Over the last two years we have seen some really exciting things happen in the cryptocurrency space. One of the most interesting events has been the introduction of the “Initial Coin Offering” otherwise known as an ICO.
The reason why this is so exciting is because, prior to ICO’s, raising funds for a project was an arduous process. In order to raise some capital you typically were forced to secure seed or venture funding from an established firm.
There had been some innovation in this area recently with the introduction of platforms such as Indiegogo or Kickstarter. However, all of these platforms required you to have a physical product in order to crowdsource funds to get your business off the ground
The introduction of the ICO allowed for efficient, globalized crowdfunding of startups for the first time in history. Additionally, these startups were able to crowdfund without the need for a third party managing their capital.
Unfortunately, this quick evolution in raising capital gave rise to some unsavory business. Thieves around the world took advantage of this and began deploying traps for retail investors looking to get in on the ICO hype. We saw with the meteoric rise of scam coins and quick-exit ploys.
Additionally, under the current regulatory frameworks, this crowdfunding model may be seen as the issuance of an unregistered security (by the SEC). Changes from country to country based on the laws, but in the US this was a problem.
To ameliorate this problem, Cooley LLP devised the SAFT using the framework from Y Combinator's 'Simple Agreement for Future Equity' (SAFE) for venture investing. SAFT stands for Simple Agreement For Future Tokens. What the SAFT does is issue a security instrument to the investor which entitles said investor to receive a project’s tokens at a later date. This ‘later date’ is presumably once the network has launched and the tokens have a real utility.
The SAFT was created as a placeholder of sorts so that projects raising via an ICO were not selling unregistered securities to investors. The core belief with this instrument is that once a token has utility, it will no longer be classified a security, and thus investors can do with their utility token as they please.
Unfortunately, this attempt at making ICO’s more appetizing in the eyes of regulators may not work out as planned. Recently, FINRA has come out and made a strong statement declaring that the SAFT has not be cleared by the regulatory body:
“Know that investing in a SAFT contract does not mean the offering is 'safe' or compliant with applicable federal and state laws”
Their statement continued by mentioning that: “a determination of whether something is a security is a facts and circumstances analysis, and titles don’t change that.”
In addition to the opaqueness of the regulators views on the SAFT, it falls short in the area of protection for investors as well. The SAFT unfortunately includes no maturity date or provision to claim company assets if the project fails.
Since the creation of the SAFT, there have been other attempts at making ICO investing more regulatory compliant and providing more investor protection. One notable alternative is the SAFTE which was drafted by the Colony project specifically for their own fundraising efforts.
The SAFTE, which stands for Simple Agreement for Future Tokens & Equity, builds on the framework of the SAFT while also providing the prospect of future equity in the company. However, the document does not provide adequate protection in the event that a project fails, as equity holders are generally compensated after debt holders in the event of liquidation.
With so unclear regulations and an industry riddled with uncertainty about ICO raises, we decided to take matters into our own hands and create not one, but two more complete investment instruments with better investor protections.
The first of the two is the Token DPA. The Token DPA, or Token Debt Payable by Assets — is a debt security created by Republic Crypto specifically for use in token pre-sales. Here’s how it works on a high level:
Companies use the Token DPA to issue debt and collect the necessary capital to build out their product.
The Token DPA then sets a time limit for how long a company can hold the funds before needing to pay interest to investors or repaying the full debt in tokens.
Some additional investor protections include incentivizing projects to use their funds slowly. Through the Token DPA, investors are given the right to request their investment back at any time, dependent on how the project is progressing.
In the absolute worst case scenario, if a project never distributes tokens to investors and the investor has not requested their investment back previously, the investor is entitled to their money back plus interest.
Our second investment instrument is the Crowd SAFE-ST, which stands for Simple Agreement for Future Equity and/or Securities Tokens. This framework allows investors the option to take their full investment in tokens or up to a set percent of their investment in equity.
The exciting thing about this is, investors are given a far greater say in the outcome of their investment. For example, if the token development process does not meet an investors expectations, they can look to future equity interest in the company instead. Additionally, dependent on the projects’ progression, investors have the ability to split their investment into both tokens and equity. This may be preferable for investors who wish to remain invested in the future of the project while also being an active user in the protocol with tokens.
While every project that has raised via Republic has used the Token DPA, we have seen interest in the investment instrument from other parties as well.
Most recently, the team at The Digital Reserve has decided to the use the Token DPA for their token sale. The Digital Reserve is utilizing blockchain to try and eliminate predatory loans. Jomari Peterson, CEO of The Digital Reserve, spoke with us regarding their decision to go with the Token DPA.
In their pre-fundraising due diligence, they considered the SAFT, hybrid instruments, as well as raising without a formal instrument. After consulting with their legal counsel, they decided to go with the Token DPA for a few reasons in particular. For one, the Token DPA “better reflected legal documentation [their lawyers] had seen previously; in contrast to the SAFT or other documents”.
Secondly, they felt the Token DPA better positioned them to be regulatory compliant as formal regulations continued to be implemented in the months and years to come. Finally, The Digital Reserve team believed that this investment instrument allowed their investors to be more cognizant of what they could expect out of investing in their project.
It is safe to say that the environment for regulated token sale investing is still very much in its infancy. As is clear by the statements of regulators mentioned above, the instruments devised during the ICO boom of 2017 may not be in compliance with the law. At Republic, we will continue to keep our eyes on regulatory developments to ensure that we create and maintain the most sound and complaint investment instruments available.
We’d love your feedback, questions and ideas. Please use the comments below to let us know what you think — we respond to every comment.