On July 10, 2019, the Securities and Exchange Commission declared Blockstack PBC’s offering statement “qualified”, thus allowing Blockstack to commence the distribution and sale of its Stacks Tokens under Regulation A. This is the first offering of digital tokens to be qualified by the Commission under Regulation A, a significant milestone for the blockchain industry which raised billions of dollars in 2016-2018 in unregistered non-exempt initial coin offerings before the Commission threw down the gauntlet in the form of lawsuits and enforcement actions alleging illegal unregistered offerings, most recently against Kik Interactive Inc. Yet given recent Regulation A headwinds, it’s unclear to what extent other blockchain developers will follow Blockstack’s lead and look to raise capital under Regulation A.
State of Regulation A
Regulation A was reformed under the JOBS Act of 2012 to allow issuers to raise up to $50 million in any rolling 12-month period with scaled down disclosure relative to full-blown registration, freedom to test-the-waters and no qualification at the state level. Referred to as a mini-IPO, Regulation A also provides a streamlined pathway to Securities Exchange Act registration (for those issuers choosing to be SEC reporting companies) and for listing on a national securities exchange. Shares issued in a Regulation A offering are unrestricted; they can be freely resold without a holding period or other restriction.
Issuers’ and securities professionals’ hopes were high that Regulation A could be a viable alternative to registered public offerings or other existing exemptions. Initial signs were encouraging. Since Regulation A went live in 2016, over 100 transactions have been consummated averaging $10 million per deal, including ten issuers that got listed on Nasdaq or the NYSE.
Unfortunately, however, Regulation A has experienced some hiccups lately. The shares of the ten listed Regulation A issuers have fared poorly, and the Commission recently approved Nasdaq’s proposed rule to require Regulation A funded companies seeking Nasdaq listing to have a minimum two year operating history. One Regulation A issuer, Longfin Corp., terminated operations less than one year after closing its Regulation A offering and is now the subject of a fraud lawsuit by the Commission.
Blockstack Offering of Stacks Tokens
Blockstack is developing an open-source peer-to-peer network using blockchain technologies to ultimately build a new network for decentralized applications. Blockstack is offering up to $40 million of its Stacks Tokens, consisting of a combination of full-priced tokens to “qualified purchasers” as defined in Regulation A, discounted tokens to holders of certain purchase vouchers and non-cash consideration tokens under Blockstack’s “app mining” program in exchange for the development of well-reviewed applications on its decentralized application network. Blockstack previously raised over $50 million in VC rounds and under Rule 506(c); among those investing were big-time early stage investors Union Square Ventures, Y Combinator, Lux Capital and Naval Ravikant.
The Evolving Token
In a June 2018 speech, SEC Division of Corporate Finance Director William Hinman broke new ground when he stated that a digital asset originally sold in a securities offering could later be sold in a manner that does not constitute an offering of a security when there is no longer any central enterprise being invested in or where the digital asset is sold only to be used to purchase a good or service available through the network on which it was created. I blogged about the speech here.
Consistent with the guidance from Hinman’s speech and with the Commission’s recent guidance in its “Framework for ‘Investment Contract’ Analysis of Digital Assets”, Blockstack asserts its Stacks Token is a security now but may not be so in the future. In its offering statement, Blockstack states that, for the foreseeable future, it anticipates treating the Stacks Token as a security based on its view that the token is an “investment contract” under the application of the Howey test to digital assets: an investment of money, in a common enterprise, with a reasonable expectation of earning a profit, through the efforts of others. With investment of money in a common enterprise and a reasonable expectation of earning a profit assumed, the real issue is whether that profit expectation is through the efforts of others.
Under the Framework and the Howey Test, a profit expectation is considered to be through the efforts of others if the network is still being developed and the token is not fully functional, because the success of the network is considered to be dependent on the efforts of management. Once the network is sufficiently decentralized, that success can no longer be said to be dependent on the efforts of management. Blockstack maintains that, currently, it employs all core developers of the Blockstack network. But as the network becomes increasingly decentralized, core developers other than those employed by Blockstack may become primarily responsible for the development and future success of the network. Blockstack also maintains it may transfer governance and control of the Blockstack network to other parties, such as network users and developers.
Whether Stacks Tokens lose their status as investment contracts will ultimately depend on whether purchasers of the tokens no longer expect Blockstack to carry out essential managerial or entrepreneurial efforts, and whether Blockstack no longer retains a degree of power over the governance of the network such that its material non-public information may be of special relevance to the future of the Blockstack network, as compared to other network participants. Arguably, purchasers will no longer have that expectation and Blockstack will no longer have that power when the network becomes truly decentralized, at which point Blockstack asserts the Stacks Tokens will no longer constitute a security.
Blockstack’s Regulation A journey has been an expensive and long one, purportedly costing it $2 million over the ten months of engaging in the process. Blockstack’s co-founder Muneeb Ali joked about what he calls Blockstack’s “$2 million donation to the crypto industry”, but he also made these interesting comments on his blog about the precedent setting potential of the offering:
“[the offering could] set a precedent for others in the industry…Recently, U.S. markets have been closed to crypto projects given regulatory uncertainty, and we believe in opening the U.S. markets to innovation in this area. We’ve been working with securities lawyers to create a legal framework that can enable blockchain protocols to comply with SEC regulations…Following a regulated path and proactively working with the regulators was a decision we made with the understanding that it’ll require a lot of work and time…This can potentially set a precedent for others in the industry, not just for public offerings, but also as a path to launch new public blockchains and establish a path to bootstrapping decentralized ecosystems.”
Whether Blockstack’s Regulation A offering will indeed set a capital raising precedent for others in the blockchain industry remains to be seen, and will depend on several factors including whether Regulation A can rehabilitate its brand and whether Blockstack’s “$2 million contribution to the crypto industry”, presumably through multiple versions of its offering circular and responses to voluminous SEC comment letters, will have created a practical, workable model from which others can follow Blockstack’s lead in a more cost-effective manner.