How to avoid pitfalls in digital currency token issuance? Five guiding principles investors must know

How to avoid pitfalls in digital currency token issuance? Five guiding principles that investors must know! To onlookers, tensions between blockchain builders and the U.S. Securities and Exchange Commission (SEC) appear to be reaching a fever pitch. The SEC believes that almost all tokens should be registered under U.S. securities laws. Blockchain builders think this regulation is ridiculous. Despite such differences of opinion, the fundamental goals of the SEC and the builders are the same - to create a level playing field.

#This tense relationship comes from the fact that both sides have completely different perspectives on the same challenge. Securities laws attempt to create a level playing field among investors by imposing disclosure requirements on companies with publicly traded securities that are designed to eliminate information asymmetries. The blockchain system attempts to create a level playing field among a wider range of participants (developers, investors, users, etc.) through decentralization, using transparent ledgers to eliminate central control and reduce management work. dependence. Although builders reach a wider audience, they also want to eliminate asymmetric information related to the system and its native assets (tokens).

It is not surprising that regulators are skeptical of the latter. Such decentralization has no similar reference in the corporate world; this prevents regulatory agencies from finding the corresponding responsible party; and, because decentralization is difficult to establish and measure, it is easy to falsify.

No matter what, it is the responsibility of Web3 builders to prove that the blockchain industry’s approach is effective and worthy of consideration. This task would indeed be easier if the SEC was a constructive partner, but the crypto industry cannot allow the SEC’s failure to fall on its shoulders. Web3 projects must strive to work within existing guidance, whether it is the Digital Asset Framework issued by the SEC in April 2019 or the recent enforcement action ruling against Coinbase.

So, where should the project start? After determining the time and method of token issuance, the project can start by following the following five major token issuance principles:

(Note: These principles are not intended to guide projects to evade the supervision of U.S. securities laws, but are intended to Inform projects how they should manage their activities so that risks related to token holdings are clearly separated from risks related to securities investments. All of these guidelines are dependent on the specifics of the project structure and activities before implementing these rules in a planned manner. Full consultation.)

##Principle 1: Never publicly sell financing tokens in the United States

In 2017, with dozens of projects Wanting to raise funds based on the promise that they will enable important technological breakthroughs, ICOs (Initial Coin Offerings) are booming. While many projects do this (including Ethereum), there are far more that don’t. At the time, the SEC's response was both forceful and reasonable. The commission seeks to apply securities laws to ICOs that generally meet all the criteria of the Howey Test — a commitment of money to a common cause in a contract, plan, or transaction based on the management or corporate efforts of others. Obtain reasonable profit expectations.

The application of the Howey test is easiest for significant transactions (i.e. the sale of tokens by a token issuer to an investor). In many ICOs, token issuers make clear representations and promises to investors that they will use token sale proceeds to fund their operations and provide future returns to investors. These use cases are all securities trading, regardless of whether the instrument being sold is a digital asset or a stock.

The industry has made significant progress since 2017, moving away from financing based on U.S. public token sales. We are in a different era. ICOs are nowhere to be found. Instead, tokens allow holders to manage the network, join games, or build communities.

Applying the Howey test to tokens is much harder now - airdrops involve no capital investment, decentralized projects do not rely on management efforts, and many secondary token transactions clearly do not meet the Howey condition, And, without overt marketing, secondary buyers may no longer rely on the efforts of others to make a profit.

Despite some progress over the past seven years, ICOs reappear in new forms with each new cycle and appear to refuse to comply with U.S. securities laws. This happens mainly for the following reasons:

• Some industry participants believe that U.S. securities laws are ineffective or unfair and therefore justify violating them - a convenience for anyone who wants to profit from them ideological stance.
• Some people invent new plans, hoping that slightly changing the facts will bring about different results. “Protocol-owned liquidity” (indirect sales of tokens by decentralized autonomous organizations (DAOs), which then control the proceeds through decentralized governance) and “liquidity bootstrap pools” (liquidity pools through decentralized exchanges) That’s how the idea of ​​selling tokens indirectly came about.
• Some hope to take advantage of the uncertainty created by the SEC’s insistence on enforcement regulations, which has resulted in many inconsistent and irreconcilable rulings.

