What Crypto Investors need to know about ICOs and STOs
Most cryptocurrency investors have some experience with ICOs. Even still, there are a lot of complexities involved in investing in and trading with ICOs. Marc Boiron has a vast amount of experience with ICOs, from both the investor and issuer point of view and joins us today to share his unique perspective on ICOs, STOs, and where he sees the future of both going.
There are a lot of complexities involved in investing in and trading ICOs. Marc Boiron, our guest today, has a vast amount of experience with ICOs, from both the investor and issuer point of view. Marc joins us to share his unique perspective on ICOs, STOs, and where he sees the future of both going.
Marc's practice has been focused entirely on the crypto and blockchain space since 2017 - his experience and knowledge is uniquely multi-faceted. [00:40]
Marc: I got interested in Bitcoin in 2015, on a more technical level than anything else. It's all I wanted to talk about and think about. Since the second quarter of 2017 my entire practice has been in the blockchain and crypto space, doing work with individuals or businesses. There's the work on ICOs and STOs. There's work on crypto funds. There's work that I'll do on just generally using cryptocurrencies in an ecosystem outside of the context of an ICO. I'll do some work on exchanges. Lastly, I work on mining farms - contract work or working with partners on leases and real estate related issues. Really kind of broadly across the spectrum.
ICOs & STOs may seem similar, but there are some important distinctions to understand. [2:26]
Marc: Generally speaking, I think of an ICO as anything where a cryptocurrency or utility token, that is not a security, is being sold. That's different from an STO where you can think of it as anything that is a security that is being sold. That might be a utility token that happens to be a security anyway, or that can be something that is intentionally a security in terms of equity. In between the two, where it's very convoluted, is where you've got instruments like a SAFT (Simple Agreement for Future Tokens) that converts into a token that is intended to not be a security. I usually throw those in the ICO category, where it's kind of a private ICO, but in the end you have a token that is not a security.
Often people think of an ICO as a public sale to a broad number of people. I think of an ICO also to include a private sale where a company is going to a few investors, or a large number of of private investors, usually high net-worth individuals, and selling oftentimes, and almost exclusively now, a SAFT.
Generally, both the ICO issuer and the ICO investor are going to be taxed based on the cost basis to develop or acquire the coin and the coin's fair-market value. [04:40]
Marc: Generally speaking an ICO is going to be taxed. I think of it like you're selling a product. The IRS has said that utility tokens, specifically Bitcoin and other virtual currencies, are property. The general view has been that utility tokens will be treated in the same way. You're selling property, which means that it is like selling a widget - a company will sell a widget and get taxed on the value of that widget, the fair market value or the price at which that token specifically is sold. Most of the time there's very little cost that went into developing that token. There's essentially a zero basis being the cost, and a fair market value being the price of what it was sold for. The tax is going to be the difference between the two.
For individuals, if we talk about a token that's actually been purchased - you know what your cost is at that time. If you've purchased it for $1, your basis is going to be $1 - at least at the time of that purchase. When you go ahead and sell it for $2, then you have a $1 gain.
Understanding the taxation of ICOs and airdrops requires knowledge of the regulatory framework underlying them. [8:00]
Marc: Most people know that a security is a defined term in the Securities Act. One of the terms that is included in the definition of securities is an investment contract - which depends on whether it meets certain factors in the Howey Test. Those factors are whether there's been an investment of money in a common enterprise, with an expectation of profit, based predominantly on the efforts of others. When you look at that in the context of a traditional ICO, I think it's pretty clear there's an investment of money - something is being given to the company in exchange for those tokens. In a common enterprise, everyone who's contributing to that ICO is in the same pool and their risks, in terms of profit or loss are going to be pooled together. There's going to be an expectation of profit - that's how almost all ICOs are sold. And, it's going to be from the efforts of the issuer who is actually selling them.
When you take an airdrop, the question becomes, is there an investment of money? The factor that we usually take for granted as present in an ICO, might not exist in an airdrop.
If you look at a true airdrop, where there is no whitelisting, and you're not giving your name and email address - one where you just happened to get a new token in your wallet. The investor doesn't give anything up whatsoever. So there's a really good argument that there hasn't been any investment of money. Now the problem with that is the SEC very likely going to disagree with you. In addition, there's no affirmative support for that argument. There's nothing against it, but there's nothing actually affirmatively saying that's okay.
