With initial coin offerings, startups and small businesses are able to raise funds from investors around the world. No longer must they court the interest of reclusive angel investors or fickle venture capitalists, nor are Main Street investors relegated to their leftovers. Everyone is able to invest in promising companies on the same terms.
As a result, ICOs have grown from an occasional novelty into daily occurrences. Hundreds of ICOs have occurred in 2017 alone.
But while many ICOs have been launched, the vast majority of them willfully or negligently violated securities regulation, a liability with the potential to destroy the issuer.
In July 2017, the Securities & Exchange Commission reiterated their authority to regulate capital markets in the United States, presenting the DAO ICO as an example of an unauthorized public offering of securities. In September 2017, the People’s Bank of China declared all ICOs illegal, and the Securities & Exchange Commission announced the creation of a new Enforcement unit for ICOs. Other national securities regulators have begun discussing ICOs as well, and ICO-funded companies are shutting down to avoid litigation.
Further still, a number of ICOs have been outright scams, the reduction of which is the whole purpose of securities regulation. If you research past ICOs today, you will find plenty of issuers have not updated their websites since their offering, or have completely disappeared from the Internet.
And exchanges are in trouble too. After the recent actions of securities regulators, exchanges have halted the trading and listing of new tokens. If regulators decide tokens are securities, as many tokens truly are, no exchange is properly licensed to trade them.
ICOs are democratizing the capital formation process. The quick transactions, instant settlement, and consensus-based custody provide benefits the traditional financial system lacks. For example, in the United States, stock trades only just moved to a two-day settlement cycle in September 2017. Before then, it took three days to settle each trade.
But for ICOs to change the world, people need to work within the system. Exchanges need to be properly licensed. Legal means of conducting ICOs and trading token-based securities must be available.
That is exactly what Gildset will provide.
Given the amount of times the Howey test has been discussed in relation to ICOs, it should be unsurprising that most tokens are securities. Most of the discussion, however, has been in an attempt to explain why the Howey test does not apply. It unfortunately does. Just because you say something is not a security, that does not mean it is not a security.
Yes, utility tokens might not be securities. However, many tokens offer no utility at their issuance and are instead forward sales of promised utility. As that promised utility may never develop, securities regulation applies.
The Howey test asks a few simple questions. If each is answered with a yes, a security was sold under United States federal law. Most ICOs are for securities under the Howey test.
Do most ICOs involve an investment of money? Yes, money is defined as anything with a consideration for value, be that United States dollars, property, assets, or digital currencies.
Do most ICOs involve a common enterprise? Yes, any time more than one ICO investor exists, there is horizontal commonality. If a company or group exists behind the ICO, such as the Ethereum Foundation behind ether, there is vertical commonality. That commonality is common enterprise.
Do most ICO’d tokens profit from the effort of others? If the token appreciates in value for any reason whatsoever due to supply and demand, or if it provides rights, a dividend, or returns any amount other than the principal investment, it would be a security given the previous two yeses.
But the Howey test is not the only test to consider. There is also a risk capital test that applies to 40% of Americans: anyone in California, Oregon, Washington, Hawaii, Illinois, Georgia, North Carolina, and more. It is much easier to declare something a security under the risk capital test, and that status applies regardless of the result of the Howey test.
Instead of profit, the risk capital test considers loss. Simply put, if capital has the potential to be lost, it is a security.
It does not matter if the company conducting the ICO is based in the United States, the Cayman Islands, Singapore, or Switzerland. If Americans can buy into the ICO, those American sales are subject to American federal and state securities regulation.
The simple solution to all of these problems is Regulation D. That is when securities are privately sold to rich people only, with their richness verified by either inspecting their finances or receiving confirmation from an attorney or registered broker–dealer who has verified them.
But ICOs are not privately conducted under Regulation D. Rather, ICOs are indiscriminately offered through public websites, online advertisements, and now celebrities are being paid to tout them on social media, without concern for Regulation D’s exemptions, safe harbors, or resale restrictions.
Something needs to change. ICOs need to be conducted with the same care as any other offering of securities. If not, they will likely be banned around the world, like they are now in China.
