The U.S. Securities and Exchange Commission (SEC) recently issued a report of its investigation on The DAO. The record-setting Initial Coin Offering (ICO) launched in June 2016, and then quickly lost a third of its assets to a hacker. The purpose given for the report is "to stress that the U.S. federal securities law may apply to various activities, including distributed ledger technology.” The report cautions market participants that offer and sell digital assets, including through ICOs and ‘Token Sales’ are subject to the requirements of the federal securities law.
Along with the report came an unequivocal tweet on the matter: “All exchanges, including platforms for trading blockchain-based securities, must register (unless exempt)”
The Commission's Division of Enforcement has investigated whether The DAO, the company developing it named Slock.it, Slock.it's co-founders, and other intermediaries have violated the federal securities laws. Slock.it and its co-founders created The DAO as a for-profit entity which sold DAO Tokens to raise capital and use proceeds to fund projects. Token investors share in any earnings from these projects as return on their investment or they can resell them on secondary markets.
The investigation also raised questions about whether the U.S. federal securities laws apply to the offer and sale of DAO Tokens as well as whether they are securities.
The SEC reiterated that all securities offered and sold in the United States must either be registered with the Commission or qualify for an exemption from the registration requirements. In addition, any entity or person engaging in the activities of an exchange must register as a national securities exchange or operate pursuant to an exemption from such registration.
“Based on the investigation, and under the facts presented, the Commission has determined that DAO Tokens are securities under the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”).”
The reaction to the news quickly engrossed the ICO and greater cryptocurrency community on Tuesday. While Forbes reported that the reaction of this news should be positive for cryptocurrencies, the markets headed in the other direction on the news. Ether (ETH), the digital currency most often used to purchase ICO tokens, took an 11 percent, or $28 hit on the news, down from $223 just before the SEC’s announcement to a low of $195 before rebounding to the low $200s.
While it could certainly have been worse, many speculated that the real damage to the industry could be elsewhere, such as more regulations for exchanges or delayed or scrapped ICO projects. Miami blockchain attorney Drew Hinkes tweeted that the ruling is a “major warning shot at exchanges.”
Meanwhile, Barry Silbert, founder of Grayscale Investments and CEO of the Digital Currency Group, doesn’t see any reluctance from ICOs. The following day, Silbert tweeted about his company’s prospective clients. “Not one ICO issuer that has approached us about investing has indicated any plans to delay or shelve their ICO,” he revealed. He also opined that “based on the resilience of the ETH price, the market seems to be reacting to the SEC news with a ‘meh.’"
The DAO’s token sale sold approximately 1.15 billion tokens for about 12 million ether (ETH), from April 30 to May 28, 2016, valued at approximately $150 million at the time. For the better part of a year, it was the highest-earning crowdsale in history.
In late May 2016, according to the SEC report’s findings, vulnerabilities in The DAO's code had become a concern. On June 17, 2016, an unknown group of hackers started diverting ETH from The DAO, and soon 3.6 million ETH, or a third of the total ETH raised by The DAO’s ICO, were moved to the hacker’s address on the Ethereum blockchain.
Slock.it's co-founders and others then endorsed a hard fork of the Ethereum blockchain and return the diverted ETH to DAO token holders, a move that eventually resulted in the split of Ethereum into two cryptocurrencies. Since then, questions about regulations in the young ICO industry have mostly gone unanswered, and both investors and issuers of The DAO were left wondering if they would ever see any legal or official outcome to their unique situation. In the report, their answer finally came.
“The Commission has determined not to pursue an enforcement action in this matter based on the conduct and activities known to the Commission at this time.”
The SEC further emphasizes that federal securities laws apply to those who offer and sell securities in the U.S. regardless of the type of issuing entity, the currency used to purchase those securities, and how they are distributed. The Commission specifically states that these laws cover decentralized autonomous organizations, digital currencies, and even other blockchain technologies.
However, each case that the SEC investigates is individually considered, based on its particular facts and circumstances, “without regard to the form of the organization or technology used to effectuate a particular offer or sale.” Each token sale will be looked at on a case-by case basis, the report concludes.
Since the DAO sale, ICOs have been planned and launched for an impressive variety of projects, and the pace of their launches has only accelerated so far. According to ICO tracking service TokenMarket, there have been at least 111 ICO token sales in the past, 41 taking place currently, and 45 scheduled for the near future. Competing listing board ICO tracker has tracked only 78 in the past, but lists 44 sales currently and has 62 on its calendar for launches this year.
The Commission encourages all ICO issuers, regardless of residency, to download and read the Investment Company Registration and Regulation Package, and US citizens who have been defrauded in an ICO will be able to at least file a complaint to start an investigation of the sale, the report says. Citizens of other countries should check with their local law enforcement to determine if they have any recourse at all before making an investment in an ICO.