By Grant P. Fondo, Mitzi Chang, Meghan Spillane, Stephen Fox, and Timothy Kistner
An initial coin offering (“ICO”) does not happen on its own. Rather, there are companies and individuals that assist in successful token sales. These can include ICO consultants, marketing firms, board members, partners at private equity and venture capital firms, and those that assisting in finding buyers for tokens. While there are benefits to those making ICO’s happen, there are also risks.
The Securities and Exchange Commission (“SEC”) Chief Commission recently stated “I have seen none of the [ICOs] that don’t have the hallmarks of securities” and that his office will start taking action against token coin offering issuers who fail to register with the agency or comply with federal laws. Thus, should the SEC find a token sale constitutes the sale of unregistered securities, it could subject the seller and those assisting the seller to an enforcement action by the SEC (or class action litigation). This article provides an overview of the kinds of activities that the SEC may deem sufficient “participation” to hold an individual liable under the federal securities laws. In light of these findings, this memorandum also includes some practical guidance for minimizing the risk of such liabilities.
SEC’s July 25, 2017, Guidance – “Participants” May be Liable. The SEC announced on July 25, 2017, that token sales, commonly referred to as ICOs, and other market “participants” offering digital assets by virtual organizations may be subject to the requirements of federal securities laws, but did not provide any further explanation for this term. The SEC uses the term “participant” in a variety of ways in different contexts. When assessing liability for individuals and outside entities involved with allegedly unregistered security offerings that did not comply with an available exemption under securities laws, as a matter of practice, the SEC appears to determine “participation” based upon the particular conduct of the individual or entity, rather than relying upon an individual’s or entity’s title or position.
Review of SEC related case law shows that liability may attach based upon an individual or company’s direct involvement in an offering. In particular, individuals or entities – including directors, officers, leading investors, public relations firms, and formally unaffiliated persons – who are directly involved with selling, issuing, or transferring shares, soliciting investors, or issuing investment materials for a particular unregistered security may be subject to the requirements of federal securities laws, and potentially held liable for violations of these laws in an SEC enforcement action.
I. ACTIVELY SOLICITING INVESTORS
Parties who actively solicit investors to buy or publicly promote the sale of unregistered offerings may be found to be necessary participants in the offering or sale of unregistered securities in violation of Section 5 of the Securities and Exchange Act of 1934 (the “Exchange Act”). Active solicitation may include publishing investment materials, such as a prospectus; contacting potential investors; serving as an intermediary between the issuer and the investor; or conducting other promotional activities on behalf of the issuer.
For example, in SEC v. StratoComm Corp., the CEO and sole director of StratoComm issued several press releases stating that the issuer had entered into multiple sales contracts worth more than $60 million – even though the releases described a product that did not exist and sales that never occurred. In addition, the issuer’s Director of Investor and Institutional Relations acted as the issuer’s designated contact for investors, relayed the terms of stock sales, handled paperwork related to stock sales, facilitated the issuance of shares, and actively sought investors using an Executive Informational Overview that contained the same misleading information as described above. The SEC found that these activities were intended to solicit investments in more than 62 million unregistered shares of stock that the company issued between 2007 and 2010. The SEC brought civil enforcement actions against both individuals and moved for summary judgment, contending in part that there was no dispute of material fact that the defendants sold millions of shares to over 100 investors, and that StratoComm’s stock offering was not registered as required by law. The court ruled in the SEC’s favor, finding that the defendants were necessary participants in the offering of unregistered securities.
In a second case, SEC v. Jones, Cheryl Jones was charged as a participant in the selling of unregistered securities based upon her active involvement in the solicitation of investments. According to the SEC, Jones’ brother created a bridge fund, which allegedly fraudulently offered unregistered securities. In 2007, Jones became one of the first investors in the bridge fund. Soon after investing with her brother, but while holding no official title in the bridge fund, Jones began to recruit investors to the fund. In this capacity, Jones sometimes served as a conduit for conveying information to investors, flew to Jamaica with potential investors to visit a real estate development project in which the funds were purportedly going to be invested, and served as an intermediary between her brother and investors after money was transferred to the fund. As part of her involvement, Jones received a commission of approximately 10% of the principal obtained from new investors, and received a legal retainer as high as $7,000. Although Ms. Jones held no formal title with the bridge fund, the SEC still asserted her liability as a participant in the selling of unregistered securities that did not comply with an exemption from registration based upon her active involvement in the solicitation of investments, charging her with violations of Section 5 of the Securities Act, and sought disgorgement of her gains, prejudgment interest, and a civil penalty. This case is one to watch as it remains pending.
Consistent with these cases, individuals who have actively solicited investors in the cryptocurrency context may also be subject to liability under the securities laws as “participants.” For example, the SEC brought charges against Erik T. Voorhees, who published prospectuses on the internet and actively solicited investors to buy shares, using Bitcoin, in “SatoshiDICE” (a gambling website that takes bets and pays out winnings in bitcoins) and “FeedZeBirds” (an entity that pays Twitter users a fee in bitcoins in exchange for forwarding sponsored text messages) on a website known as the Bitcoin Forum, as well as on Facebook. Voorhees ultimately settled with the SEC, which had claimed that “SatoshiDICE” and “FeedZeBirds” were unregistered securities that did not comply with an exemption under securities law. The profits ultimately earned by Voorhees through the unregistered offerings totaled more than $15,000. Voorhees agreed to pay full disgorgement of the profits plus a penalty of $35,000. Thus, any individual who is engaged in soliciting investors to purchase unregistered shares, including by publishing prospectuses, may be subject to an SEC enforcement action.