Yes, there is little regulators can do to outright stop all non-compliant ICOs. But they can definitely make things difficult for organizers, participants, and exchanges, treating ICOs akin to money laundering or similar. The network may be decentralized, but its users and nodes are not.
Gildset is building a platform for the legal issuance and regulated trading of tokens, token-based securities, and cryptocurrencies. Gildset will underwrite ICOs, provide an exchange for their post-ICO trading, and be regulated by the SEC, FINRA, FinCEN, and member SIPC.
Gildset will be properly licensed, and Gildset will file regularly on EDGAR. That licensing and transparency will demonstrate that not everyone in the token industry is fly-by-night. It will attract not just global retail investors and startups looking to take on capital, but also angel investors, venture capitalists, and institutional investors.
It will be a long process, but the end goal is for the Gildset exchange to be recognized by the Securities & Exchange Commission as a national securities exchange, on par with NYSE, Nasdaq, CME, CBOE, CHX, and IEX. That recognition will make it even easier to launch ICOs on the platform.
The Gildset platform will initially focus on a very specific niche: underwriting ICOs and providing post-ICO token trading. Gildset will be a registered broker–dealer and money service business, the exchange will be a Reg ATS trading venue, and account positions will be insured up to $500,000 by SIPC.
Gildset will additionally register with FINRA as a funding portal. Doing so will allow startups to publicly showcase themselves on Gildset before their ICO, and it will allow issuers to offer their ICOs under Reg CF and other methods.
Gildset will provide both public ICOs and private Reg D ICOs. For Reg D ICOs, Gildset will verify investor accreditation on the behalf of startups, and anyone with an account balance meeting the definition of an accredited investor will be automatically accredited. Reg D ICOs will trade on the exchange, providing instant investor liquidity, but they will only be traded by accredited investors until the startup files with regulators.
Startups that handle the regulatory process behind their public ICO will launch for free on the platform. However, if startups request that Gildset handles regulatory compliance for them, Gildset will charge a minor underwriting spread to cover costs. Gildset will also offer business formation services, allowing startups to incorporate and launch an ICO in one fell swoop. Gildset will serve as agent for service of process, provide a street address, forward all mail received, and act as proxy for investors.
Unlike NYSE or Nasdaq, Gildset will not charge a fee to list tokens on the exchange, saving issuers hundreds of thousands of dollars a year. Nor will Gildset set market capitalization or revenue requirements for continued listing. The only requirement will be Gildset’s belief that the issuer is compliant with all regulations and that its principals are not bad actors.
Once a handful of tokens have launched on the platform, token indices will be introduced. The indices offered will be of varying methodologies, including capitalization weight, equal weight, and internal market breadth. A few of the indices will be offered as index funds.
Quarterly options will be experimented with on one of the most liquid index funds. If those quarterlys become decently liquid, monthlys and LEAPS will be introduced as well. If options are an overall success, they will be rolled out to other indices and some of the most liquid single-name tokens.
The Gildset exchange will operate as an order matching engine on top of a distributed ledger for custody and clearing. The ledger will use delegated proof of stake for speed and minimal power consumption. The reason for using a distributed ledger for custody and clearing instead of an even faster internal database is future planning.
The long-term plan for the Gildset platform includes users being able to conduct off-exchange transactions, as well as a way for other companies to build their own products and services on top of the ledger.
The intent of the ledger being a separate product from existing ledgers is the assurance that all instruments on it met regulatory requirements. Tokens originally issued elsewhere can be added to the ledger, if they meet Gildset’s requirements, through a means similar to a mutual fund.
The ledger’s currency will be pegged to United States dollars, redeemable from Gildset or any other supporting money service business. Trades on the exchange will actually be trades of tokens against that pegged currency, as all trades conceptually are.
The on-ledger currency will not circulate in excess of funds held by Gildset, which will maintain 100% reserves. Gildset will welcome any and all independent audits of the currency without delay.
One future area of interest for Gildset in particular, due to its relative straightforwardness, is money transfers. Using the ledger for custody and clearing, Gildset will allow users to send their currency to others, either directly or through an intermediary escrow process. Gildset will further explore providing traditional debit cards and modern NFC payment fobs to users, allowing for the purchase of real-world goods through the Gildset platform. Just as well, other modern banking amenities, such as automated bill pay, would be possible to introduce.
