Securities brokers are well-known in the market, and sufficient clarity about the role they perform exists. However, the role of an Initial Coin Offering broker requires clarity.
Initial Coin Offerings (ICOs) are increasingly becoming important for the blockchain-cryptocurrency start-ups, for e.g. these start-ups have raised US $ 5.6 billion from ICOs in 2017. However, out of the 902 ICOs in 2017, only 435, i.e. 48% were successful.
The start-ups are trying to find effective means to raise funds, and some are considering utilizing ICO brokers to attract investors to their project. However, if you engage brokers without understanding the regulations, there can be adverse legal impacts on your ICO project. In this guide, I explain the role of Initial Coin Offering brokers and what the start-ups should consider before engaging them.
Initial Coin Offering brokers: what does the law say?
In the securities market, brokers affect transactions in securities for others and receive a compensation that is dependent on the outcome or the size of the deal. They are different from dealers who buy and sell securities themselves. The brokers are also different from ‘finders’ who attract investors to the security and receive a flat fee irrespective of the outcome or size of the deal.
In the US, the Securities Exchange Act of 1934, commonly known as the “Exchange Act”, regulates the brokers. To offer brokerage services, a broker in the US must register with the Securities and Exchange Commission (SEC), join a self-regulatory organization (SRO). They also often need to register with the Securities Investor Protection Corporation.
Brokers in securities have important obligations towards protecting the investors from unlawful practices, and the regulatory bodies are constituted to oversee the compliance with the law. If someone offers brokerage services in securities without registering with SEC, the person could face legal actions, fines, penalties and even criminal prosecution.
You as the blockchain-cryptocurrency entrepreneur must determine whether your crypto token is a utility token or security. Security tokens are shares of the blockchain start-up company, distributed in the blockchain ICO. On the other hand, the utility tokens represent access to the product or service the company offers.
If you determine yours as a securities token, then you must engage only registered brokers as your initial coin offering brokers.
How to determine if your token is security and whether you are hiring a broker:
You first need to determine whether the token you are issuing for ICO funding is a security, and you need to use the ‘Howey test’ for this. This was created by the US Supreme court to determine whether a transaction qualifies as an ‘investment contract’.
There are two conditions, as follows:
- If the investors are buying it expecting a future increase in price, then that transaction is a security.
- If the issuer is a single entity, instead of a democratic network governance, then it’s a security.
- If your token meets these two criteria then it’s a security token. On the other hand, if it only allows access to a product or service of your company, then it’s a utility token.
Note: The ‘Howey test’ isn’t the only such test available, and you need to use other tests depending on circumstances. Also, securities laws are complex, and I recommend that you take professional legal advice.
Now, you need to determine if you are utilizing the service of a finder or a broker. If you only need the person to introduce investors to your ICO project, and you pay a fixed fee for that irrespective of the deal outcome or size, then you only need finders, and not registered brokers.
However, the regulators look for a pattern of the activities the finders have performed over the years, and not just one instance. If the finders in question have earlier acted as brokers, or if their mode of functioning suggests that they will offer brokerage services in future, then they should register as brokers.
On the other hand, if you need them to affect transactions for you, and you pay them commissions depending on the deal outcome or size, then you need registered brokers. The US SEC provides guidance on this, and you need to ask the following questions:
- Is the person taking part in solicitation, negotiation, or execution of a securities transaction?
- Are the fees dependent on the outcome or size of the deal?
- Is the person in the business of facilitating securities transactions?
- Does the person handle securities or funds of others in relation to securities transactions?
A ‘Yes’ answer to any of the above questions indicate you are dealing with a securities broker, and registration is mandatory. If you are in the US, you can check the persons’ registration in the ‘BrokerCheck’ tool that the Financial Industry Regulatory Authority (FINRA) has.
Now you need to make sure the broker or the brokerage firm you engage has the necessary expertise to provide the services you need. You also need to work with the broker closely to raise the funds you need.
How do the Initial Coin Offering brokers work?
If you engage, you need to know how they work. The brokers do the following for the ICO of your altcoin:
- The brokers enable people from diverse geographies to participate in your ICO crowdfunding by pooling contributions.
- They typically publish their fee structure, which is generally dependent on the investment amount.
- The brokerage firm opens accounts for the investors, and often use ‘My Ether Wallet’ (MEW) for this.
- The investors deposit their funds in a public address they get from the brokers.
- The brokers create an investment pool for your blockchain project ICO.
- They can obtain bonuses during investment phase if the pool is large enough.
- The brokerage firm makes one transaction only and it helps in ICOs that sell very fast.
- Most ICOs are conducted over the Ethereum platform, and to execute transaction ‘gas’ is needed there. Since the brokers create a large investment pool, they can contribute more gas, enabling faster transaction execution.
- Upon receiving tokens, the brokers transfer them to the investors’ MEW account.
- They then securely transfer the MEW account details to an encrypted USB drive and send that to the investor via registered post.
- After the investors confirm receipt of the USB drive the brokers destroy the records concerning the USB drive so that only the investors control their wallet.
An example of an ICO broker is Icobroker.io.
Note: If you need an in-depth understanding of the concept of ICO, you can read this guide.