Munch On This: The Future of ICOs after the SEC Crackdown
A chilling effect on an overheated machine may not be all bad.
On Monday, the U.S. Securities and Exchange Commission (SEC) issued a Cease-and-Desist order against Munchee Inc. to halt its initial coin offering (ICO). The San Francisco-based food review app was seeking to raise 15 million USD in an offering of tokens (MUN) that would reward users for posting restaurant reviews, selling advertising and promoting in-app purchases. Soon after the order was published, SEC Chairman Jay Clayton issued a statement on cryptocurrencies and ICOs, directed at “Main Street” investors and market professionals.
Why it matters:
In the relatively short history of token law, this week’s SEC actions will go down as a milestone. Sure, the SEC has taken action against ICOs in the past but this week’s intervention is only the second time — the first being the Investigative Report on the DAO — that it has involved a legitimate business case that didn’t include elements of a potential fraud or smell like a scam. This intervention is also the first time the SEC has somewhat addressed the utility-token argument: whether the usefulness of a particular token saves it from being designated a security. Naturally, this raises questions for companies that are planning an ICO for a utility token of their own.
The Good:
As governments around the world start to address the question of cryptocurrency regulations, it is refreshing to see the SEC take a careful look — particularly one that doesn’t just label the whole basket as rotten. The SEC Chairman in his statement acknowledged, “I believe that initial coin offerings — whether they represent offerings of securities or not — can be effective ways for entrepreneurs and others to raise funding, including for innovative projects.”
In the wild west that is ICOs, any clarity from regulators is appreciated. Especially constructive is that the SEC stopped the sale midstream, didn’t penalize Munchee and seemed mainly concerned with consumer protection and turning this into a ‘teachable moment’ for those, like Munchee, who are not actually bad actors.
“The positive fallout from this, we’re hoping, is that it will clear out the noise from the ICO market, so the truly innovative ideas will ring loud,” says J. C. Figueroa, Director of Operations at New Alchemy. Forcing teams to consider deeply how the Blockchain can improve a system or make one that didn’t exist will get this space back to what drew the innovators here in the first place.
The Bad:
According to the order, Munchee’s most egregious offense was telling investors the company’s efforts would result in an increase in the value of the tokens, even though the app would need a year or more of development for token functionality. Munchee also promised investors it would take steps to create and support a secondary market for the tokens. The SEC determined that both statements combined would give investors a reasonable belief that their investment in MUN could generate a return that would be due to the efforts of others. Hence deeming it an “investment contract” aka a security, contrary to the MUN Whitepaper stating that Munchee had done a “Howey Analysis” and found its token sale to be in the clear.
The marketing of the Munchee ICO was another offender. The SEC order pointed out that Munchee had exclusively targeted people interested in investing in Bitcoin and other digital assets, without marketing to existing users within the Munchee App or advertising in “restaurant industry media to reach restaurant owners.” Munchee’s rhetoric implied they were marketing a ‘token with value’ rather than a ‘product with utility.’
Perhaps the clearest takeaway is that mere claims of utility in a white paper and other marketing messaging won’t fool anyone, much less the SEC.
The Unclear:
Despite the insight the SEC actions offer, there’s still much left in the grey. As Token Report pointed out in its post on the subject, “What about projects that don’t make an explicit promise, and yet the expectation of returns is understood?” Or just how much “utility” does a token need, and how would that be quantified? What about tokens that have real consumptive utility but also good investment value?
The Way Forward:
In the next few days, we can expect legal firms within the cryptocurrency space to publish analyses of these most-recent SEC actions. Consult with your legal counsel, especially in this uncharted territory. Focus on creating the strongest organization with the best offerings to the public and concentrate on the value of the overall project. Most of all, ensure you’re marketing the benefits of the project — and to future customers — rather than focusing on token value. “In our experience, the best tokenizations are those that innovate on fundamental business mechanics and we believe that should be allowed to continue in America,” says New Alchemy Managing Director, Peter Vessenes. “As industry participants, we have an interest in making sure regulators engage productively to both keep consumers safe and not overreach unreasonably into the realm of truly useful tokenizations.”
At heart, this SEC guidance is a sign of growing maturity within the industry. It’s also an opportunity for the most innovative tokenizations to stand out, an opportunity to clear a crowded field of less legitimate blockchain and tokenization projects.
In other words, this isn’t necessarily bad news. Don’t fear.
New Alchemy is a strategy and technology advisory group specializing in tokenization. One of only a handful of companies able to offer a full spectrum of guidance from tactical technical execution to high-level theoretical modeling, New Alchemy provides technology, token game theory, smart contracts, security audits, and ICO marketing, strategy, and facilitation to the most innovative startups and tokenization projects worldwide.
