insight magazine

Raising Capital in the Cryptocurrency Age

Help, my client wants to do an initial coin offering. By RYAN WATSON, CPA | Summer 2018


Once upon a time, companies looking to raise capital to start or expand a business venture were limited to a fairly small, highly regulated set of options — banks, hedge funds, venture capitalists, and the like. Then crowdfunding through public platforms, like Kickstarter and GoFundMe, picked up following the proliferation of the online market economy. While these options often provide for greater flexibility and ease of access, they leave a mess of regulatory and compliance nightmares in their wake. Today, the latest fundraising fad fueling the business world is the initial coin offering, or ICO.


An ICO is a means of raising capital by a startup or business engaging in cryptocurrency. Instead of issuing debt or equity, the company creates a digital token or coin — a new cryptocurrency, à la Bitcoin — and “sells” that coin for legal tender, other cryptocurrencies or, in many cases, promises of goods or services. The company then uses the capital raised to continue funding their business projects or operations.

You may be wondering why someone would want to buy into an ICO. Broadly speaking, these coins derive their value in one of two ways: 1) by tying their value to the growth of the company, or 2) by providing utility or value, think early access or pre-order discounts on a future product or service being built by the issuing company, among other things.


It is no coincidence if ICOs make you think of IPOs, or initial public offerings. So, given the high degree of scrutiny placed on securities offerings, how then are these ICOs treated?

The original intent of cryptocurrencies was to escape government regulation and advance global decentralized free trade. Governments and regulatory bodies around the world have a different take on that. To consider cryptocurrencies and ICOs as currently regulated would be a stretch, but the regulatory environment is certainly evolving rapidly as businesses and consumers increasingly adopt cryptocurrencies.

Some countries, like China, have banned ICOs outright, claiming they represent illegal public offerings and are fraught with criminal activity and fraud. Other countries, like ours, are adopting more coin-friendly, though vague, approaches to ICOs — for now.

In the U.S., cryptocurrencies themselves are classified as property by the IRS — therefore exchanges of cryptocurrencies are subject to capital gains taxation, like day-traded stocks. Treatment of the issuance of a new cryptocurrency, however, is dependent on the way in which the token derives its value. If the value is tied to the growth or earnings of the company issuing the coin, that offering is often subject to securities regulations, like equity financing. If the value is instead tied to some future utility on a platform or service created by the issuer, the regulation is less concrete, and for the most part such offerings have avoided the scrutiny of securities regulators. For obvious reasons, the majority of ICOs are classified in this manner, although the Securities and Exchange Commission (SEC) is becoming increasingly vocal on the subject.

While evaluations are conducted on a case-by-case basis, the cryptocurrency community has mostly self-regulated itself, applying the “Howey Test” in determining whether an ICO represents a sale of securities. The Howey Test, named after the 1946 Supreme Court case SEC v. Howey Co., establishes whether there is an "investment contract" under the Securities Act based on whether the scheme involves an “investment of money in a common enterprise” with “profits to come solely from the efforts of others.” If the test is met, the presumption is the contract is subject to SEC regulations. Issuers attempting to circumvent SEC regulations then focus on the ways in which their ICO does not meet the Howey Test.


The explosion of interest in cryptocurrencies, coupled with their relatively light regulatory oversight, has made ICOs a popular source of funding for many companies over the last year. In 2017 alone, Fabric Ventures and TokenData reported a whopping $5.6 billion raised through ICOs.

The trouble is, as with all opportunities offering high reward and light regulation, misuse, abuse, and outright fraud have plagued the ICO market — N.Y.-based cryptocurrency advisory firm Satis Group estimates over 80 percent of all ICOs are scams. One such scam, PlexCoin, was perpetrated by founder Dominic Lacroix, who was previously convicted by the SEC of defrauding investors. In his investment materials, Lacroix committed to delivering returns of 1,354 percent and had false experts corroborate his project and obscure his past financial crimes. PlexCoin’s ICO raised $15 million before it was halted by the SEC in December 2017. Lacroix was jailed and the PlexCoin parent company was fined $100,000. To little surprise, the Satis Group currently labels less than 2 percent of all ICOs as “successful.”

In fact, in a recent review of documents produced for 1,450 ICOs, the Wall Street Journal uncovered deceptive and fraudulent methods — including plagiarized investor documents, promises of guaranteed returns, and missing or fake executive teams — were used to attract investors into 271 of the ICOs, which managed to raise $1 billion collectively.

Given the rampant bad behavior in ICOs, large tech giants have begun to act. In January, Facebook announced it would ban all advertisements related to cryptocurrency offerings, citing the “deceptive promotional practices” pursued by many issuers. Shortly thereafter, Google, Snapchat, Twitter, and others announced similar plans to limit or ban ICO advertisements on their platforms. But that does not mean ICOs will cease or are a lost cause.


ICOs represent one of many possible options for raising capital. For the right project, an ICO provides a business with valuable funding flexibility and offers its consumers early-access to discounts, features, investment stakes, and more. For the wrong project, an ICO can result in a substantial regulatory burden or legal and compliance risk. If you or your client is considering an ICO, make sure to evaluate the opportunity with care. At the simplest level, if the ICO feels incidental or unrelated to the project — a gimmick if you will — it probably is.

Cryptocurrency advocate Fred Wilson, partner at Union Square Ventures, suggests using these criteria when evaluating the merit of a potential offering: “(1) a relationship between the amount of money being raised and the complexity of the project, (2) a very clear use case that requires the decentralization approach brought by blockchain technology, (3) a reasonable valuation based on the size of the opportunity being pursued, (4) a credible team, and (5) the technology has been built, at least to a point where it is demonstrable.”

And when in doubt, as with any new technology or opportunity, don’t go it alone — seek advice and guidance from respected experts in the field.

So, when your client or CEO approaches you about a possible ICO, what will you do?

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