The SEC recently highlighted this risk when, on November 1, 2017, it issued guidance that individuals who promote investments into ICOs may be subject to an enforcement action. The SEC advised that “any celebrity or other individual who promotes a virtual token or coin that is a security must disclose the nature, scope, and amount of compensation received in exchange for the promotion. Failure to disclose this information is a violation of the anti-touting provisions of the federal securities laws.” The SEC also noted that individuals “making these endorsements may also be liable for potential violations of the anti-fraud provisions of the federal securities laws, for participating in an unregistered offer and sale of securities, and for acting as unregistered brokers.” Although the SEC guidance focuses on “celebrities,” the statement suggests that all individuals who are promoting ICOs need to be aware of the risk that the SEC may consider their activity to be unlawful.
II. TRANSFERRING AND SELLING SHARES
Significantly, even individuals who are not directly involved with the public-facing offering of unregistered securities that do not comply with an exemption may be subject to liability as a “participant” under the securities laws if they are involved in transferring the shares. For example, in SEC v. Platforms Wireless Intern. Corp., the SEC alleged and the district court found that because the defendant was CEO of Intermedia, an affiliate of the initial seller of unregistered securities, he was liable for selling unregistered securities in violation of Section 5 of the Securities Act. The court found liability because the CEO controlled the affiliate at the time of the transactions, did not take reasonable care to ensure that the affiliate was not an underwriter, and because the shares were unregistered. The court further held that the transaction could not qualify for a resale safe harbor under the securities laws and did not qualify for an exemption because of Platforms’ Executive Vice President – who received many of the shares from the affiliate before selling them to the public – qualified as an “underwriter”: “Intermedia’s affiliate status precludes any eligibility for the exemption. Because Intermedia was an ‘affiliate’ of Platforms at the time the transactions took place, by definition it necessarily also qualified as an ‘issuer’ for the limited purpose of defining underwriters… Having acquired the securities from an ‘issuer’ with an aim to distribute those securities to the public,” the Executive Vice President was rendered an underwriter and thus the transaction was ineligible for an exemption.
III. FACILITATING ISSUANCE/TRANSFER OF SHARES
Liability under the securities laws may also extend to individuals and entities that facilitate the issuance of certain unregistered securities through intermediaries. For example, in SEC v. Wyly the SEC brought a civil enforcement action against Samuel Wyly (Chairman of the Board of Directors of Michael Stores) and Charles Wyly (Michael Stores’ former Vice Chairman of the Board of Directors). Michael Stores sold two million shares of unregistered stock, and later sold two million options to purchase unregistered stock, to independent, offshore trusts of which Wyly family members were beneficiaries. Subsequently, those trusts sold the shares of unregistered stocks to the public at increased prices, without ever disclosing that the trusts were affiliates of Michaels Stores by virtue of being commonly controlled by the Wylys, or without properly registering the securities.
The SEC filed a complaint against both Wylys, each of whom was subsequently found liable by a federal jury for selling unregistered securities in violation of Section 5 (as well as other violations). The Wylys’ were ordered to disgorge all funds from the sale of these unregistered securities, plus prejudgment interest for the entire period of the violations.
While the SEC may use an individual’s or entity’s participation in the transferring of shares as a basis for this “participation,” the title of “transfer agent,” without more, will not necessarily provide a basis for liability under the securities laws. In SEC v. CMKM Diamonds, Inc., 729 F.3d 1248 (9th Cir. 2013), the Ninth Circuit considered the case of a transfer agent, Helen Bagley, and the corporation she owned, Global Stock Transfer Agency, LLC (“Global”), who had been found liable at summary judgment by the district court for serving as CMKM’s transfer agent in the course of issuing 622 billion shares of unrestricted CMKM stock (A court will grant summary judgment where there is no genuine dispute as to any material fact, and the party moving for summary judgment is entitled to judgment as a matter of law. Here, the court found that the SEC was entitled to summary judgment against Bagley and Global). Bagley and Global argued that they relied upon opinion letters written by co-defendants which caused them to understand that the stock was to be issued without a restrictive legend because payment for the stock had been made, or the stock split had occurred, at least two years earlier. Bagley also testified that Global is “only the transfer agency. That’s all we do. If we get proper paperwork, we do what needs to be done.”
The Ninth Circuit ruled that the SEC had failed to show as undisputed fact that Global and Bagley were “substantial participants” in the distribution. “A participant’s title, standing alone, cannot determine liability [for selling unregistered securities], because the mere fact that a defendant is labeled as an issuer, a broker, a transfer agent, a CEO, a purchaser, or an attorney, does not adequately explain what role the defendant actually played in the scheme at issue. Instead, whether a defendant is a necessary participant and substantial factor in the distribution of unregistered securities that do not qualify for an exemption from registration under securities laws is a question of fact requiring a case-by-case analysis of the nature of the securities scheme and the defendant’s participation in it.” CMKM at 1255, 1258 (emphasis added). Thus, once again it is not the title or position that is crucial in determining whether the SEC may be able to bring a successful enforcement action – instead, an individual’s or entity’s specific role in the offering itself is the determining factor.
