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Idea To IPO Blockchain Slides

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Idea to IPO
December 18, 2019
Blockchain Basics
Roger Royse
rroyse@rroyselaw.com
www.rroyselaw.com
Research Assistant: Nat...

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Roger Royse
• Founder of Royse Law Firm
• Advises Technology startups on complex tax structuring, high-stakes business
neg...

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BlockChain Basics
• The trust protocol
• Technology
• Business cases
• Legal environment

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Idea To IPO Blockchain Slides

  1. 1. Idea to IPO December 18, 2019 Blockchain Basics Roger Royse rroyse@rroyselaw.com www.rroyselaw.com Research Assistant: Natalie Ryang
  2. 2. Roger Royse • Founder of Royse Law Firm • Advises Technology startups on complex tax structuring, high-stakes business negotiations, and large international financial transactions. • Author of Dead on Arrival: How to Avoid the Legal Mistakes That Could Kill Your Start-Up • Teaches Blockchain for Stanford Continuing Studies and Corporate Tax at Golden Gate University School of Law.
  3. 3. BlockChain Basics • The trust protocol • Technology • Business cases • Legal environment
  4. 4. Blockchain is: • Psuedononymous • Immutable • Transparent • Secure • Immediate • Frictionless • Trustless
  5. 5. Blockchain” Distributed Ledger Systems Public internet-based digital ledger that records transactions between parties in the network Peer-to-peer and Decentralized: no central authority, contrast the client/server model The ledger includes all transactions since date of creation Transactions are secured by public/private key encryption All participants become “nodes” –Each maintains an identical copy of the ledger –Each entry records participants exchanging value
  6. 6. Evolution of the trust protocol • Double entry accounting enabling commerce and corporation Source: Investopia where they describe double accounting entry
  7. 7. How Blockchain works • Triple entry accounting Source: Cryptocurrencytalk website where they describe triple entry accounting
  8. 8. Evolution of the trust protocol • eCash in 1993: early private and secure digital cash • Early peer to peer network: Napster, BitTorrent Source: Images from Wikipedia
  9. 9. How Blockchain works • (R)Evolution: Centralized, Decentralized, and Distributed Source: an image from Everys website where they describe different types of ledgers
  10. 10. Evolution of the trust protocol • Financial Crisis of 2008 affected trust in intermediary Source: Medium where they describe what happens after a financial crisis
  11. 11. Evolution of the trust protocol • The rise of bitcoin Source: money.cnn.com
  12. 12. Evolution of the trust protocol • Ether and dApps Source: Coinweez website where they describe decentralized applications
  13. 13. 1. Evolution of the trust protocol • Tokenization Source: Fast Charge Payment Gateway website where they describe credit card tokenization
  14. 14. The problems Blockchain solves • Eliminate the trusted intermediary Source: Blockchainlion website where they describe Blockchain and Government
  15. 15. What Blockchain does: The Ledger of Everything • Internet allows digital transfer of information • Blockchain allows digital transfer of products • Reduces cost of verification • Reduces cost of networking
  16. 16. Part 1: Technology • Distributed Ledger • Decentralized • Cryptographically secure • Consensus mechanisms • Hashes • Miners
  17. 17. Overview Of “Blockchain” Distributed Ledger Systems When an exchange occur: 1. The exchange is encrypted 2. All the nodes in the network communicate with each other and record the exchange 3. Consensus algorithm assures validity of the transactions 4. Upon validation, all copies of the ledger are updated 5. “Mining” nodes bundle transactions into “blocks” that are added to the ledger 6. New blocks contain information that refers back to previous blocks 7. All blocks in the chain link together in the distributed identical copies 8. The link is secured by the miner after the correct “hash” value for the block is determined 9. Cannot delete or alter the entries once they have been validated and accepted by the network 1. If a node modified a previous block 1. Will not be in sync with rest of network 2. Would then be excluded
  18. 18. Public Key Cryptography Source: a chart from Aaxix Commerce website where they describe public-key cryptography
  19. 19. Bitcoin Transaction • Alice has a bitcoin wallet with addresses, each of which refer to a balance of bitcoin • Bob creates a new bitcoin address for Alice to send bitcoin to • Alice tells her Bitcoin client to transfer 3 BC to Bob. The client signs her request with Alice’s private key. • Anyone on the network can use Alice’s public key to see that the request is from Alice (psedonymous).
