A few weeks back the US Securities and Exchange Commission (SEC) issued a cease and desist order against a fraudulent ICO named “Tomahawkcoins” or “TOM” by Tomahawk Exploration LLC, which sought to raise $5 million through the ICO, purportedly to fund oil drilling in Kern County, California. They had previously tried unsuccessfully to raise money for the project through private investments and the public capital markets. This order is particularly interesting because it is the first time SEC has directly addressed the issue of the legality of airdrops and bounty campaigns.
What are airdrop and bounty campaigns?
An airdrop is a distribution of tokens of a particular project for free, usually to the holders of other popular cryptocurrencies like ether and bitcoin. They are also sometimes used to incentivise potential investors/users to sign up for the project or use the utility being developed by the project. This is akin to giving out free samples for potential users to try or free trial period for various subscription-based services. The main objective here is to spread awareness about the project.
A bounty campaign is where the tokens of a particular project are issued to certain key opinion leaders (KOLs) or influencers for promoting the project among their followers. It provides an inexpensive way for the projects to promote themselves.
Ever since SEC started cracking down on ICOs by classifying them as a sale of securities there has been considerable debate about the fate of airdrops and bounty campaigns. Many in the crypto community believe that since in an airdrop tokens are issued for free without any monetary consideration they are not considered as a sale of securities. However, the SEC considers it otherwise.
Why are airdrop and bounty campaigns, a sale of securities?
As per SEC most ICOs are in the nature of investment contracts. An investment contract involves an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others. Most projects are at a very early stage when they are conducting an ICO and the success of the project is highly dependent on the efforts of the management team. Hence, they are most likely to be classified as securities. Further, in the case of TOM tokens, the holders had an “option” to convert TOM tokens into equity shares of Tomahawk Exploration LLC. Thus, they constituted “an option, or privilege on any security” and hence were considered securities themselves.
Once tokens are classified as securities the lack of monetary consideration does not mean that there has been no sale or offer for sale of securities. As has been held in the case of SEC v. Sierra Brokerage Servs., Inc, so long the issuer receives some real benefit by disposing of securities it is considered as a sale of securities.
In the case of TOM ICO, the issuers received value in exchange for the bounty distributions, in the form of online marketing including the promotion of the ICO on blogs and other online forums. The issuers also received value in the creation of a public trading market for its securities. Thus, it was not actually a gift but an exchange for value and hence, constitutes a sale of securities.
What does SEC mean by real benefit?
The word real benefit is quite broad and can mean a lot of things. Here are some examples.
- Bounty Campaigns: The issuer derives value in form of marketing and promotion of the ICO on various forums which helps to increase awareness about the project which can be considered quite valuable.
- Sign up bonus: The personal information that the issuer gets when some signs up has been considered as valuable by the SEC.
- Referral Campaigns: These again may be considered as valuable as it helps to spread awareness about the project and helps recruit more people to sign up for a particular project and thereby helps to sell the project.
- Airdrops to achieve decentralisation: Many would consider this to be a pure donation as there is no information collected and no apparent benefit derived by the issuers. But the SEC would still consider this valuable as in their opinion it may help issuer by spawning a fledgling public market for their tokens, increasing their business, creating publicity, increasing traffic to their websites and generating possible interest in their ICO.
The bottom line is there are no free lunches and no matter how you structure an airdrop it would always result in a direct or indirect benefit for the issuer and thus would be considered a sale of securities by the SEC.
What does this order mean for ICOs targeting US persons?
- Airdrop Campaigns: It has major implication for any new project trying to achieve decentralisation by airdropping tokens to the users of popular blockchain networks like Ethereum, as there are a significant number of crypto hodlers based in the US. Further due to pseudonymous nature of blockchain it is next to impossible to distinguish between a wallet belonging to a US person and a non-US person. Hence, this would mean an end of blanket airdrops, where all the users of a particular blockchain network get free tokens based on their holdings. Expect airdrops to become more targeted.
- Bounty Campaigns: This is bad news for KOLs and influencers based in the US as they can no longer participate in bounty campaigns unless the issuer complies with the US securities laws. This is true even if the services of US-based KOLs and influencers are used to target non-US investors.
What does this order mean for ICOs targeting non-US persons?
- Airdrop Campaigns: The key reason why airdrops are considered to be a sale of securities is that the tokens themselves are considered as securities. What constitutes a security differs from jurisdiction to jurisdiction. So long as the token itself is not considered a security in a particular jurisdiction the airdrop should be legal. Hence, issuers may be able to continue to use airdrops to spread awareness about their projects in most non-US jurisdictions as long as the tokens themselves are not considered a security in a particular jurisdiction.
- Bounty Campaigns: The above analysis would generally hold for bounty campaigns as well. As long as tokens themselves are not considered a security in a particular jurisdiction, bounty campaigns should be legit in that particular jurisdiction.
Hope this helps you to make more sense of the SEC order on airdrop and bounty campaigns. If you find this article helpful then please show your love by clapping and sharing this with your friends. Please share your views and ask questions by commenting on the article. Your feedback will motivate me to continue to write useful content like this. Last but not the least, none of this is legal advice, please consult a lawyer before relying on the views presented in this article.