Projects need to be careful to avoid these scenarios. None of this is sufficient reason to ignore or violate U.S. securities laws.

The only legal way for a project to avoid having securities laws applied to its own tokens is to reduce the risks targeted by these laws (e.g., reliance on management efforts and information asymmetries). Selling public tokens to Americans for the purpose of financing is antithetical to these efforts, which is why the top crypto concern for regulators over the years has been financing (including some minor adjustments and changes to financing).

The good news is that it is easy to avoid legal consequences for publicly selling tokens for financing purposes in the United States. Of course, even if you don't do this, you can still raise money in other ways. Public sales of shares and tokens and private sales of shares and tokens outside the United States may be conducted in a compliant manner without subject to the registration requirements of securities laws.

Summary: In the United States, public sales are an own goal. Avoid at all costs.

Principle 2: View decentralization as your North Star

Builders can use many different token launch strategies. They can decentralize their projects before the token is released, launch it outside the United States, or limit the transferability of their tokens, preventing access to secondary markets in the United States.

In this article, I will discuss all of these issues in detail using the DXR (Decentralize, X-clude, Restrict) token issuance framework, which points out how each strategy reduces risk.

If the project has not yet achieved "sufficient decentralization," both the X-clude and Restrict strategies can help the project comply with U.S. securities laws when issuing tokens. But crucially, neither can replace decentralization. Decentralization is the only path projects can take to help eliminate the risks that securities laws are designed to address, making the application of securities laws unnecessary.

So, no matter which strategy a project chooses at the outset, those who intend to use tokens to convey a wide range of benefits (economics, governance, etc.) should always have decentralization as their north star. Other strategies are just stopgaps.

How does this work in practice? No matter how a project evolves over time, it should always seek to make progress toward higher levels of decentralization. For example:

• After the mainnet is released, the founding team of the L1 blockchain may want to invest a lot of development efforts to achieve several technical milestones. To reduce the risks associated with “reliance on regulatory efforts,” they could first exclude the United States from the issuance area and then only issue tokens in the United States when they have made progress toward decentralization. These milestones could include supporting permissionless deployments of validator sets or smart contracts, increasing the total number of independent builders developing and building on the network, or reducing the concentration of token staking.

• Web3 gaming projects may wish to use restricted tokens in the United States to incentivize in-game economic activity. Over time, as more user-generated content is created, as more gameplay relies on independent third parties, or as more independent servers come online, the project may Remove token restrictions.

Developing these steps for a decentralized plan is arguably the most important part of completing a token issuance. The strategy chosen for a project will significantly impact how it operates and communicates, both at launch and in the future.

Summary: Decentralization matters a lot. Take this into consideration in all endeavors.

Principle 3: Communication is everything, manage yourself accordingly

"Communication", I cannot emphasize it enough, no matter what communication looks like No matter how inconsequential or innocuous, it can make or break a project. One misstatement from the CEO could put the entire project in jeopardy.

Projects should have strict communication policies tailored to the nuances of their token issuance strategy. So let’s break this down using strategies from the Token Issuance Framework:

(1)Decentralize

This strategy is to ensure that purchasers of project tokens do not have “reasonable expectations of profit based on the management or corporate efforts of others” (as stated in the Howey test). In a decentralized project, token holders will not expect the management team to provide profits because no one group or individual has this power. The founding team shall not give other instructions, otherwise securities laws may be involved.

So what are “reasonable expectations”? A lot depends on what the project or token issuer has to say about the token (as well as tweets, texts, and emails). Courts have repeatedly found that when a project announces that its core team is driving progress and significantly developing economic value, it is reasonable for investors to rely on the efforts of that core team to obtain a return on their investment. This finding can be used to justify the application of securities laws.

