January 23, 2018

Navigating the Uncharted Waters of Cryptocurrency: Are Pre-Network Launch Tokens Securities?

5 min

Much attention has been focused lately on guidance issued by and ultimately actions brought by the SEC and CFTC relating to cryptocurrencies. In a recent case, a company was hauled into court for its token offering (ICO). However, in this instance, the plaintiffs are a class of private investors seeking, among other things, rescission of their token purchases, alleging that the tokens they received in connection with the ICO are securities under the federal securities laws. This case highlights the potential exposure related to ICOs where the token issuance could be deemed a security under the securities laws.

Background on the Offering

This case involves a Washington-based company (the Company) that purports to be a full-service crypto mining provider.1 According to its white paper, the Company maintains large turnkey processing centers that provide mining equipment and an energy infrastructure that can support several miners.2 In July and August 2017, the Company launched an ICO, after which it is alleged that Plaintiffs contributed a total of more than $20 million in cryptocurrency in exchange for either (1) ICO tokens that could be used to access the company's facilities rent-free for 50 years, or (2) mining equipment and power supplies to be set up by the Company's on-site team. According to Plaintiffs' complaint, each investor was given a future right to receive Giga Watt tokens or machinery "that would allow the investor access to the yet-to-be developed Giga Watt project."3

In essence, according to Plaintiffs' complaint and the Company's white paper (released in or about May 2017), the investments collected in the ICO were deposited into an escrow account managed by the Company's counsel. The Company's white paper provided a construction timeline and the anticipated date in which the Company's tokens would be issued to investors, with a caveat that:

If the completion of the capacities is delayed by more than 3 months from the projected date, and, consequently, the relevant [Company] tokens are not issued, the escrow agent may issue a refund at the request of the [Company] token purchasers. The refund will be issued in the original form of payment at the exchange rate on the date of the refund.4

The white paper construction timeline anticipated that Plaintiffs' ICO tokens would be issued by September 5, 2017 and the miner equipment would be available by October 1, 2017. Instead, on December 14, 2017, Defendants announced on their website that investors who purchased tokens by a certain date (including Plaintiffs) would not receive their ICO tokens on time, and that those investors were entitled to a refund.5 On or about November 22, 2017, Plaintiffs demanded that their investments in the Company be returned.6 Plaintiffs assert in the complaint that the Company has since refused to issue a refund of Plaintiffs' cryptocurrency.7

Focus of Plaintiffs' Claims

Plaintiffs allege that the Company engaged in the offer and sale of securities without properly registering with the Securities and Exchange Commission (SEC), in violation of the Securities Act of 1933 (the Securities Act). They argue that because the Company offered the opportunity to invest cryptocurrency into their company before the network was functional, and Plaintiffs subsequently invested in the Company with the expectation that the Company's expertise and managerial efforts would dictate the success of the network, the Company were "sellers" within the meaning of the Securities Act.8


The area of cryptocurrency, and its legal implications, is generally uncharted and developing, which leaves the outcome of this litigation unclear. Not only is this one of the few instances where private citizens have brought a cause of action against a company for the purported unregistered sale of utility tokens; it also raises the question of whether a pre-network launch sale of tokens is indeed a security. Moreover, this is made more interesting by the fact that the alleged consideration for the token issuance was access to and hardware for crypto-currency mining.

Until the beginning of last year, the cryptocurrency market appeared to be an area that had escaped significant regulatory scrutiny. Then, in July 2017, the SEC issued its DAO report—finding that a particular ICO was indeed a security under the securities law.9 In doing so, and as the SEC continues to gather information and understand the cryptocurrency market, companies are left exposed and wondering if launching such a campaign is worth the risk. Accordingly, it is important for companies contemplating ICO issuances to engage experienced counsel to thoroughly assess the applicability of the securities laws to their potential issuances.

[1] Bitcoin mining is "the process by which transactions are verified and added to the public ledger, known as the blockchain, and also is the means through which new bitcoin are released." Complaint, ¶ 35, Stormsmedia, LLC v. Giga Watt, Inc., No. 2:17-cv-00438-SMJ (E.D. Wash. Dec. 28, 2017).

[2] Giga Watt, Token Launch White Paper at 5 (May 2017) (white paper).

[3] Complaint, ¶ 6.

[4] White paper at 26-27.

[5] Complaint, ¶¶ 66-68.

[6] Id., ¶ 22.

[7] Id., ¶ 68.

[8] The unregistered sale of a security occurs when a person "make[s] use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security" or "carr[ies] or cause[s] to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale." 15 U.S.C. § 77e.

[9] See Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO (Exchange Act Rel. No. 81207) (July 25, 2017) (the DAO report).