  20. 20. BC Transactions • BC transaction is verified by the nodes • Then sits in the Memory pool or “Mem Pool” until…. • “Miners” bundle the transactions of the past ten minutes into a block • If user has enough BC, transaction will be deemed valid and bundled; otherwise will be rejected
  21. 21. The Block, or Record of Transactions • Transactions are grouped together in “blocks” • Each block links together to create a sequential timestamped chain • Each block contain information about transfers (and any other data) • Block has a “header” to organize the data base. The Header contains • A “hash” or unique fingerprint of data in the block • Timestamp • A hash of the previous block
  22. 22. Verification of New Blocks • In a centralized system, a trusted authority would verify transactions and create and store the “blocks” • In a distributed system, the collective must verify • How can we trust the block? Who is allowed to store information on the chain?
  23. 23. Verification (Bitcoin) • Miners bundle data into a block and create a hash • A hash function maps data of arbitrary size to data of fixed size. • values returned by a hash function are called hash values, hash codes, hash sums, or hashes. • Bitcoin uses “nonces” to create different hash values from the same data • A “nonce” is a random number added to data in the block prior to hashing • The new hash value is based on the previous hash value, the new transaction block and a nonce. • Each hash must have a certain number of leading zeros • Miners must create many nonces until they produce a hash with leading zeros • Requires expensive, difficult trial and error calculations (“mining”) • The high cost of mining prevents fraud • Solving the puzzle is “Proof of Work” • Miners awarded BC for solving the puzzle (reward) • The hash is broadcast and other nodes verify that the hash meets the requirements (consensus) • State updated every ten minutes (calculates balances)
  24. 24. Consensus Mechanisms: Proof of Work • Artificially makes it computationally costly for network users to validate transactions • The benefit of making it costly to validate transactions is that validation can not be influenced by the number of network identities someone controls, but only by the total computational power they have • Rewards them for trying to help validate transactions • Block reward and transaction fees for every valid hash • Reward is used so that people on the network will try to help validate transactions
  25. 25. The problem with Proof of Work • Bitcoin requires massive amount of energy
  26. 26. Delegated Proof of Stake • Delegated PoS • Consensus determined by elected delegates • Micali’s Algorand • Lottery system that randomly selects writers of the block from among users • Chia Coin • Proof of Storage
  27. 27. Consensus Algorithms: verified by miners •Proof of work • The most utilized consensus algorithm for a blockchain • Every computer (node) competes to solve a mathematical puzzle • Winning node earns the right to write the next block and receives an incentive for that work • Energy and cost: requires a large amount of computing power •Proof of Stake • An alternative consensus algorithm for a blockchain yield • Instead of mathematical contest, miners put up a stake in return for the right to validate the network • Stake as a non-revocable security deposit against fraud or inaccuracy
  28. 28. Forks and Double Spend • Suppose Alice transfers the same bitcoin to 2 different people? • And the nodes verify them both? • Who wins?