An interesting result of using a distributed ledger with delegated proof of stake is its potential use as a modern cash savings account. By staking funds with a delegate, users would be able to earn dividends from their delegate’s cleared transactions. As delegates will clear all transactions, both on and off exchange, it may be a worthwhile for users to keep some of their funds staked with a delegate instead of being fully invested in tokens. Transaction fees on the ledger will be fixed and miniscule, but the ledger’s focus on speed and volume may produce an interesting alternative to a traditional cash savings account or money-market fund in today’s low interest rate environment.
However, further regulatory research is required for all of those goals, and Gildset does not plan to spread itself thinly across a hundred products. The focus of Gildset is immediately set squarely on ICOs and token trading, an area in which it intends to provide an unmatched level of service.
Gildset has a fiduciary responsibility to users of its platform.
All Gildset employee accounts will be monitored. Employees caught abusing their position within Gildset, such as by trading on non-public information, will be fired and reported to regulators. Employees with abnormally profitable accounts, trades, or trades with interesting entry or exit times, with be required to justify their trading. Employees caught trading under accounts registered to others will be fired and reported for fraud.
Any employee with an ability to view an account’s resting orders or personal information will be closely monitored. Any perceived ethics violation by an employee, whether provable or not, may result in reassignment or firing.
Gildset will not serve as a market maker on its exchange, giving no incentive to trade against users, give bad fills, or run stops. For the sake of liquidity and to promote market making by others, Gildset will provide volume-based discounts to everyone, and flat-rate discounts to registered broker–dealers, exchange seat holders, and institutional investors.
Due to the increasing concern regulators have for ICOs and digital assets, Gildset will work to create a non-profit self-regulatory organization for digital asset exchanges, broker–dealers, and other market intermediaries.
Upon platform launch, Gildset will sell exchange seats on a first-come, first-serve basis, like a traditional securities exchange. The proceeds will be used to help finance a real-world marketing campaign in select areas of select cities frequented by financial professionals and tech workers.
The benefits of seat ownership will be reduced exchange commissions, zero transaction fees, and the ability to run a delegate clearing pool. Exchange seat owners will be able to sell or lease their seats to others.
A market maker or active trader would want to buy or lease an exchange seat to reduce their trading costs beyond what volume-based discounts provide.
Once all seats are sold, seats will only be able to be bought from seat owners. Seats will trade on the exchange like any other product. If in the future it is believed that more seats are needed to maintain network robustness, seats will be split, allowing owners to sell or lease their extra seat to others.
Gildset will allow two methods for launching an ICO on the platform. The first method will be free and the second method will have a minor cost.
The first method is the startup looking to launch an ICO handles all regulatory costs themselves. For this method, launching the ICO and listing the token on the exchange will be free.
The second method is the startup delegates regulatory compliance to Gildset. For this method, Gildset will charge a minor percentage of the ICO’s proceeds to cover expenses, but the on-going exchange listing will be free.
Gildset will register as a funding portal to provide a roadshow area for startups to show off their ICO ideas to users. Popular ICO ideas will move into a book building area, where users will pledge towards the ICO and Gildset will perform due diligence on behalf of users.
For startups that wish for a traditional venture capital approach, Reg D ICOs will be available. Gildset will verify user accreditation status, and any user with an account equity value meeting the definition of an accredited investor will be automatically accredited. Tokens ICO’d in this manner will have potentially instant liquidity on the exchange, but they will only be tradable by accredited investors until the startup files with regulators.
Each token on the Gildset platform will have a governance page for issuers and investors to contact one another through, deliver proxy materials, and put issues to vote. The page can be public or visible only to token holders.
For the benefit of ICO investors and their protection, Gildset will provide startups with the free option of using Gildset for ICO proceed escrow. Startups will set development milestones for themselves, and upon reaching those milestones, Gildset will confirm the milestone’s completion before releasing the next tranche of funding. If the startup miscalculates their needs and requires additional funds to hit the milestone, they can request an early release of funds on the token’s governance page. We feel using the optional escrow service would demonstrate good faith toward investors.