The flurry of recent Initial Coin Offerings (ICOs) have raised questions as to whether, and in what circumstances, virtual currencies and digital tokens may be considered securities whose offer and sale are subject to federal registration requirements. A recent report by the U.S. Securities and Exchange Commission cautioning investors that digital assets may be securities is a turning point for the token marketplace and other blockchain-based mechanisms of alternative fundraising. SEC Release No. 81207, “Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO,” July 25, 2017.
A blockchain is an electronic distributed ledger that is maintained by participants in a network of computers. In a typical ICO, a blockchain-based product or service provider offers proprietary digital assets (“tokens”) in exchange for working capital, usually provided in the form of a cryptocurrency such as Bitcoin or Ether (ETH). One of the first truly significant ICOs was carried out by The DAO, whose name stands for Decentralized Autonomous Organization. The virtual organization was created by a company called Slock.it to operate as a for-profit entity that would create and hold assets through the sale of tokens to investors. Those assets would then be used to fund “projects,” selected by a group of Curators. Ownership of a DAO Token vested certain limited voting and ownership rights in the holder. The holders of DAO Tokens would vote on proposed projects and stood to share in the anticipated earnings from those projects as a return on their investment in DAO Tokens. DAO Token holders could also monetize their investments in the tokens by re-selling or transferring them. From April 30, 2016 through May 28, 2016, The DAO offered and sold approximately 1.15 billion DAO Tokens, valued at approximately $150 million. Id. at 2-3. In June 2016, a hacker used a flaw in The DAO’s coding to steal approximately one-third of The DAO’s Token assets, totaling more than $50 million. To avoid any loss to the investors, Slock.it’s co-founders implemented a protocol to enable DAO Token holders to exchange their tokens for ETH.
