Cryptocurrencies are gaining popularity worldwide. With the tremendous success of Bitcoin, more and more cryptocurrencies are entering the market. The startups launching these new currencies are looking to offer purchasers with financial privacy and freedom from government regulation. They do so in exchange for massive profits. New cryptocurrencies are introduced through what are known as initial coin offerings, or ICOs.
What Is an ICO?
Initial coin offerings allow funds to be raised for new cryptocurrency ventures. Banks and venture capitalists usually have rigorous and highly regulated processes for giving capital to startups. ICOs allow startups to bypass these processes. Initial coin offerings allow the early backers of new cryptocurrencies to purchase tokens in exchange for legal tender or other cryptocurrencies. ICOs are also sometimes referred to as Initial Public Coin Offerings (IPCOs).
The first step for a cryptocurrency startup firm looking to raise money through an initial coin offering is to release a white paper. This white paper serves as a plan which states what the project is about, the needs that it will fulfill, and the capital investment required. The white paper will also discuss the number of cryptocurrency tokens that the project’s founders will keep for themselves. Additionally, it will lay out the types of currency accepted in exchange for the new cryptocurrency. Lastly, the white paper will describe the how long the initial coin offering will run. During the ICO campaign, those who support the initiative will buy the newly released tokens using fiat or virtual currency.
There are many parallels between the purchase of tokens by the backers of a cryptocurrency and the purchase of shares of a company by investors. Shares of a company are sold in an initial public offering, or IPO. In an initial public offering, if the money raised does not meet the requirements of the company, the money is returned to backers. As a result, the IPO is considered to be unsuccessful. The same is true of an ICO. If an initial coin offering does not raise the required funds, the funds received will be returned to backers.
Early backers usually get involved in an ICO because they hope that the cryptocurrency being launched will be successful. If a new cryptocurrency is successful, it may appreciate to a value far beyond the value that it was purchased for at the initial coin offering. One example of a very successful ICO is Ethereum. Ethereum is a cryptocurrency made up of coins known as Ethers. In 2014, the initial coin offering of Ethereum raised $18 million in bitcoins. This worked out to a value of about US$ 0.40 per ether. After the ICO, the popularity of Ethereum skyrocketed. In 2015 and 2016, the value went up as high as US$ 14 per ether with a market capitalization of over $1 billion.
ICOs share similarities with IPOs and crowdfunding. As with an IPO, interest in the startup in an initial coin offering is sold to fund the new cryptocurrency’s operation. The major difference between an IPO and an ICO legal structure is that those contributing to an IPO are investors. They receive a stake in the company that they are supporting. Conversely, the backers of an ICO are purchasing a product. This product is the tokens issued by the new cryptocurrency. In this way, ICOs are similar to crowdfunding. The biggest difference between ICOs and crowdfunding is that backers of an ICO expect their tokens to appreciate in value. The funds raised for crowdfunding campaigns are usually either donations or purchases of products which will not appreciate. For this reason, ICOs are frequently referred to as crowdsales.
Why Take ICOs Offshore?
Though there have been several successful ICOs, there is a substantial threat of government crackdowns on initial coin offerings, particularly in the United States.
There was a massive surge in ICOs in 2017. This caught the attention of the governments of certain countries who are currently taking steps to regulate initial coin offerings. In September of 2017, the People’s Republic of China officially banned ICOs. The reasoning that the Chinese government gave was that ICOs are disruptive to economic and financial stability. The Chinese government also said tokens cannot be used as currency on the market. Chinese banks also cannot offer services relating to ICOs. This decision caused both Bitcoin and Ethereum to drop in value dramatically. It was viewed as a sign that regulations of cryptocurrencies are coming in other countries. In the beginning of 2018, Facebook, Twitter, and Google banned the advertisements of ICOs. Since then, the United States Securities and Exchange Commission (SEC) has been trying to treat ICOs in the same manner as IPOs. The SEC heavily regulates IPOs.
Ideal Offshore Corporate Structure for ICO
As a result of the increasing scrutiny over ICOs in the United States, many startups are choosing use offshore corporate structures for initial coin offerings. An example is a Nevis LLC with virtual office and bank account. This is the most popular, and one of the best countries for ICOs. Many startups choose to separate the issuer company and the operating entity into a two-pronged corporate structure. This corporate structure may be comprised of two offshore companies. One Nevis LLC can operate the business. The other Nevis LLC can raise the capital, for example. It may also be comprised of a legal entity such as a foundation or trust used in combination with another offshore corporation. Promoters place the proceeds in an offshore bank account. The issuing entity is referred to as an ICO-CO while the operating entity is referred to as an OPCO.
This division is created for a number of reasons. First, separating these entities legally separates the liability associated with the ICO. Second, separating the entities allows for the creation of many OPCOs in different ICO friendly countries. This is advantageous because it allows for support payments to staff in various fiat currencies. It can also be difficult to obtain bank accounts for ICO-CO under certain circumstances. However, tokens received in the ICO may be transferred to one or more of the OPCOs in several different ways. Finally, there are legal entities, such as trusts and foundations, which can be advantageous for the ICO issuance. However, these entities may not be suitable for conducting ongoing business. As a result, using two entities may be preferable.
Operating without a structure is not advisable. This is because in most jurisdictions this will mean defaulting to a general partnership. In a general partnership, the founders are both jointly and severally liable. This means that the founders of the startup behind the initial coin offering put their assets at risk if the offering fails.
While the two part structure described above will limit the liability of the startups founders, it is not foolproof. Initial coin offerings are not to be undertaken lightly. There are complex events which can subject startups to substantial risk.
Though ICOs and token sales are currently unregulated, that does not mean this will always be the case. Furthermore, laws regarding securities, tax, AML/KYC, commodities laws, general fraud and tort, and other areas have the potential to affect ICOs. The nature of ICOs is also inherently international. It would be prohibitively expensive for startups to secure legal opinions in every country whose laws could potentially affect the ICO. Even if a startup were to secure legal opinions in all of these jurisdictions, this wouldn’t necessarily prevent legal action.
One of the single most important things to avoid with regards to a token sale is having it classified as a security in the eyes of a regulator. This is the case in any jurisdiction where the ICO would potentially operate. The reason for this is that there are significant regulations with regards to securities which initial coin offerings usually will not meet. Startups must never give token purchasers any indication that they will have rights or privileges to the business. It is essential that startups never issue any guarantees of stock or future profits in any way. LLCs and companies are not suitable entities for initial coin offerings. Foundations, trusts, and companies limited by guarantee are preferred legal entities. This is the result of the limited powers that token purchasers would have with regards to the latter entities. Having the token classified as a security could result in potential fines or jail time as a penalty from a regulator.
Additionally, it is essential that startups act in good faith with regards to an ICO. If a startup does not deliver on what they promise, their activities may constitute fraud. Before launching an initial coin offering, startups must define a genuine rationale for the issuance of their token. There must be a tangible reason for the new cryptocurrency, as well as a defined protocol for how it is used. It is also important to establish whether the creation of a native token is essential. It may be possible in many situations for startups to ride on top of another existing token. Launching an initial coin offering is a legally complex process which offers potentially huge rewards with equally high risk. It should only be considered after careful and deliberate planning. It is vitally important that the entities used to launch the initial coin offering be set up to the letter of the law. For this reason, it is essential that startups seek expert guidance.