Speaking of decentralization, a strict communication policy is not a cheesy tactic to evade U.S. securities laws—it is a legal way to reduce the possibility of token buyers relying on management or corporate efforts to make profits. , which helps protect web3 projects and their users. The truth is, by refusing to write constructive rules and weaponizing dialogue with builders, the SEC has created incentives that are diametrically opposed to its mission. Web3 builders are actually encouraged to reveal as little as possible about their projects and activities to the public.

So what does this strategy look like in practice?

First, projects should not discuss or mention their own tokens before releasing them, including potential airdrops, token distributions or token economics. The consequences of doing so could be severe—the SEC has successfully blocked many companies from issuing tokens, and they may do so again. Don't give them a chance.

Second, after the token is issued, projects should avoid discussing the price or potential value of the token, or treating it as an investment opportunity, including mentioning any mechanism that may cause the token to appreciate, as well as any comments on its use The commitment of private capital to continue funding the development and success of the project. All of these actions will increase the likelihood that token holders will have reasonable expectations of profits.

After a project is decentralized, how members of the project ecosystem—including founders, development companies, foundations, and DAOs—talk about their roles is crucial. It’s easy for a founding team to speak of a centralized nature even if the project is very decentralized, especially if they are used to talking about achievements, milestones, and other projects in the first person.

Here are a few ways to avoid falling into this trap:

• Don’t refer to yourself in a way that vaguely implies ownership or control of the protocol or DAO (e.g. , "As the CEO of such-and-such agreement...", "Today, we have opened such-and-such function of the agreement...").

• Avoid forward-looking statements whenever possible, especially regarding mechanisms such as planned “burning” of tokens to achieve pricing targets or stability.

• Avoid making promises or guarantees about work in progress, and avoid describing work in progress as being of outsized importance to the project ecosystem (e.g., using “initial” where appropriate Development Team" rather than "Core Development Team" or "Main Development Team", and do not refer to individual contributors as "Directors").

• Highlight efforts that have promoted or will promote greater decentralization, such as contributions from third-party developers or app operators.

• Let the project’s DAO or foundation have its own voice to avoid confusion with the DevCo or founder who started the project. Better yet: To avoid confusing third parties, rename or re-advertise the original DevCo so it doesn't have the same name as the protocol.

Ultimately, all communications should reflect the principles of decentralization, especially in public settings. Communication must be open and designed to prevent any individual or group from obtaining significant asymmetric information.

Summary: Once decentralization is achieved, no one person or company will be the spokesperson of the project. The project's ecology has its own operating system, which is independent and unique. Just one mistake can be catastrophic.

(2) Shares issued outside the United States are not subject to certain registration requirements under U.S. securities laws.

The goal of this strategy is to prevent the flow of tokens into the United States, so communications should avoid "targeted sales efforts" to promote or advertise tokens in the United States, risking "regulating the U.S. market" (i.e. creating demand for tokens). Ultimately, the strictness of these policies will depend on whether there is “substantial U.S. market interest” (SUSMI) in these tokens (i.e., significant market demand for the tokens in the United States).

Summary: If you don’t offer tokens in the US, don’t act like you do. Any statements you make about project tokens on social media should specifically emphasize that these tokens are not available in the United States.

(3)Restrict

Limiting the issuance of tokens to the transfer of restricted tokens or "off-chain" points allows for a more flexible communication strategy. Projects that are thoughtfully executed insulate themselves from legal risk because individuals cannot earn tokens by making a “fund investment” under the Howey test.

Nonetheless, this isolation could quickly break down if projects encouraged participants to view the transfer of restricted tokens or points as an investment product. These remarks could seriously undermine the legal basis for restricted tokens.

