ICOs are a variant of cryptocurrencies. The crypto space is evolving with new state of the art technology for fund raising and investment. The key word is a token. A token is a utility, an asset or a unit of value issued by a company. ICO is a process through which these tokens are created on a blockchain through a de-centralized software protocol. These ICOs have become a source for early stages of start-ups for crowdfunding or other fundraising activities through for these start-ups. These digital tokens can be exchanged with cryptocurrencies such as bitcoins or ethers or directly with fiat currency or a combination of both.
These tokens might have different functionalities; in some cases, they might function as digital currency; in others, they might represent the real estate or gold. But some are unique and popularly known as AppCoins, which are the Blockchain tokens which can be used in new protocols and networks to create distributed applications. But the riskiest and speculative digital tokens are the ones that represent the parts of a speculative venture(s).
The issue of ICOs has emerged as an alternative to traditional forms of start-up financing. The issuance of ICO is generally preceded by the company issuing a whitepaper on its technology and explaining the objective for raising funds. These tokens can be transferred across the network and can be traded on cryptocurrency exchanges. They can serve multiple functions: from granting investors access to a service, to entitling investors to a share of the start-up companies. The Cryptocurrency ICO Stats for 2018 show a total number of 983 ICOs issued as on December 1, 2018. The funds raised through ICOs exceeded USD 20 billion as on December 01, 2018.
The advantages of issuing an ICO are as under:
1. It provides economic and financial incentives for the blockchain network by giving it access to early funds.
2. The ICOs give all the users to be part of the blockchain network and incentivizes them to start using the network from the beginning.
The ICOs can be classified into two broad categories, i.e., pre-release and post-release. The pre-release occurs when the project or the blockchain network needs funds to develop the product, software, or service. Post-release ICOs happens when a(n) initial product or token has been launched and wants to raise additional funding to continue the development. Following steps shall be taken by the company to review to issue an ICO:
1. Publish a detailed Whitepaper, along with a technical whitepaper or yellow paper, if imperative. The whitepaper shall contain a clear and compelling reason for the blockchain network and the digital token to exist. Clear and realistic expectations for the total distribution and supply of the tokens shall also be set.
2. A detailed and realistic road map shall be given for the project. It shall contain time and estimates of costs and time for each stage of the project. The names of the advisors and key team- members of the project shall be made public. The proposed roadmap shall also include the allocation of funds that would be required at each stage of the project.
3. The details regarding the private blockchain shall be given, and the steps as to how to become the part of the blockchain network shall be elaborately explained. But ideally, an open public blockchain shall be used, and the code for the project shall be published. This provides transparency and gives open access for the participation of the independent developers and token holders.
4. This step is to use realistic, logical, and fair pricing for token sales. This step would also include the maximum number of tokens, which would be sold in the crowdfunding and setting up a price mechanism so that it does not increase over time.
5. The final step is to determine the number or percentages of the token, which would be set aside for developers, marketing, advisors, and other members of the initial team.
Note: The tokens shall never be marketed as an investment as doing such would bring the tokens under the purview and ambit of SEBI (Security Exchange Board of India), which would end up defeating the purpose of issuing an ICO (if these need to be registered with SEBI).
In India, the Supreme Court in IMAI vs. RBI iterated that “Initial Coin Offerings (hereinafter, “ICO”) are a way for companies to raise money by issuing digital tokens in exchange for fiat currency or cryptocurrency, but there is a clear risk with the issuance of ICOs as many of the companies are looking to raise money without having any tangible products. In the year 2018, as many as 983 ICOs were issued, through which funds to the tune of USD 20 billion were raised.”
RBI had highlighted some of the possible ways to enforce the prohibition on VCs in the RBI Representation, which includes: “Initial Coin Offerings (“ICOs”) ought to be prohibited, and VC asset funds may be allowed to be set-up and/or operated within the legal jurisdiction of India as also perform such transactions in India. ICOs that were in the nature of multi-level marketing or pyramid schemes can be banned;”
There is a clear risk with issuance of ICOs as many of the companies are looking to raise money without having any tangible products. Regulators, the world over are mulling on how to regulate ICOs and digital tokens. Are they securities or not? How to tax them?
The regulation of digital coins or tokens depend on the characteristics and the purpose for which they are being issued. Depending on the objective of issue, tokens can be grouped into two broad categories:
1. Utility tokens: Utility tokens offer investors access to a company’s products or services. They are not to be treated as investment in a company. An example of the Utility Token is File Coin. Holders of said tokens will be granted access, through these tokens, to its decentralized cloud storage platform.
2. Security tokens: Security tokens represent investment in a company. Just like shareholders in a company, token holders are given dividends in the form of additional coins every time the company issuing the tokens earns a profit in the market. But what are security Tokens? The Howey test by the U.S. Securities and Ex- change Commission (SEC) provides an objective framework to distinguish between utility tokens and security tokens. In order for a financial instrument to be considered a security and fall under the ambit of the SEC, the instrument must meet these four criteria:
a. It must be an investment of money;
b. With an expectation of profit;
c. In a common enterprise; and
d. With the profit to be generated by a third party.
In conclusion, even though the ICO seems to be a good option for crowdfunding, these shall be meticulously strategized in all aspects so they do not violate any law or regulatory mandate.
 Writ Petition (Civil) No.528 of 2018
By Siddharth Dalmia
The StartUp Sherpa