  29. 29. Forks and Double Spend
  30. 30. Double Spending Problems The double spend problem: Preventing someone making a purchase with digital cash from reusing the same token to purchase again Source: an image from Steemit website where they describe the double spend problem
  31. 31. Consensus when the BC forks Miners will pick the longest chain
  32. 32. Integrity of the Blockchain • Small change in data will change the hash and break the chain • The 51% Attack: 51% of the miners could theoretically collude to approve false transactions but no one has that much computational power • Creating extra nodes to mine is expensive
  33. 33. Permissioned and Permissionless networks Source: Blockchainhub website where they describe blockchain & distributed ledger technologies Permissioned Permissionless Faster Slower Managed upkeep Public Ownership Private Membership Open & Transparent Trusted Trust-free Legal Allegal
  34. 34. Part 2: The Business Case
  35. 35. The Dark Side: MT Gox Source: Japan times
  36. 36. Source: CNN Money The Dark Side: Silk Road
  37. 37. I. Intro: Market Opportunity in Blockchain • Bitcoin is a $200 Billion market as on end of 2017 (McKinsey) • By 2027, 10% of Global GDP will be on the blockchain • VCs invested $1 billion in bitcoin in 2017 • 2017 ICO market of $5 billion • IBM has invested $200 million into blockchain and IoT
  38. 38. How long will it take for Blockchain to become ubiquitous? • Blockchain is a foundational layer with applications built on top of it • In internet, the economic value has gone to the application layer e.g. Google, Amazon and Facebook who have built applications on top it • Will blockchain go the same way? • Will the most value be derived from the DApps built on top of the Ethereum blockchain, or will it remain with the Ethereum blockchain itself? • How long will it take for Blockchain to become ubiquitous? • TCP/IP was born in 1972 by U.S. Department of Defense and it took 30 years to shift foundations on which our world operates
  39. 39. Simple Economics of Blockchain • How blockchain technology will shape innovation in digital platforms • Blockchain technology will lower the two key costs 1. Cost of Verification: reducing the cost of verifying transaction 2. Cost of Networking: creating a digital marketplace without a trusted intermediary • Result: Increased competition, lower barriers to entry, lower privacy risk, and shared investment and infrastructure • Challenge the market incumbents and open opportunities for data ownership, licensing, digital advertising, incentivizing product adoption, auctions, and reputation systems http://www.nber.org/papers/w22952.pdf
  40. 40. Zero Cost Verification • 70% of value of BC is cost reduction • Costless verification – all parties agree on information • When costs of verification exceed benefits, markets fail • Verification may required information disclosure (leakage and privacy) • Non Excludable - public • Excludable Information • Self censored • Cheap talk
  41. 41. Network Effects in Blockchain • A network effect (also called network externality or demand-side economies of scale) is the positive effect described in economics and business that an additional user of a good or service has on the value of that product to others.
  42. 42. Is Blockchain foundational or disruptive? • Foundational: General Purpose Technology (GPT) • BC has features of a GPT as it enables innovation and productivity across many industries, like steam engine, electricity and the internet • Like internet, Blockchain will create new foundations on which how economic system is operated
  43. 43. Blockchain, a disruptive technology • Blockchain technology displaces industries • “Dis-intermediation” 1. Supplement existing industries 2. Private BC for secure real time exchange of data • Example: Australia Stock exchange, Maersk Shipping (dominant players)
  44. 44. Cryptoeconomics: • Cryptoeconomics is the use of economic incentives and cryptography to design new kinds of systems, applications, and networks. • Specifically about building things, and has most in common with mechanism design – an area of mathematics and economic theory • Cryptoeconomics apply cryptography that takes economic incentives and economic theory into account. • Example: Bitcoin, ethereum, zcash and all other public blockchains are products of cryptoeconomy https://www.coindesk.com/making-sense-cryptoeconomics/
  45. 45. Three systems from Cryptoeconomics • Reliable consensus without having to rely on a central trusted party • Improving consensus systems: e.g. Ethereum’s plan to migrate to proof-of-state 1. Consensus protocols • After solving consensus problem, build applications that sit "on top" of a blockchain like ethereum. • The underlying blockchain gives us (1) a unit of value that can be used to create incentives and penalties, and (2) a toolkit with which we can design conditional logic in the form of smart contract • The applications we build with these tools can also be a product of cryptoeconomic design. 2. Application Design: Incentives used to prove applications • Cryptoeconomics also includes the practice of designing much smaller sets of interactions between individuals. The most notable of these are state channels e.g. Bob and Alice transactions over blockchain 3. State channels: moving transactions off the BC
  46. 46. Ethereum • Transaction based “state machine” • Will read inputs and transition to a new state • Uses miners, Proof of Work, and rewards with Ether • Developed by the Ethereum Foundation, a Swiss non-profit, • Unlike bitcoin, Ethereum is turing complete • Value aware • Block chain aware • State
  47. 47. Ethereum – 2 accounts • Externally owned account • Public private keys • Can send Ether • Contract Account • Public address, no private key • Stores data and runs smart contracts • Collects Ether • Ethereum, Virtual Machine (EVM) • Runs smart contracts • Charge a fee (“gas”) for each computational step • Solidity – high level language in which smart contracts are written
  48. 48. How Ethereum Works PoW consensus mechanism Double Spend GHOST – Greedy Heaviest Observed Subtree Pick the path with the most computations (highest block number) Full and Light Nodes Full node downloads full chain Light node uses Merkel trees and only down loads headers Gas and payment Computations require a fee to execute Gas, gas price and wei – measures of Ether
  49. 49. Ethereum • ERC721 token for tracking unique digital assets • ERC20 token standard • Issued on the Ethereum network and can be exchanged for other currencies • ERC20 standard makes the assets more easily interchangeable and ensure they can work with Dapps adhering to the same standard.