IV. OVERSEEING A SCHEME TO CONVERT LOANS INTO UNREGISTERED SECURITIES
Notably, liability under the securities laws may also extend to contexts beyond the sale of traditional equities. For instance, in SEC v. E-Smart Tech, defendant Mary Grace (E-Smart’s President, CEO, CFO, and Director) sought investor capital by selling unregistered free-trading e-Smart shares. The sale, which Grace conceived of and executed, consisted of a convertible loan scheme, in which investors would make short-term loans to two intermediary corporations which Grace controlled, who would then offer up their restricted e-Smart shares as collateral for the loans. When the loans inevitably defaulted, the lender-investors would be given the option to convert their notes into e-Smart stock at $0.10 / share. As a result, millions of dollars in loans were exchanged for unregistered e-Smart shares. Grace was ultimately held liable for selling unregistered securities, making false statements in a 2008 press release, and failing to manage her business in accordance with SEC regulations.
V. CLASS ACTION LITIGATION
Separately, outside the realm of SEC enforcement, the scope of potential liability for participating in the alleged unregistered security sale not in compliance with securities laws may also be informed by the positions taken by private plaintiffs in civil litigation. In the recent class action lawsuit of Baker v. DLS, plaintiffs set forth allegations against a variety of individuals in executive level positions for allegedly selling unregistered securities, and even extended potential liability to a public relations firm that helped to promote the allegedly unregistered ICO by making allegedly false statements to the public about the offering. Plaintiffs’ position arguably is similar to the SEC’s apparent focus on individual “participants” who are actively involved in the solicitation and promotion of unregistered securities, but also expands the scope of potential liability to individuals wholly outside of the subject organization. While there has been no findings in that case, nor does it appear the SEC has taken “participant” liability that far, this case is worth watching to see how the court responds to these issues raised by the allegations.
In light of the SEC’s treatment of “participants” in these other contexts, we offer the following practical guidance that may assist an individual or entity in preventing or limiting liability when providing services to organizations in connection with an ICO, in the event that the token sale may be determined to be governed by the federal securities laws:
1. Do Not Be a Leader in the Decision to Do the ICO or in Executing It.
2. Perform Due Diligence on the ICO and Understand the Legal Status of the Token: It is important for potential participants to under understand the mechanics of the ICO in an effort to appreciate whether the sale is likely to be deemed a securities offering, and to possibly minimize securities-like activities the company may be engaging in when selling the token.
3. Test the Veracity of All Promotional Materials: Where “participant” liability may attach under the securities laws for any individual involved in the solicitation of purchasers in the context of an ICO, potential participants should be on the alert for information used in the solicitation of purchasers or investors – or the promotion of a company issuing tokens – that is not fully truthful and accurate. Forward looking statements should avoid promises of future profits or an increase in the value of the token, and be couched in language stating that such statements are only speculative.
4. Refrain from Marketing the Token. “Participant” liability may attach under the securities laws for any entity or individual involved in the solicitation of purchasers in the context of an ICO. Therefore, to the extent possible, it is best to avoid marketing the token in any way and, in particular to investors (which are distinguishable from likely users of the tokens), nor should you seek compensation for doing so.
5. Refrain from Transferring Tokens: In light of liability that might attach from the transferring of unregistered securities not in compliance with securities laws, if you have received or purchased tokens, you should carefully evaluate transfers and sales, particularly on a public exchange.
6. Indemnification and Insurance. Evaluate whether your insurance covers governmental investigations/actions or civil litigation in the context of an ICO, and assess whether the seller will indemnify you for any legal fees and expenses or a judgment as a result of the ICO.
7. Stay off the Board. If you are not on the Board, stay off it – at least through the ICO.
8. Keep Track of Tokens: If the SEC were to find an individual liable as a “participant” in an unregistered securities offering not exempt from registration, tokens received as a result of services provided may be subject to disgorgement. As such, it may be advisable to keep track of how tokens were acquired, and to whom they were transferred.
9. Avoid Cap Table Allocations and Carefully Consider Pre-Sale Purchases: Private equity and venture firms and other investors may further limit their risk of potential liability as a “participant” in an unregistered securities offering by avoiding the granting of tokens through a cap table allocation provided to current equity holders only. Further, any purchase of pre-sale tokens should be done in a manner that complies with an available exemption from registration under the securities laws.
10. After the Sale. Potential participants, to the extent possible, should help ensure that companies, after the sale, do not spend the money raised foolishly or do anything inconsistent with the company’s representations in its white paper and sale agreements. For example, companies should not use funds raised to support lavish expenses, the enrichment of founders and employees or, unless explicitly disclosed, to invest in other token sales.
* * * * *
Grant Fondo, an experienced federal prosecutor and former Assistant U.S. Attorney in the Northern District of California, is a partner in Goodwin’s Securities Litigation & White Collar Defense Group, its Privacy & Cybersecurity Practice and Chair of its Digital Currency & Blockchain Technology Practice. He represents technology, FinTech, blockchain, digital currency, life sciences, private equity and venture capital clients in a wide range of contested matters, as well as digital currency and blockchain companies in token sales and other matters.
