Is Your Airdrop Violating U.S. Securities Laws?
An airdrop is used to describe the free distribution of a blockchain startup’s cryptocurrency or token. Airdrops have developed as a way for companies to raise awareness and to attract users. It is used as an alternative to pay-per-click advertising and is now particularly appealing since Facebook, Google, and Twitter have banned cryptocurrency ads.
In 2017, blockchain startups leveraged public sales of its tokens (also called, “initial coin offerings” or “ICOs”) for both funding and public awareness of their companies. By labeling their tokens, “utility tokens,” some companies believed that they were not subject to securities laws. Jay Clayton, current chairman of the SEC, explained that whether a “utility token” is a security is based on a facts and circumstances analysis and that most of the ICOs he has seen involve the offer and sale of securities.
The SEC continued cracking down on ICOs, issuing subpoenas to 80 companies suspected of conducting ICOs in violation of U.S. federal securities laws earlier this year. Since then, startups have turned back to traditional means of fundraising such as private placements. Unlike an ICO, which raises funds from the public at large, capital raised through private placements are from a few accredited investors. To increase public awareness, some blockchain startups have turned to airdrops.
Airdrops can be used to distribute to everyone indiscriminately on the blockchain where a particular token is used or on a more targeted basis to those users most likely to use the tokens or have interest in a particular project. Indiscriminate airdropping isn’t very attractive to founders because giving tokens to uninterested recipients results in wasted tokens. Some founders have addressed this issue by using on-chain data to determine which users that are most likely to be interested and only airdrop to those users. Others offer free tokens in exchange for certain actions, such as joining a company’s telegram page or posting on social media. Yet others, identify existing token holders and incentivize the continued holding of tokens by awarding additional tokens based on current holdings.
By giving away free tokens, founders hope to build a large community of users, adopters, and evangelists to ensure the success of their blockchain project. However, some mistakenly believe that distributing free tokens in the United States helps create a U.S. market, while taking their activities outside of the purview of U.S. securities laws. The Securities Act of 1933, which governs the offer and sale of securities, provides that a sale of a security includes the disposition of a security for value and an offer of a security includes every offer or attempt to dispose of a security for value. “Value” is not limited to the exchange of money. A gift of free shares, for example, can constitute the disposition of securities “for value” because the “value” created is a public market for the issuer’s shares.
In 1999, the SEC brought enforcement actions against four companies giving away free stock to people who signed up for their website or referred others to sign up, reasoning that, “a gift of stock is a “sale” within the meaning of the Securities Act when the purpose of the “gift” is to advance the donor’s economic objectives rather than to make a gift for simple reasons of generosity.” The airdrops of today are similar to past attempts to distribute shares, which served to create a public market, create publicity, attract business, or attract users to a company’s website. Thus, a company doing an airdrop to U.S. citizens or residents must determine whether their token is a security and if so, comply with U.S. federal securities laws before any distribution of tokens.
This article is also posted on Medium.
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