Fair launch projects may be the answer to these regulatory hurdles. [14:14]
Marc: I put GRIN in the category of a fair launch project because when the network was launched, nobody had any allocation of tokens. Nobody had any benefit that others didn't. Everybody had an equal shot at it and there's no central party that is going to go ahead and manage GRIN itself. For that reason there's a really good argument that that "efforts of others" prong of the Howey Test is not satisfied, because there is no central party that is providing the entrepreneurial or managerial efforts. The argument would be that a fair launch project like GRIN, and the tokens that are received by miners in the network, that there's really no security there. I think that's a pretty good argument.
The SEC has been strict on ICOs, for good reason - but the regulatory framework behind ICOs can still be difficult to interpret. [16:45]
Marc: We have kind of come full circle to a point where now the SEC is saying, yes, we can have something that is not a security. When does that happen? That is extremely unclear - under the "sufficiently decentralized" test, when are you sufficiently decentralized? I get this question all the time and it's frankly impossible to know when you're considered to be sufficiently decentralized. Frankly, what does the term decentralized really even mean? You know, a lot of people say "oh, we are decentralized", which is true at a technical level, but not at from a managerial perspective. You're not - you've got a central system that is marketing all of this. That's kind of, I think, an interesting development in terms of how you're actually going to try to analyze this.
Essentially, what hasn't been answered at all, is how do you get to a point where you are sufficiently decentralized but comply with securities laws?
With regulations that are confusing and somewhat subjective, are ICOs going to decrease in popularity amongst issuers and investors? [29:35]
Marc: Most successful ICOs now are raising one or two million dollars. It's a very tiny market. That being said, I expect it to continue when it comes to any kind of protocol - anything that truly, absolutely needs a token. I see protocols continuing to grow and token sales related to protocols continuing to grow. I see everything else shifting more towards STOs and internal tokens. Internal tokens are nothing more than reward points. Something that people think is more efficient to have on the blockchain. They will not be listed on exchanges.
Federal laws are complicated enough, but things get even more dicey when you factor in any state laws regarding securities. [34:04]
Marc: Instead of using the Howey Test for determining what is a security, around a dozen states use something called the Risk Capital Test. Essentially that test pretty much looks at are you putting the capital of somebody at risk? I think there are quite a few situations in which you might have a security under state law, that is not a security under federal law.
Most STOs are being sold the traditional way securities are sold - representing equity in a company. [37:42]
Marc: With a STO, you're going to go out and actually sell a security. That security could technically be a utility token, but what we're seeing is that there's not really much interest in a utility token being sold as a security. Frankly, there'd be a lot of issues with its use. Most of them are being sold the way traditional securities were sold, representing equity in a company. Oftentimes these are startups, some of them are companies that hold real estate, and it's intended to represent ownership in that real estate. Same thing with art. We're starting to see more discussions around debt. So essentially what you'll have is a company that's going to follow traditional securities laws.
The implications relative to ICOs are that most STO investments are all traditional, in that their value is going to be tied to an underlying asset or the performance of an underlying asset - maybe the future cash flow of a property or a company. Unlike an ICO where there's lots of different models as to how a token might be valued, and how its value might grow.
It's generally up to the investor to understand if they are investing in an ICO or STO, and the implications that surround each type of investment. [43:40]
Marc: It's definitely on the investor. The investor needs to always be diligent and figure that out. If they are diligent, and they can't tell the difference, then there's probably some kind of liability there for the issuer - it should be very obvious.
For issuers, if you're selling a utility token that is not a security, then you shouldn't need to have the same level of disclosures as you would with a security token.
If you want to reach out to Marc, or view some of his detailed and insightful presentations on these topics, you can simply Google "Marc Boiron". [50:35]
Marc: Yeah, I mean you can Google my name (Marc Boiron). It's unique enough that it pops up! I'm on Linkedin or on Twitter @boironattorney.
If you enjoyed our podcast, be sure to check back frequently for more great discussions about a range of topics in the crypto space. If you have any questions for Marc Boiron he can be reached via the Fisher Broyles website, or via email at marc..