ICO Battlefields Proliferate: Preparing for Private Litigation and Regulation Now

The popularity of cryptocurrencies and initial coin offerings (ICOs) has risen so dramatically that this year Merriam-Webster added definitions for both phrases to its most recent edition. In light of the wave of regulatory actions and private litigation that has followed ICOs—a wave that is sure to accelerate—it is perhaps more than a coincidence that Merriam-Webster's newest edition also added the phrase “dumpster fire.”

Some innovative companies have sought to use ICOs as a new method to raise capital. In an ICO, a company will offer a coin or token in exchange for fiat currency or other cryptocurrencies, which provide capital to the company or fund specific projects.

One key issue plaguing cryptocurrency regulation is the application of Great Depression-era securities regulations—and private class action lawsuits based on those regulations—to a modern, rapidly developing technology. For over 80 years, the SEC and the courts have consistently used the Howey test—first established by the U.S. Supreme Court in the 1940s—to determine what activities fall under federal securities laws, see SEC v. W.J. Howey, 328 U.S. 293 (1946). Under the Howey test, an instrument is considered a security if: a person invests money; in a common enterprise; with the expectation of profits; and solely from the efforts of others. In light of this construct, SEC Chairman Jay Clayton recently testified before the Senate that “I believe every ICO I've seen is a security,” despite the fact that “not one” of these ICOs has been subjected to the registration requirements of the Securities Act and the Exchange Act. As the chairman implied, actual application of securities laws to ICOs by courts has been slow to develop, but it is increasingly picking up speed.