So you want to conduct an ICO? Consider these legal issues first

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This article was edited by those at Asia Law Network.

So you have a tech startup that needs to raise funds and you figure that instead of incurring debt, issuing equity, or entering into a convertible loan agreement (CLA) that you’ll conduct an initial coin offering (ICO) or a digital token sale.

(I’m using ICO because it’s a shorter, well-recognized abbreviation than “digital token sale,” even though the term may be a bit of a misnomer.)

But for every ICO that makes headlines, many fall far below the issuers’ expectations. A lot of this is based on investors/purchasers’ sentiment, but some of it also depends on things like good marketing, a viable business model, a credible team, etc. If you want to build credibility for your ICO, there are some things you need to consider from a legal and regulatory perspective.

Your business model or technology

Is your business model or technology something that will attract crypto-investors?

This is not a legal question; it’s a human one. Imagine a fledgling food truck business conducting an ICO. You get the idea. Of course, there’s nothing prohibiting that, but what makes one think that an ICO would succeed?

ICOs that have done well have tended to be conducted by issuers who deploy blockchain technology (mostly on Ethereum) with novel applications and business models. For instance, blockchain startup TenX’s technology allows users to use cryptocurrency in their digital wallets by way of a TenX debit card that can be used like a credit card.

Investors can sniff out a credible issuer from those that aren’t. They generally prefer ICOs that focus on selling digital tokens that have a clear use case in a blockchain application. The utility of the tokens in an application with a solid concept and strong potential means that there would be a demand for the tokens if the application succeeds.

So if you’re issuing tokens that aren’t pegged to your underlying business or technology in any way, it’s meaningless. But if the tokens somehow give holders rights to some returns, dividends, or profits, then you’re going to run into some thorny legal/regulatory issues (more on that below).

Structuring your ICO

There are many ways to structure your ICO or digital token sale. The structure matters in terms of what you want to achieve and how potential investors view your ICO. Here are some considerations:

1. Capping the amount of tokens for sale
2. Setting aside a certain percentage of total token supply for insiders (i.e. founders, development team, advisors, the startup, etc.)
   
3. Letting token purchasers decide on the token price (i.e. at market value or at a fixed price)
   
4. Selling tokens on a first come, first served basis or through some other way
   

The most common structure is the capped first come, first served structure. This refers to an ICO selling a fixed amount of tokens sold at a fixed price on a first come, first served basis for a given sale period. Usually, a percentage of tokens will be set aside for insiders.

Another one is the capped auction structure. Here, there is a cap on the total amount of tokens sold. Investors bid for the desired price and at a specified budget. The amount of tokens actually sold varies depending on the bids. (There is also the uncapped version of the same structure.)

Legal and regulatory issues

Conclusion