Mitzi Chang, a partner in Goodwin’s Technology Companies & Life Sciences Group, focuses her practice on corporate and securities law, representing public and private companies, venture capital and private equity firms and investment banks in capital markets transactions, mergers and acquisitions, venture capital financings, SEC reporting and other general corporate and securities matters. Ms. Chang advises companies through every stage of the corporate life cycle – from initial financing through successful initial public offering or acquisition.
Meghan Spillane is a partner in Goodwin’s Securities, White Collar Defense & Business Litigation Group. She focuses her practice on white-collar criminal defense, including conducting internal investigations on behalf of corporate entities and representing companies and individuals in connection with government investigations and prosecutions. She also maintains an active civil practice, representing companies in complex business and financial litigation matters.
Stephen Fox is an associate in Goodwin’s Business Law Department. His practice focuses on advising emerging companies and investors throughout the corporate life cycle, including pre-incorporation planning and formation, venture capital financings, mergers and acquisitions, and general corporate representation and counseling. Mr. Fox represents clients in a variety of life sciences, technology, blockchain, digital currency, private equity and venture capital clients.
Timothy Kistner, an associate in the firm’s Securities Litigation & White Collar Defense group, concentrates his practice on government and internal investigations, corporate governance and securities litigation, white-collar criminal defense, and complex commercial litigation. Mr. Kistner has represented clients in federal government investigations related to national security, health care fraud, False Claims Act violations, Anti-Kickback Statute violations, immigration and visa issues, contract fraud, and export control violations.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
Request Securities & Capital Markets on Bloomberg Law
To a beginner, the entire concept of Ethereum and Ethereum token can get very confusing very fast. The idea that Ethereum not only has its own currency (Ether) but also has tokens on top of that which can act as currency themselves, can be a little mind-boggling. Before we even begin understanding what Ethereum tokens are all about, it’s important to grasp some basic concepts.
The entire Ethereum network is a giant mass of nodes (computers) connected to one another. In fact, the entire network can be visualized as a single entity called the “Ethereum Virtual Machine” or EVM for short. All the transactions that have happened and will ever happen in this network are automatically updated and recorded in an open and distributed ledger. So what is the advantage of this? Before we explain that it is important to know what a “smart contract” is.
Smart contracts are how things get done in the Ethereum ecosystem. When someone wants to get a particular task done in Ethereum they initiate a smart contract with one or more people. Smart contracts are a series of instructions, written using the programming language “solidity”, which work on the basis of the IFTTT logic aka the IF-THIS-THEN-THAT logic. Basically, if the first set of instructions are done then execute the next function and after that the next and keep on repeating until you reach the end of the contract.
The best way to understand that is by imagining a vending machine. Each and every step that you take acts like a trigger for the next step to execute itself. It is kinda like the domino effect. So, let’s examine the steps that you will take while interacting with the vending machine:
Step 1: You give the vending machine some money.
Step 2: You punch in the button corresponding to the item that you want.
Step 3: The item comes out and you collect it.
Now look at all those steps and think about it. Will any of the steps work if the previous one wasn’t executed? Each and every one of those steps is directly related to the previous step. There is one more factor to think about, and it is an integral part of smart contracts. You see, in your entire interaction with the vending machine, you (the requestor) were solely working with the machine (the provider). There were absolutely no third parties involved.
So, now how would this transaction have looked like if it happened in the Ethereum network? Suppose you just bought something from a vending machine in the Ethereum network, how will the steps look like then?
Step 1: You give the vending machine some money and this gets recorded by all the nodes in the Ethereum network and the transaction gets updated in the ledger.
Step 2: You punch in the button corresponding to the item that you want and record of that gets updated in the Ethereum network and ledger.
Step 3: The item comes out and you collect it and this gets recorded by all the nodes and the ledger.
Every transaction that you do through the smart contracts will get recorded and updated by the network. What this does is that it keeps everyone involved with the contract accountable for their actions. It takes away human malice by making every action taken visible to the entire network. But, having said that, what mainly incentivizes these people to fulfill their end of the bargain anyway? What are they getting by helping out the requestors? This is where Ether comes in.
Every single step in a smart contract is a transaction or a complex computation and would have a cost that is measured in “gas”. The price of this gas is paid by the requester in “Ether”. Ether is the currency with which everything runs in the Ethereum. When people talk about ETH and ETC they are actually talking about the value of the Ether in their respective blockchain.
Let’s check out the graph of gas prices over the years:
Every command has a specific gas limit which ensures that a buggy piece of code doesn’t end up depleting your entire ether wallet. So basically, the main reason why people fulfill their end of the bargain in a contract is that they are incentivized to collect Ether.
What happens when your ether supply gets depleted in the middle of the contract? If you do not have the ether required for all the gas payments, then all the transactions that have already taken place during the course will go back to the original state. But, your ether wallet will still reflect the change in balance since all transactions made in the blockchain are irreversible.
Going forward it is very important that you have two things absolutely clear:
- Smart contracts are how things get done in Ethereum.
- Ether is the currency that is used in the Ethereum network to do anything.