  50. 50. Dapps: • Ethereum is a "decentralized appstore" where anyone can publish their apps (Dapps) • What is a Dapp? • Unlike Apps (e.g. Uber, Gmail), a Dapp does not require a middleman to function or to manage a user's information • Dapp Features • Open Source • Decentralized • Incentivized • Protocol
  51. 51. Governance • Governance is a self-sustaining mechanism for change • Allows for maximum improvement and growth for all participants • Possible outcomes • Autonomous – the code runs unchanged • Existing systems – corporations, courts, regulators, developers, cartels • Government censorship • International legal institutions • Private corporations
  52. 52. Smart Contracts are… • Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract, or that obviate the need for a contractual clause. • Smart contracts usually also have a user interface and often emulate the logic of contractual clauses. • Smart contracts are stored on the blockchain where all parties have a copy of the contract • All contract transactions are stored in chronological order on blockchain for future access, along with the complete audited trail
  53. 53. Smart Contracts: Pros and Cons • Pros • Autonomy • Trust • Backup • Safety • Speed • Savings • Accuracy • Cons • Need coding skills • No regulation • Need for intermediation • Not suited to complex relationships • Need for dispute resolution • Need for oracles
  54. 54. Oracles • Oracles find and verify real world data and events and submit this info to the blockchain to be used by smart contracts • Software oracles may parse text for information • Hardware oracles may submit sensor data • Human oracles submit events or outcomes
  55. 55. Tokenization and ICOs • ICOs in Q1 2018: $6.3B Source: Coindesk website where they compare ICO size in 2017 and 2018
  56. 56. Tokenization and ICOs • Tax • Tax perspective: Is token equity? • Presale and SAFT • IRS view • Legal • Anti-money laundering and KYC • Patent issues • Securities • Federal, foreign and state laws • Regulation • Is my token a security? • A currency? • A commodity? • Privacy • Data Ownership
  57. 57. Securities Law • What is a security? • SEC Definition • Under Section 2(a)(1) of the Securities Act, the term “security” is defined as: – any note, stock, treasury stock, security future, security-based swap, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing
  58. 58. Securities Exchange Act of 1934 With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self regulatory organizations (SROs). The various securities exchanges, such as the New York Stock Exchange, the NASDAQ Stock Market, and the Chicago Board of Options are SROs. The Financial Industry Regulatory Authority (FINRA) is also an SRO. The Act also identifies and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them. The Act also empowers the SEC to require periodic reporting of information by companies with publicly traded securities.
  59. 59. Securities Act of 1933 Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives: Requires that investors receive financial and other significant information concerning securities being offered for public sale; and Prohibits deceit, misrepresentations, and other fraud in the sale of securities.
