised — and voila, the project is funded.
The above may be an oversimplification of initial coin offerings, but it lays the groundwork for understanding the niche. In a nutshell just think of ICOs as the love child of crowdsourcing and IPOs.
To avoid the wrath of the SEC and/or CFTC, ICO’s should avoid using the term “investment” or “invest” in marketing materials.
How Common Are ICOs?
So far, in 2017, startups have raised over $320 million in ICOs. It’s outpacing venture funding, which is weighing in at $295 million for the same term.
Why do people invest in ICOs?
You may be cocking your head to one side, throwing the screen a side-eye, and thinking: Isn’t investing in ICOs ridiculously risky!? How can anyone benefit from made-up money!?
Those are fair questions. After all, not all startups succeed.
On the other hand, some startups hit it out of Fenway. (Ethereum’s ICO was originally priced at .0005 Bitcoin per ETH; at the time of this writing the ratio is .0819 Bitcoin per ETH.) So, if you participate in the “next Amazon’s” ICO, you stand to rake in millions.
Are cryptocurrencies considered “securities” subject to SEC oversight?
Though judges have christened crypto investment packages as “securities,” the jury is still out as to whether or not virtual currencies are inherent securities.
Judges use the Howey test to determine whether or not a cryptocurrency product or investment opportunity qualifies as a security. (SEC v. Howey)
Howey was a slick entrepreneur who owned a Florida orange grove. He invited people to tour his orange grove and buy one-acre plots. After someone bought, Howey made them sign a land maintenance contract.
Well, the SEC took Howey to court, claiming that his arrangement was actually an investment contract and thus a security. SCOTUS developed a test to establish the existence of a security.
- Someone must invest money;
- In a common enterprise;
- Where there is an expectation of profit that comes from the efforts of others.
If, however, legislators update language in the Securities Act of 1933 and Exchange Act of 1934, the Howey standard could change.
Risks associated with cryptocurrencies
A huge ambiguity currently taunting cryptocurrencies is classification. The legal status of virtual monetary systems is still up for debate. If the courts eventually deem them subject to the Securities and Exchanges Acts, the industry won’t be recognizable, and the profit potential may plummet.
Anticipating looming regulations, startups are structuring ICOs to comply with SEC exemptions. Some businesses are avoiding the US altogether by restricting investment access.
Fraud is another looming issue. Speculation is ripe, and the industry is nascent, so people are looking at ways to game it.
Connect With An Initial Coin Offerings Lawyer
Are you wrestling with a cryptocurrency legal issue? Want to chat with an attorney about the ins-and-outs of blockchain technology and initial coin offerings? Either way, we’re here and ready. Get in touch today to begin the conversation.
Kim, R. (2017, June 13). Initial Coin Offerings: A Growing Method For Blockchain Startup Financing. Retrieved September 03, 2017, from https://www.bna.com/initial-coin-offerings-n73014453179/
Sharma, R. (2017, June 14). Blockchain ICO Offerings Have Outpaced VC Funding This Year. Retrieved September 04, 2017, from http://www.investopedia.com/news/blockchain-ico-offerings-have-outpaced-vc-funding-year/
Roberts, D. (2017, June 21). Everything you need to know about initial coin offerings. Retrieved September 04, 2017, from https://finance.yahoo.com/news/everything-need-know-initial-coin-offerings-123332195.html