What Is An Ethereum Token: The Ultimate Beginner’s Guide
The primary difference between Ethereum and any other cryptocurrency is that it’s not just a currency, it’s an environment. Here anyone can take advantage of the blockchain technology to build their own projects and DAPPS (decentralized applications) through smart contracts. This is a very important distinction because this very thing shows you the true scope of what is possible in Ethereum.
Think of Ethereum like the internet and all the DAPPS as websites that run in it. There is something really interesting about these DAPPS, they are all decentralized and not owned by an individual, they are owned by people. The way that happens is usually by a crowd-sale called the “ICO” (more on that later). Basically, you buy certain tokens of that DAPP in exchange of your ether.
These tokens are usually of 2 varieties:
- Usage Tokens.
- Work Tokens.
Usage Tokens: These are the tokens that act like native currency in their respective DAPPS. Golem is a pretty good example of this. If you want to use the services in Golem then you will need to pay with Golem Network Token (GNT). While these tokens have monetary value they won’t give you any particular rights or privilege within the network itself.
Work Token: These are the tokens that identify you as a sort of shareholder in the DAPP. Because of that, you have a say in the direction that that DAPP takes. A perfect example of this is the DAO tokens. If you were a DAO token holder then you had the right to vote on whether a particular DAPP could get funding from the DAO or not.
Why Do We Need Tokens?
Right now you must be wondering, if all these DAPPS are made in the Ethereum Network, then why don’t we simply use Ether to pay for every transaction within those DAPPS? Why do we need a native currency for them? The answer to that is pretty simple, even in real life, there are tons of places where we use a form of token over cash.
Remember that time you went to the water park? Remember how they took your money and tied a band around your wrist which you used to gain access to all the rides in the park and to buy food as well? In this example the water park is the DAPP, your money is ether and the band is the token.
Okay, how about the time you bought those movie tickets for Wonder Woman and included an extra popcorn and coke in your ticket? The moment you entered the theater how did you get in the hall? You showed them the ticket. How did you buy your popcorn and coke? Again, by showing them the ticket. In this case, the cinema theater is the DAPP, your money is Ether and the ticket is the token.
By using tokens to execute certain functions in the smart contract of the DAPPS you make the process much more simple and seamless. Plus, tokens are also great for the overall value of ether as well (more on that later). Before we go any deeper, let’s first learn how exactly can one create a token and how can a DAPP issue tokens in exchange of ether.
How To Create An Ethereum Token
The simplest way for you to create a token is simply going to Token Factory and check out their system. They have a superbly user-friendly system which you can use right away:
If, however you want to code your tokens from scratch then you should definitely be well versed in Solidity aka the language used to code in Ethereum.
(You can also use Bancor to create smart contents, we will cover that a bit later in the guide.)
Token contracts can be very complicated but this is what a basic token contract looks like:
So let’s break down the code into its bare necessities. As you can see, there are three specific parts of this function:
- The mapping
- Giving the creator all the tokens.
- Transfer the token to a sender for ether.
The mapping: This part of the code is the mapping part:
This creates a database wherein everyone can see the balance of your tokens. Tokens like ETH itself is logged into an open ledger. Anyone can see all the balances and transactions of that particular token.
Giving the creator all the tokens: In this part of the function, whoever has created the smart contract and tokens will get all the tokens:
Transfer the token to a sender for ether: Now finally, the last part of the code. This is the part where a sender can get an equivalent amount of token for the ether that they invest into the DAPP.
The function is very self-explanatory. Firstly, it will check if the sender has the requested amount of tokens in their balance. Then the code will deduct the said amount of token from the sender balance and then add that value to the recipient’s balance. It is very straightforward.
So as you can see, the creators of various DAPPS have to create their own tokens. While this might sound good on the surface, it was an absolute nightmare for wallets, exchanges and other smart contracts who were going to interact with various DAPPS and tokens. Why was it so bad? Basically, for every single DAPP who had their own unique token they would have to completely re-invent the wheel every single time to make their system compliant with the DAPP.
Imagine reinventing and updating your code time and again every single time you need to interact with a new token! Something had to be done to circumnavigate this problem. Vitalik Buterin, in DevCon 1 2015, introduced the Initial Standards Token which would solve all these issues. Fabian Vogelstellar, one of the founders of the Mist Wallet, then took these standards and polished them up and added some of his own to come up with the Ethereum Request for Comments 20 aka ERC20 standard for tokens.
ERC20 Ethereum Standard For Tokens
The ERC20 standard is basically a specific set of functions which developers must use in their tokens to make them ERC20 compliant. While this is not an enforced rule, most DAPP developers are encouraged to follow the standards to ensure that their tokens can undergo interactions with various wallets, exchanges and smart contracts without any issues. This was great news for everyone because now they at least had an idea of how future tokens are expected to behave. ERC20 tokens have gotten widespread approval and most of the DAPPS sold on ICO’s have tokens based on the ERC20 standard.
So, what does a token need to have to be ERC20 compliant? It is basically a set of 6 functions that can be recognized and identified by other smart contracts, which in turn leads to seamless interactions. When executed, the following 4 basic activities are what all the ERC20 tokens required to do:
- Get the total token supply.
- Get the account balance.
- Transfer the token from one party to another.
- Approve the use of token as a monetary asset.