  60. 60. State Blue Sky Laws States also regulate the sale of securities in their states National Markets Improvement Act of 1996 (NSMIA) The NSMIA amended Section 18 of the Securities Act to pre-empt state “blue sky” registration and review of specified securities and offerings. The preempted securities are called “covered securities.” The NSMIA also amended Section 15 of the Exchange Act to pre-empt the state’s authority over capital, custody, margin, financial responsibility, making and keeping records, bonding or financial or operational reporting requirements for brokers and dealers.
  61. 61. Is a Token a Security? Howey Test: a transaction is an “investment contract” if: 1. It is an investment of money 2. There is an expectation of profits from the investment 3. The investment of money is in a common enterprise 4. Any profit comes from the efforts of a promoter or third party The SEC takes the position that some cryptocurrencies may be securities
  62. 62. SEC Chairman, Jay Clayton “I do not believe that digital tokens such are Bitcoin, when used to replace currency as a medium of exchange are securities.” “Then there are tokens, which are used to finance projects. I've been on the record saying there are very few, there's none that I've seen, tokens that aren't securities. To the extent something is a security, we should regulate it as a security, and our securities regulations are disclosure-based, and people should follow those and provide the information that we require.”
  63. 63. SEC Scrutiny of the ICO and Enforcement • The SEC’s Office of Investor Education and Advocacy is warning investors about potential scams involving stock of companies claiming to be related to, or asserting they are engaging in, Initial Coin Offerings (or ICOs) • Fraudsters often try to use the lure of new and emerging technologies to convince potential victims to invest their money in scams. • These frauds include “pump-and-dump” and market manipulation schemes involving publicly traded companies that claim to provide exposure to these new technologies
  64. 64. SEC Actions DAO Token – model described by one of the DAO founders as similar to “buying shares in a company and getting…dividends” Munchee - restaurant meal reviews SEC halted cease and desist – unregistered securities ICO targeted investors, who had an expectation of future profits, rather than users of the products, with intention to use proceeds to develop application and future “ecosystem”, which would increase the value the MUN token Marketing materials stated additional development and ecosystem would increase the price of the MUN token and could trade on secondary market within 30 day after ICO Recent ICO Subpoenas
  65. 65. Rule 10(b)-5 Private Right of Action Section 10(b) of the Securities Exchange Act of 1934 gives shareholders a private right of action to seek damages for securities fraud Rule 10b-5 forbids “any person, directly or indirectly, . . . [t]o make any untrue statement of a material fact” in connection with the purchase or sale of securities Ripple XRP Class Action Lawsuits are an example
  66. 66. Securities Law Compliance 1. Public offering (S-1 registration) 2. Reg CF, Reg D, Reg A, Reg A+, Reg S 3. Crowdfunding 1. Initial disclosure requirement 2. Exemption from registration: Up to 1.07 million in 12 months period 3. Issuer disclosure requirement
  67. 67. Are Cryptocurrencies Commodities? • CFTC definition: “Commodity” • Until Congress clarifies, the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency – March 6, 2018 US Dist. New York • This decision allows the CFTC to proceed with a fraud enforcement case against CabbageTech Corp., doing business as Coin Drop Markets, and its CEO
  68. 68. CFTC A commodity, as defined in the Commodity Exchange Act, includes the agricultural commodities enumerated in Section 1a(9) of the Commodity Exchange Act, 7 USC 1a(9), and all other goods and articles, except onions as provided in Public Law 85-839 (7 USC 13-1), a 1958 law that banned futures trading in onions, and all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in; (2) A physical commodity such as an agricultural product or a natural resource as opposed to a financial instrument such as a currency or interest rate. See 7 USC 1a(9) In a preliminary injunction order issued March 6, 2018, U.S. District Court for the Eastern District of New York ruled that the CFTC has concurrent authority, along with other state and federal administrative agencies, and civil and criminal courts, over dealings in virtual currency. This decision allows the CFTC to proceed with a fraud enforcement case against CabbageTech Corp., doing business as Coin Drop Markets, and its CEO
  69. 69. CFTC The CFTC does NOT have regulatory jurisdiction under over markets or platforms conducting cash or “spot” transactions in virtual currencies or other commodities or over participants on such platforms. T The CFTC DOES have enforcement jurisdiction to conduct civil enforcement actions against fraud and manipulation in virtual currency derivatives markets and in underlying virtual currency spot markets. The CFTC does have both regulatory and enforcement jurisdiction under the CEA over derivatives on virtual currencies traded in the United States. This means that for derivatives on virtual currencies traded in U.S. markets, the CFTC conducts comprehensive regulatory oversight, including imposing registration requirements and compliance with a full range of requirements for trade practice and market surveillance, reporting and monitoring and standards for conduct, capital requirements and platform and system safeguards.
