Since the advent of Initial Coin Offerings, promoters have sought to sell their tokens through various “funding portals,” the majority of which have ignored or skirted equity crowdfunding regulation. But, as with everything in cryptocurrency, there is significant grey area when crowdsourcing a token sale.

Crowdfunding Regulation

Today, a majority of countries regulate crowdfunding in some form – which includes the sale of cryptographic securities. Popular destinations for the crowdfunding of security tokens include:

1. United States: The Securities and Exchange Commission (SEC) regulates crowdfunding under the JOBS Act. Crowdfunding platforms must register with the SEC or operate under an exemption, such as Regulation Crowdfunding (Reg CF).
2. United Kingdom: The Financial Conduct Authority (FCA) regulates crowdfunding platforms in the UK. Platforms may need to obtain appropriate permissions and meet certain criteria to operate legally.
3. Australia: The Australian Securities and Investments Commission (ASIC) regulates crowdfunding platforms under the Corporations Act 2001. Platforms may need to hold an Australian financial services license (AFSL) or operate under a specific exemption.
4. Singapore: The Monetary Authority of Singapore (MAS) regulates crowdfunding platforms in Singapore. Depending on the type of crowdfunding, platforms may need to obtain a Capital Markets Services (CMS) license or operate under certain exemptions.

The list is long and regulation can vary greatly by country.

General Crowdfunded Offering Parameters

In the United States, under Reg CF, the maximum amount a company can raise in a 12-month period is $5 million. Moreover, there are certain additional requirements that issuers must adhere to.

First, issuers are required to use a registered intermediary, either a broker-dealer or a funding portal, to facilitate the crowdfunding process. The intermediary must be registered with the SEC and the Financial Industry Regulatory Authority (FINRA) (more on this below). Second, the issuer must file an offering statement with the SEC. This offering statement must include, among other information:

• Description of the business: Provide a detailed description of your business, including the products or services you offer, your management team, and your business plan.
• Financial information: Disclose your financial condition, including your financial statements, any material debts, and how you intend to use the funds raised.
• Offering details: Specify the target amount of funds you aim to raise, the deadline for the offering, the price of the securities, and any other terms or conditions.
• Risk factors: Identify and disclose the key risks associated with your business, such as industry risks, competition, regulatory risks, and financial risks.

Finally, third, the issuer must file a Form C with the SEC detailing the offering and results of the offering.

Investor Limitations

Issuers must also be wary of who is investing in the crowdfunded offering and how much the investor is investing.

Reg CF allows both accredited investors and non-accredited investors to participate in crowdfunding offerings. Accredited investors meet certain income or net worth thresholds defined by the SEC – typically a net worth of a $1,000,000 or more, while non-accredited investors do not meet those thresholds. Moreover, there are investment limits for Reg CF based upon an investor’s annual income and net worth. For investors with an annual income or net worth below $107,000, the investment limit is the greater of $2,200 or 5% of the lesser of their annual income or net worth. For investors with an annual income or net worth equal to or greater than $107,000, the investment limit is 10% of the lesser of their annual income or net worth, up to a maximum of $107,000.

Crowdfunding Portal Registration

The first step to become a registered crowdfunding portal is to register with the SEC as a “funding portal.” This is done via the SEC’s EDGAR system and involves basic disclosure information. Notably, the SEC does not directly oversee crowdfunding portals. Instead, it designates FINRA as the self-regulatory organization (SRO) responsible for overseeing and regulating crowdfunding portals. Thus, an SEC-registered crowdfunding portal operating is required to partner with a FINRA registered broker-dealer. This requirement ensures compliance with the regulatory framework established by the SEC for crowdfunding intermediaries.

Second, registration with FINRA becomes necessary and is a considerably more complex process. FINRA’s New Member Application (NMA) is a comprehensive application that requires detailed information about the crowdfunding portal’s ownership, control, business activities, compliance procedures, and personnel. It covers various areas, such as governance, operations, financial condition, and regulatory compliance. During the application process, FINRA may have additional questions or require clarifications regarding the NMA. Note that there is an application fee in the amount of $2,700 due at the time of application together with submission of fingerprints for key personnel.

Cryptocurrency and Crowdfunding

The intersection of cryptocurrency and crowdfunding can take multiple forms.

First, ICO’s may fall under crowdfunding regulation with the underlying token is deemed to be a security. This has been a major emphasis of SEC enforcement as it has reclassified many tokens sold in prior ICOs (especially between 2017-2019) to have been unregistered securities offerings. Thus, the delineation and determination as to the true nature of the token is of paramount importance for issuers.

Second, unlike ICOs, STOs are designed to comply with securities regulations. Security tokens represent ownership interests or investment contracts in a project or venture, providing investors with rights and potential financial returns. In an STO, it is axiomatic that the token is in fact a security and that compliance with Regulation CF is required.

Third, DeFi platforms can incorporate crowdfunding-like mechanisms, enabling individuals to participate in funding projects, lending and borrowing, or providing liquidity through smart contracts and cryptocurrencies. This is a massively grey era for both promoters and regulators insomuch that DeFI platforms, by nature, are decentralized without core management and driven by smart contract.

Finally, fourth, the tokenization of real-world assets, such as real estate, art, or intellectual property allows assets to be divided into tradable tokens, which can be offered to investors in a crowdfunding-like manner. In nearly all such offerings, the token falls under the definition of a security and therefore triggers the requirements of Regulation CF.

Conclusion

Gone are the days of unlicensed funding portals for ICOs. Regulatory enforcement has increased significantly and has been focused on the selling of unregistered securities (e.g., unlicensed crowdfunding). This has included regulatory peril against both the issuer and funding portal. Thus, it is perhaps advisable to at a minimum explore registering as a crowdfunding portal even if the emphasis will be the sale of non-security utility tokens.

As always, be sure to reach out to me with any questions or book a meeting here.

About Adam Tracy

Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.

Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor – both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.

In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.

Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, Hollywood Reporters, CNBC, Reuters, CoinDesk, and Bitcoin.com.

Find Adam: https://linktr.ee/adamtracy

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