Ok so now that we have learnt what tokens are and what exactly they do. We have also learned how to create them and what rules they follow. But, the big question is, how exactly do you get your hands on them? When a new and exciting DAPP comes along, how do you get your hand on its tokens? The answer is through the ICOs.
What Are ICOs?
- They have provided the simplest path by which DAPP developers can get the required funding for their project.
- Anyone can become invested in a project they are interested in by purchasing the tokens of that particular DAPP and become a part of the project themselves. (We are talking about Work Tokens here).
So, how does an ICO work?
Firstly, the developer issues a limited amount of tokens. By keeping a limited amount of tokens they are ensuring that the tokens itself have a value and the ICO has a goal to aim for. The tokens can either have a static pre-determined price or it may increase or decrease depending on how the crowd sale is going.
The transaction is a pretty simple one. If someone wants to buy the tokens they send a particular amount of ether to the crowd sale address. When the contract acknowledges that this transaction is done, they receive their corresponding amount of tokens. Since everything on Ethereum is decentralized, an ICO is considered a success if it is properly well-distributed and a majority of its chunk is not owned by one entity.
The DAO ($150 million) was the biggest ICO of all time until it was recently overtaken by Bancor ($152 million).
In the past 12 months alone a staggering $331 million dollars have been raised in ICOs.
NOTE: ICOs have become an extremely controversial topic nowadays because of the sheer amount of money that developers have been raising even before the creation of an Alpha version of their product. Some people are accusing it of being a Ponzi scheme. While we don’t exactly label it that, it is true that certain aspects need to be checked before proceeding with future ICOs.
How Does An Ethereum Token Get Its Value?
Now that we know how you can get your hands on you tokens, let’s find out what gives them their value in the first place. Tokens get their value from the same place that most things get their value. They are mainly two factors:
- Supply & Demand.
Supply & Demand: This is basic economics 101. More the demand and lesser the supply more will be the price of the product. The supply-demand graph looks sorta like this:
The sweet spot where both the curves intersect is the equilibrium. So, how do Ethereum Tokens take care of supply and demand? Do you remember the token creation code? Specifically, the second part of the code? Let’s take another look now, shall we?
As this code implies, there is a fixed amount of tokens that can be issued in the first place. Each and every token is accounted for because like ether, token transactions are also recorded in the open ledger. If in case the developer wants to change the number of tokens issued, then they will have to create a new application. Any code that is issued in the blockchain is irreversible so the old application cannot be changed in any way.
So, now that we have a fixed and finite amount of tokens, that takes care of the “supply” part. What about the demand? The demand obviously depends on a lot of factors. What is the quality of DAPP in itself? Are people excited about the DAPP? Has that DAPP been marketed properly? Is that DAPP going to solve problems? If the demand of the DAPP is sufficiently high, and with the supply remaining constant, it goes without saying that the value of the token is going to be pretty high.
Trust: Like with any currency, tokens will only have value if people have trust in it. Trust comes from a lot of sources like the credibility of the developers, the kind of service provided by the DAPP etc.
Now that we have gained at least an introductory knowledge about tokens, let’s do some research on the 3 hottest Ethereum Tokens in the market right now:
Founder: Julian Zawistowski
Token Cap: 1 Billion GNT
Money Raised In ICO: $8.6 million
Think about this for a second. You are in your home with a super powerful PC and CPU and you are hardly using it at night, while at the same time, halfway around the world in Philippines, an animator is desperately looking to render a high-def video. Wouldn’t it be awesome if he could somehow access your computer’s power for the night and get his work done? With Golem that’s no longer a pipedream.
Golem describes itself as an “Airbnb for computers”. It is essentially a peer-to-peer network which is aiming to be the world’s first decentralized supercomputer. By tapping into the Golem network you can essentially “rent out” some of the CPU power in the network and use it for your own projects.
There are 3 kinds of people in the Golem network:
- Software Developers.
Image credit: Golem White Paper.
Requestors: These are people who want to access the power in the golem network. They can do so by paying with GNT (Golem Network Token).
Providers: These are people in the Golem network who are renting out their computer power. They get paid in GNT for their services.
Software Developers: These are people who are going to be uploading the software they develop into the Golem system. In case the requestors want to use their software, they will have to pay GNT to the software developers to gain access to their software and then pay the providers the required amount to rent out their computer power.
There is one way that the Golem system can be exploited. Suppose a requestor rents out a provider’s hardware and uses it to run a virus code which steals all the data in that hardware or the entire system. What happens then? To counteract this issue all the transactions in Golem will be run in a sandbox environment. What does that mean? When you rent out a provider’s hardware you will be under a lot of rules which will restrict your movement. So, if you were a hacker you won’t really have the freedom to move about and do what you want.
This is what the Golem graph, as of writing, looks like.
The Market Cap is currently sitting at ~$500 million.
- A very interesting concept which can effectively create the world’s first decentralized super computer.
- Can give access to people living in poorer parts of the world to world-class computer machines.
- The team behind Golem is very good and proven.
- The value of GNT has been steadily rising over the last few years.
- The sandbox environment contains any potential hacks.
- Gives software developers a platform to release and showcase their software.
- Makes good use of underutilized computer equipment.
- Even though there is a way to contain any hacks, no sandbox is perfect. A bug can be exploited which can render the entire system useless.