  70. 70. Financial Crimes Enforcement Network US Department of Treasury The mission of the Financial Crimes Enforcement Network is to safeguard the financial system from illicit use, combat money laundering, and promote national security through the strategic use of financial authorities and the collection, analysis, and dissemination of financial intelligence. Money Services Business Registration Bank Secrecy Act compliance Suspicious Activity Reports OFAC (Office of Foreign Assets Control)
  71. 71. FINCEN FEB 13 LETTER Financial Crime Enforcement Network (FINCen), Dep’t of Treasury letter to Senator Ron Wyden (D- Ore) 1) A developer that sells convertible virtual currency (i.e., bitcoin, ether, ripple, etc) including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply with AML/CFT requirements that apply to this type if MSB ( and register as a MSB with FInCen - a form filed annually and disclosure of some financial information). 2) An exchange that sells ICO coins or tokens, or exchanges them for other virtual currency, fiat, or other value that substitutes for currency, would typically also be a money transmitter. 3) FInCEN AML/CFT rules likely do not apply to ICO structures where (a) the tokens are offered as securities - SEC jurisdiction and their AML/KYC requirements or (b) future interests in commodities - CFTC jurisdiction and their AML/KYC requirements.
  72. 72. Exemption from Registration • The private company issuer (aggregated with predecessors and companies under common control) may sell up to $1.07 million of securities in a 12-month period [adjusted for inflation] • Individual investments in all crowdfunding issuers in a 12-month period are limited to: o If either their annual income or net worth is less than $107,000, then the greater of:  $2,200 or  5 percent of the lesser of their annual income or net worth o If both their annual income and net worth are equal to or more than $107,000, then 10 percent of the lesser of their annual income or net worth (up to a maximum of $107,000) o Issuer may rely on intermediary’s calculation of investor limits, unless issuer knew it was or would be wrong • Process is expensive and burdensome Reg CF Crowdfunding
  73. 73. • Investment must be through the online platform of an “intermediary” broker or funding portal o Intermediary must register with the SEC and FINRA o Issuer can only use one intermediary in any concurrent offerings based off of crowdfunding exemption; however, multiple crowdfunding offerings may be conducted using different portals so long as the aggregate amount in the same 12-month period does not exceed the 1.07 million limit o Many limitations on what entities can be intermediaries (e.g., must be good actor) o Stringent limitations on having financial interests in issuers using platform o Only allow issuers if reasonable to believe they are compliant, and there is no reasonable basis to think there is a potential for fraud o Cannot accept commitment from investor until investor has account with platform, and platform provides needed information o Must make sure investors aren’t exceeding their caps, and that they acknowledge and understand the risks o Must provide communication services between investors and issuer o Many other requirements and filings Crowdfunding
  74. 74. • Issuer disclosure requirements o File basic business, offering details in Form C with SEC; then display publicly o Amend Form C if any material changes occur via Form C/A o File updates (Form C-U) with SEC within five days of certain milestones (such as enough commitments, offers, or closing of issuance) o File financial statements meeting GAAP, and GAAS or PCAOB if applicable  Audited if offering exceeds $500,000, except first time issuers need only have independent CPA review  Reviewed by an independent CPA if offering is between $100,000 and $500,000  If $100,000 or less, certain information from tax forms and CEO-certified financials  In any event, if more trustworthy financials available than are required (i.e., if audited or CPA-reviewed are available), use those instead o File annual SEC reports via Form C-AR o File Form C-TR to terminate annual reporting obligations in five days of eligibility (e.g., became Exchange Act issuer, has fewer than 300 recorded holders or not more than $10 million total assets) Crowdfunding
