In Coins and Tokens 101 (Part 1), we talked about the difference between coins and tokens and how tokens are generated. If you forget about the details we discussed, you can click here to read again.
What is Initial Coin Offering (ICO)?
Most tokens are issued for the purpose of raising funds. The development teams of DApp will launch Initial Coin Offering(ICO) which is selling tokens to the public to collect funds for future operations. The tokens can be used to pay for service, deduction of fees and receive dividends.
To raise funds from the market, it will cost too much time and effort to build a new blockchain to issue coins like Bitcoin. Hence, many projects choose to issue tokens rather than coins. In this case, developers just need to use the frameworks like ERC20 and ERC721 to deploy smart contracts on other blockchains. This will save a lot of effort, because developers don’t need to come up with the whole structure of blockchain and worry about other issues like security, transaction speed. etc. All they need to do is filling the customized information in the structure already set by others.
It’s like the difference between building a official website and establishing a fan page on Facebook. The former costs a lot of time and money. You’ll need to build the website’s framework and layout all by yourself and the outcome is not necessarily better. While the latter is simple and easy. You can forget about the codes and layouts and focus on the use of tools then publish the content you want to share. Besides, the security is normally more reliable and trusted by the public.
How to classify tokens and what are the regulations?
The classification of tokens remains ambiguous today. However, the ICO Guidelines published by Swiss Financial Market Supervisory Authority (FINMA) are considered credible and widely accepted. It categorises tokens into three types:
Tokens like USDT are viewed as currency which can be used for payment and is not connected to any particular applications. This type of tokens are not treated as securities and not regulated by related laws. But they still need to comply with anti-money laundering regulations.
Utility token is an access rights to an application or service, and can not be used as currency. FINMA thinks that Utility tokens don’t need to be regulated. Most tokens used in Ethereum game DApps, like keys in FOMO 3D, are treated as Utility tokens.
This category is regarded as securities and has to comply with securities law requirements. ICOs will try to avoid being classified under this category, because the obligations of securities law will increase the difficulties of launching ICO similar to IPO. There are barely any ICO projects can pass such a strict test.
The Howey Test
The most common way to determine whether a token should be treated as securities is the Howey test. It is a standard established by the U.S. Supreme Court for reviewing cases between Securities and Exchange Commission (SEC) and Howey company. If a token fulfills the four conditions below, it will be considered a security:
1.It is an investment of money
Though the Howey Test uses the term “money”, the judgement criteria in later cases has expanded. Investments of assets with value other than money are also included, such as equipments and other resources.
2.There is an expectation of profits of the investment
Buying stocks is a common example of this definition, because most people want to earn profits by investing in stocks. If the investors of ICOs are expecting selling the tokens in the secondary market and earning profits from it, it will meet this requirement. However, tokens which are mainly used as access rights to services don’t apply.
3.The investment of money is in a common enterprise
Needless to say, buying stocks satisfies this criteria, since the money are used to invest in a company. If we look at ICOs, most of them apply since they are investing in particular project.
4.Any profit comes from the efforts of a promoter or third party
Stock investors normally do not participate in the decision making and operations of companies and earn profits only through investments of money. However, if the investors have to earn profits by making other efforts other than paying money, then the condition will not be satisfied. For example, Youtube is going to issue tokens to reward video makers, but they have to contribute contents on the platform for the audience. Then, this case do not apply.
It is worth mentioning that coins are treated the same as tokens before the law. Coins can also be classified into the three types above. Take Bitcoin and Ether for example, they are categorized into payment token.
How to buy tokens?
There are many ways to buy tokens. It depends on which type of tokens you are going to buy. Buying payment tokens like USDT are the same as buying coins. You can use cash to buy from its development team or use other coins or tokens to trade on exchanges.
As for buying utility tokens or tokens issued for raising funds, there will be a website built by the team for investors to operate. This will be helpful to the investors who are not familiar with blockchains and smart contracts, because they will have a graphical interface to interact with. Besides, the rules and exchange rate of buying tokens and any other related information will be displayed. Most tokens are bought by using coins. For instance, the tokens in the popular game FOMO3D can be bought by using Ether.
When investors transfer their funds to smart contracts to buy tokens, the smart contracts will send back corresponding tokens automatically based on the specified exchange rate and rules. Normally, exchanges will remind users not to use the withdraw function of their exchange accounts to interact with DApp or participate in ICOs. The main reason why is if exchanges are not supporting the particular kind of tokens, users may not receive them successfully since tokens will be returned directly to the exchange.
Tokens which are issued for the purpose of raising funds will flow into secondary markets after ICO. Investors can later trade the tokens they bought on the exchanges where they are able to make profits from them. Hence, most projects will try to have their tokens be listed on as many exchanges as possible so to increase the desire for people to invest.
Article by wqqhou, JOYSO