- According to the roadmap given in their white paper, Golem will take 8 years to run at an optimal state which is too long a time.
- Potential latency issues because of over usage.
It looks like Golem has a pretty bright future with a very interesting concept. Along with that, it has a very good team backing it, headed by a very capable leader. The team has been together since DevCon 1 and it looks like they have what it takes to make the concept really work. Seeing the growth in GNT’s value over the past few months, there is no reason to doubt their potential.
Founders: Joey Krug & Jack Peterson.
Token Cap: 11 million REP
Money Raised In ICO: $5.2 million
Remember that old game show “Who Wants To Be A Millionaire?” Every participant on that show had 3 lifelines, one of which was audience poll. Basically, if they were stuck on a question, they could ask the audience that question. The audience was then supposed to vote on the option that they felt (or knew) was to be correct. More often than not, the audience got it right. This phenomenon is called the “Wisdom Of The Crowd”, which states that groups of people, in general, are correct more often than individuals. Now what Augur did was use that same idea in prediction markets.
What Are Prediction Markets?
Prediction markets are speculative markets which allow users to purchase and sell shares in the outcome of an event. Suppose you have specialized knowledge in a particular field eg. A basketball match. By taking various factors into consideration you wager on the favorable outcome.
Image Credit: Augur white paper.
How does Augur work?
There are three kinds of people who use augur:
- The Reporters aka the REP token holders.
- The Wagers.
- The Market Creators.
The ReportersThese are the people who own the REP tokens and are therefore obligated to report on the outcomes of their fields of choice. When an event is near maturation they report on the outcome (this will be discussed later). If they report wrongly or they do not report at all they risk losing 20% of their REP coins. The value of augur is directly proportional to the quality of the reporters. Why? Because if a lot of the reporters are dishonest then no one will want to use augur which will greatly decrease the demand. This forces all the reporters to remain honest.
The Wagerers: These are the ones who will be betting on the outcome of the future of the markets based on the reports by the reporters.
The Market Creators: They will be creating the markets for the reporters to report on and earn market fees as a result.
The Reporting Period
The reporting is done in 2 phases. Within the first month of the completion of the event, the reporters submit their report to the network which is tightly secured and kept away from the public. A month later, the second phase happens where the reports are shown in an open ledger which is free for all to see. When that is done, we reach a final consensus.
Aftermath Of The Consensus
- The wagerers get their appropriate reward for putting their bets.
- The reporters who reported honestly get fees from the wagerers.
- The reporters who didn’t report correctly get 20% of their REP deducted and that, in turn, go to the reporters who reported honestly and correctly.
Let’s take a look at augur’s curve:
Current market cap is sitting at ~$345 million
- Based on the concept of “wisdom of the crowd” which helps keep the whole system honest.
- Helps to make correct future predictions for markets.
- Forces the reporters to report honestly at the risk of losing REP tokens.
- Not dependent on a central entity for market predictions which keep it free of human greed.
- Tends to reward those who bought in early and accumulated REP coins as compared to newer buyers.
Augur is growing from strength to strength but is facing stiff competition from Gnosis, which is a similar token. How it comes out of this battle will greatly affect its future.
Founders: Bprotocol Foundation.
Token Cap: Unknown
Money Raised In ICO: $153 million
Bancor has shaken the crypto world down to its very foundation’s thanks to its ICO. People have invested a staggering $153 million into the company! So what is the noise all about? What is so interesting and exciting about Bancor? One of the problems that MAY affect the Ethereum community in the future is the sheer amount of tokens. While most of the popular tokens can be easily exchanged, the problem arises when you have rare tokens.
While you can easily exchange and buy tokens like GNT, what happens when you have tokens that nobody wants to exchange with? How do you liquidate your tokens then? This is where Bancor offers an extremely elegant solution. Bancor has come up with the idea of issuing smart tokens.
What Is A Smart Token
The idea of the smart token is to make tokens which completely do away with currency exchanges. Normally if you were to buy a token what happens is that you will have to go to an exchange, wherein someone will try to match you with someone else and after the transaction takes places. If you have a rare token that no one really uses, it can get hard to have someone match up with you.
So what bancor does is that it builds tokens with smart contracts built inside it. The smart contract has a mathematical formula inside it which allows you to have exchanges directly with the smart contract itself. Basically, it becomes its own market maker!
The Maths Behind Smart Tokens
The smart contract inside these smart tokens runs on the following formula:
Price = (Balance)/ (Supply * CRR)
Let’s examine the equation.
- Price = The price of the smart token.
- Balance = The money with which you were buying the token (ETH in this case because we are solely talking about Ethereum tokens).
- Supply = The total supply of the tokens available in the market.
- CRR = Constant Reserve Ratio. This is the ratio between the original balance and the market cap. This is a constant and will never change. Its value is always <1.
So now that we have defined all the values and variables in the equation, let’s see how altering every single one of them will affect the price of our token.
Case 1: Buying new tokens
When you are buying new tokens you will do so by adding ETH to the smart contract of your token. When you do that obviously “Balance” will increase. Since you are buying new tokens, it also means that you are creating new tokens out of nothing, which in turn increases the “Supply” itself. Since ”CRR” is a constant, it won’t change.