  75. 75. • Accredited investors only who may self verify • $200,000 annual income current year and prior two years ($300,000 jointly) or • $1,000,000 net worth excluding personal residence • Issuers are prohibited from making general solicitations • Direct communications to persons with whom the issuer or its broker has a “pre-existing, substantive relationship” are not considered general solicitations Private Offerings Under Rule 506(b)
  76. 76. 506(c) Offering Rule 506(c): issuers can offer securities through means of general solicitation as long as: oAll purchasers are accredited investors; and oThe issuer takes “reasonable steps” to verify the purchasers’ accredited investor status
  77. 77. • A determination of “reasonable steps” requires consideration of: o Nature of the purchaser; o Amount of information the issuer has about the purchaser; and o Nature of the offering, terms, amount, and method of solicitation • The SEC has provided a non-exhaustive list of methods to verify status: o Review IRS forms that report income e.g. Form W-2 or K-1; o Review documents for asset details e.g. bank or brokerage statements; or o Obtain confirmation from CPA, lawyer, SEC-registered investment advisor, or broker-dealer that reasonable steps were taken to verify accredited investor status General Solicitation
  78. 78. • The oldest exemption issued by the SEC • Although it allowed non-accredited investors to invest, was rarely used, because of high compliance costs relative to the maximum funds raised o $5 million maximum offering o Did not preempt state law registration, requiring registrations in many states • The JOBS Act included legislation to create what is nicknamed “Regulation A+”, an upgrade to Regulation A • The new Regulation A keeps the allowance of non-accredited investors, and features two kinds of Regulation A offerings, called “Tiers”: o Tier 1, with a $20 M maximum, does not preempt state law registration, but has low federal compliance burdens o Tier 2, with a $50 M maximum, preempts state law registration, but has high federal compliance burdens including ongoing semi-annual, annual, and current disclosures Reg. A – History
  79. 79. Issue 506(b) 506(c) Reg. A Tier 2 State law regulations? Preempted Preempted Preempted Maximum amount raised? Unlimited Unlimited $50 M in 12 months, up to $15M of which from current holders Per investor maximums? Unlimited Unlimited Up to 10% of greater of unaccredited investor’s net worth or net income; unlimited for accredited Investor limitations Unlimited accredited, and 35 sophisticated non-accredited; self-certification standard Accredited only, and issuer must take steps to certify they are accredited Unlimited accredited (self- certified), unlimited non- accredited 506(b), 506(c), and Reg. A Tier 2
  80. 80. Issue 506(b) 506(c) Reg. A Tier 2 Issuer limitations No bad actors No bad actors Cannot be public, shell company, bad actor, those failing certain SEC compliance rules Solicitation, advertising Banned Soliciting of anyone is allowed Testing for interest, soliciting OK Initial disclosures Non-accredited: Equivalents of what they get in registered offering, plus anything accredited investor can get For accredited, see 506(c) Optional; must be available to answer questions Financial statements for past two years disclosed, plus offering circular with audited financials 506(b), 506(c), and Reg. A Tier 2 (cont.)
  81. 81. Issue 506(b) 506(c) Tier 2 Ongoing disclosures Form Ds Form Ds Yes, if 300+ holders; annual, semiannual, and current events. But special exemption from Exchange Act registration until over $75M float. Share restriction Restricted for a year Restricted for a year Unrestricted; affiliates still have some limits Allowed securities? ABS not specifically banned ABS not specifically banned Asset backed-securities banned 506(b), 506(c), and Reg. A Tier 2 (cont.)
  82. 82. Regulation S Regulation S is a "safe harbor" that defines when an offering of securities is deemed to be executed in another country and therefore not be subject to the 1933 Act. Two safe harbors: an issuer safe harbor and a resale safe harbor.