Summary: The Restrict restriction strategy does not exempt builders from legal worries. Careless remarks could cause problems for the project in the coming years, preventing it from changing its release strategy or even achieving decentralization.

Principle 4: Treat secondary market listings and liquidity with caution

Secondary market listings and liquidity are another display of SEC enforcement regulations created Areas of incentives that run counter to their mission.

Projects often seek to be listed on secondary exchanges so that more people can acquire their tokens and use them to access blockchain products (for example, you need to own ETH to use the Ethereum blockchain). This usually requires ensuring that there is sufficient liquidity on the trading platform, a lack of liquidity can lead to price fluctuations and increase risks for the project and its users. Why? In the early days of a token’s launch, large-scale purchases or sales on a specific platform can significantly affect the price of the token. When prices fall, everyone loses money. When prices rise, FOMO-driven investors may push prices to unsustainable levels—and when prices stabilize, they may lose more.

For Web3 users, increasing access and ensuring there is sufficient liquidity (usually through market makers) is a better option. It also helps make markets more fair, orderly and efficient. Although this is the SEC’s stated mission, it has used announcements by projects regarding the availability of their tokens on secondary trading platforms to oppose these projects. It also attempts to treat secondary market liquidity provision as an ordinary token sale.

Projects that do not initially adopt a decentralized token issuance strategy have greater flexibility in secondary market listings and liquidity, as both strategies would delay the availability of fully transferable tokens within the United States. . This buys projects time to resolve liquidity issues by increasing the public holdings of their tokens (the number of tokens in circulation) before the tokens become widely available in the U.S., so token issuers are less required to The United States deals with secondary market listings and liquidity issues.

Summary: Projects need to treat these listings and liquidity with extreme caution. A risk/benefit analysis is usually not worth it. At a minimum, projects that are unsure whether they have achieved "sufficiently decentralized" should not publish news about their tokens being listed on exchanges, nor should they engage in any market-making activities within the United States.

Principle 5: It is critical to always keep the token locked for at least one year after the token issuance

. Projects should implement transfer restrictions on all tokens issued to internal personnel (employees, investors, consultants, partners, etc.), affiliated companies, and anyone who may participate in token distribution. These restrictions shall apply for at least one year after the token issuance.

The U.S. Securities and Exchange Commission has successfully used the lack of a one-year lock-up period to prevent token issuers from issuing tokens. It may do so again. To make matters worse, SEC precedent gives plaintiffs’ attorneys a road map to file class action lawsuits against companies that fail in this regard. This is free money for them, but it is a huge pain for the project.

Ideally, the token lock and other appropriate transfer restrictions should only begin to be unlocked after the end of the one-year period, starting with the token launch, and then linearly distributed over the next three years from there, The total lock-in period is four years. This approach can help mitigate the legal risks described above. It can also position the project for long-term success by reducing downward price pressure on the token and demonstrating confidence in its long-term development.

This is a win-win situation.

Given these obvious benefits, projects should also be wary of investors seeking to request a shorter lock-in period. Such demand may indicate that these investors will not comply with securities laws and may sell tokens in the first instance.

For projects issuing tokens outside the United States, any issuance of tokens to U.S. employees, investors, and other insiders should follow this guidance. Teams should discuss with their lawyers whether a broader application of the lockdown strategy is necessary to retain exemptions from Regulation S.

Finally, any project that uses transferring restricted tokens or points as part of its token issuance strategy should adjust this approach so that one year after the project tokens become transferable within the United States Then lift the transfer restrictions.

Conclusion:

As we mentioned in this article, each token launch is different. But there are some guidelines that apply to most projects, such as avoiding public fundraising, developing a decentralization plan, enforcing strict communication guidelines, carefully considering the secondary market, and waiting at least a year before unlocking token locks, which can all help Projects avoid the most common pitfalls of token offerings. Not only that, but adhering to these general guiding principles can help builders strengthen their legitimacy, innovate safely, and move the industry forward.

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