So keeping these things in mind, let’s re-examine the equation:
Price = (Balance)/ (Supply * CRR)
Now, keep in mind, CRR remains unchanged, so while the value of supply has changed (Supply * CRR) will still be a smaller value than (Balance).
Numerator (Balance) > Denominator (Supply * CRR), the overall value of the price of a token will INCREASE.
Case 2: Selling your tokens
Now, what happens when you are selling token? Since you are taking Eth out of the smart contract your “Balance” will go down. At the same time since you are literally commanding the smart contract to destroy the required amount of tokens, your “Supply” will go down. CRR being the constant remains the same as before.
Now put these values in the equation:
Price = (Balance)/ (Supply * CRR)
The numerator will still be greater than the denominator, but since the new numerator will be less than the original numerator (on account of balance reducing) the overall price will drop.
You can simply put numbers in the equation and check out the changes itself. So what exactly is happening whenever you are buying and selling new smart tokens?
Now, what happens if you sell a lot of coins at once and you don’t have enough balance to counter it out? The equation has been made in a way that it adjusts itself dynamically to any and all circumstances. If you are interested you can check out the Bancor white page where they have a couple more complicated formulas which very much proves that the equations will always hold true.
When you BUY smart tokens you are giving ETH to the smart contract and instructing the equation to literally come up with new tokens for your out of the thin air.
When you SELL smart tokens you are instructing the smart contract to destroy the required amount of tokens and deduct the value of ETH from your Balance and transfer it to your wallet.
- Has completely taken the middle man out of cryptocurrency exchanges.
- You won’t have to pay any extra taxes or charges because the middle man no longer exists.
- The idea of smart tokens has enormous potential.
- Makes sure that you can always liquidate your tokens.
- Gives an interface for you to make newer tokens.
- The ICO was highly controversial because they didn’t keep a market cap initially for close to an hour. Not keeping a market cap greatly affects the price of the tokens.
- The idea of the smart tokens can be a little tough to grasp for people who are new to cryptocurrency.
- The idea is extremely nascent and untested.
Questioning the future of Ethereum tokens is the question the future of DAPPs and Ethereum itself. In the past one year, a number of tokens that have come out is truly staggering and it shows no sign of stopping. As long as people are looking to innovate on the Ethereum blockchain, you will be getting a new and steady supply of tokens.
Since a token can be anything fro currency, to real-world assets, to IOUs, tokens are going to evolve into becoming more and more versatile. Fabian Vogelstellar, the man who gave us the ERC20 token Standard has this to say about tokenization:
“I believe we are just at the beginning of tokenizing everything. Maybe in the future, you will be able to buy a share of the chair you are sitting on, the paint inside your house or a fraction of equity in a huge building complex.”
Original article was posted by Ameer Rosic on BlockGeeks.com
An Initial Coin Offering (ICO) is the process or event that Blockchain enterprises adopt to raise funds for their ventures or projects. It bears some similarities with Initial Public Offering (IPO) as pertains with mainstream stock market, the difference here however is that investors actually do not own shares in these blockchain companies. They only get allocated tokens whose values rise or fall based on the performance of these companies. But just like shares on the stock market, tokens can be traded and liquidated on cryptocurrency or digital asset exchanges.
Since almost all ICOs require the processes of token creation and allocation, there comes the need to make use a Blockchain to power the ICO and its tokens. A Blockchain is a decentralized public database of digital transactions which is permanently recorded and can never be altered or erased.
The ICOWatchList.com Team has over the period dedicated time to study and research over 400 ICO projects and the Blockchains on which they have been hosted and have come up with the following findings as a result;
It was discovered that the Ethereum Blockchain has so far been quite popular with the majority of ICO projects. Approximately 56.83% of the 400+ ICOs made use of this Blockchain. One major reason accounting for this is Ethereum’s smart contract feature.
A sizeable chunk of ICO campaigns also made use of their own customized Blockchains. An estimated 29.96% either developed their own Blockchain from scratch or made use of an open source Blockchain platform and tweaked it to fit their project needs.
The Waves Blockchain came in a distant third as only 2.20% of digital projects have made use of it thus far. Waves was specifically designed to assist projects run their own ICOs with comprehensive features such as cost-effective value transfer and an effective decentralized exchange for tokens being a few of its many attributes. The blockchain is also set-up for easy audit and also has a publicly accessible and unalterable ledger of transactions. Project founders are able to create their own customized tokens off the wave tokens they are allocated by virtue of signing-up to place their ICO campaigns on the Blockchain.
1.76% of projects made use of the Bitcoin fork blockchain whiles 1.32% utilized Hyperledger. Hyperledger is an open source blockchain which came into existence as a result of a global cross-industry collaboration. It is hosted by the Linux foundation in collaboration with industry leaders in Banking and Finance, supply chains, Internet of Things, Manufacturing and Technology.
Other blockchain platforms used by ICOs include Bitshares (0.88%) which is a blockchain mainly focused on the real financial sector, Rootstock (0.88%) – the first open source blockchain platform equipped with a 2-way smart contract which is pegged to Bitcoin and also rewards bitcoin miners.
Additionally, less than one percent of ICO projects made use of NEM (A distributed ledger blockchain technology which promotes quick and secure transactions) and whiles some 4% of the projects made use of other lesser known Blockchain platforms.
This article was originally published by ICO WatchList.
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