  83. 83. Issuer Law • Securities Law • Tax • AML/KYC • Anti Fraud • FINCEN • CFTC • FTC • Investment Company Act • Exchange Act $ Step 2: Build Platform Step 1: Pre-Sale $orCrypto SAFT Investors Step 3: ICO Tokens Investors The ICO Team • Legal US • Tax US • Foreign Legal • Compliance • Marketing • KYC/AML • ICO Economies • Blockchain Technical Utility • Use of Token • Secondary Trading • Scarcity • Voting + Democratized
  84. 84. US Platform Co. Cayman ICO Co. Singapore ICO Foundation $ $ SAFT $ tokens Token Securities Compliance Step 1 Step 3: Cash to US Co. $ Step 2: ICO Issuance 1) 506 – All accredited 2) 506/Reg S foreign targeted offering 3) Non US offering 4) Foreign Utility Tokens – not a security 5) Reg A+ 6) Register with SEC 7) Sec 4(a)(2) private offering Resale Rule 144 (12 month holding) Section 12(g) Rule 12g3-2(b)
  85. 85. Cryptocurrency Regulations among States • Delaware’s Blockchain Initiative (DBI) • Initiated DBI committed to use blockchain technology in 2015 • When distributed ledger technology hit their radar screen in 2015, State officials immediately understood the ramifications of the technology • The state’s strong motivation to attract business from companies: improving services related to registrar, UCC, land titles, personal properties, and professional license • The first milestone: The rollout of distributed ledger technology at the Delaware Public Archives • The second milestone: “Smart UCC filings”
  86. 86. Cryptocurrency Regulations among States • Wyoming’s Blockchain bills • Wyoming’s House of Representatives passed two blockchain bills in 2018: Utility token bill (HB 70) and Bitcoin bill (HB 19)Delaware’s benefit • HB 70: Utility Token Definition defines a utility token, or “open blockchain token” as neither traditional money nor a security if it meets some conditions • HB 19: Cryptocurrency Exemption exempts cryptocurrencies from Wyoming Money Transmitter Act, an act it impractical for cryptocurrency exchanges to operate in the state • Other bills in the pipeline • HB 101: “Blockchain filings bill” • HB 126, “Series LLC bill” • SF 111, “Crypto property tax exemption bill”
  87. 87. Cryptocurrency Regulation: Global • Switzerland: known for progressive attitude toward cryptocurrency regulation . In February 2019, the Swiss Financial Market Supervisory Authority FINMA became the first major economy to set out clear guidelines on ICOs • South Korea : Significant cryptocurrency presence in the past but regulatory uncertainty and negative prospects • Singapore: relatively progressive compared to other Asian countries. The country’s law is attempting to remove distinction between transactions conducted using fiat currency and cryptocurrency • Malta: an early pioneer in blockchain and cryptocurrency regulation
  88. 88. Tax Considerations • Equity? Debt? • Capital asset? Barter exchange? • Prepaid goods or services? • Deferral? • Open - transaction? • Forward contract ? • Executory Agreement to Sell? • Information Reporting • FATCA • FBAR
  89. 89. ROYSE LAW FIRM, PC For questions , Contact PALO ALTO 1717 Embarcadero Road Palo Alto, CA 94303 LOS ANGELES 11150 Santa Monica Blvd. Suite 1200 Los Angeles, CA 90025 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Palo Alto Office: 650-813-9700 CONTACT US www.rroyselaw.co m @RoyseLaw MENLO PARK 149 Commonwealth Drive, Suite 1001 Menlo Park, CA 94025 SANTA MONICA 520 Broadway Suite 200 Santa Monica, CA 90401 SAN FRANCISCO 135 Main Street 12th Floor San Francisco, CA 94105 Menlo Park Office: 650-813-9700 CONTACT US www.rroyselaw.com @RoyseLaw ORANGE COUNTY 135 S. State College Blvd Suite 200 Brea, CA 92821 rroyse@rroyselaw.com

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