Bit by Bit, Digital Financing Coming to Little Rock

Scott Davis, founder and CEO of MobX, shows off a Trezor digital wallet containing around $64,000 in bitcoin currency. Digital wallets can hold an unlimited amount of currency.

Two Little Rock technology companies, MobX and Freedom Coin Inc., say Arkansas is on the cusp of seeing its first “initial coin offering,” a new way for startups and individuals to raise capital for businesses and projects.

With an ICO, investors would be entering a barely regulated, heavily hyped brave new digital money world, a world trading in cryptocurrencies — encrypted digital monies, the most famous of which is bitcoin.

ICOs are like crowdfunding, but they’re structured like initial public offerings.

Supporters say ICOs can be a superior way for companies to raise money just because they are lightly regulated. ICOs can accommodate investors who might not be able to afford more traditional investments, and they have the potential to pay off big.

Skeptics, including several Arkansas investors, said ICOs are part of the unproven and volatile cryptocurrency market, which they say is rife with fraud and filled with naive people dreaming of getting rich quick.

“Both proponents and opponents will tell you that it is risky. That’s why you should not be investing in cryptocurrency any more money than you’re able to lose,” Octavio Blanco, a multimedia content creator for Consumer Reports, told Arkansas Business. “There is no safety net. If the money’s gone, it’s gone. It can be a really risky, high-wire act in the investing industry.

“That’s not to say there isn’t opportunity. Sure, there might be.”

Professionals agree that existing regulations promulgated by the U.S. Securities & Exchange Commission for security offerings might apply to some or all ICOs, but if they do, the regulations are not being enforced.

All of the professionals interviewed by Arkansas Business said investors in ICOs should exercise more due diligence than they would expect to exercise with stocks before any money changes hands.

The company planning to launch the first ICO in Arkansas has hired MobX as a consultant, MobX said, declining to identify its client other than to say it is based in Little Rock. Freedom Coin Inc. has been hired by three other companies planning ICOs this spring and over the summer. It also declined to identify its clients.

Here’s how an ICO works:

Investors can exchange traditional currency like U.S. dollars or cryptocurrencies like bitcoin for digital assets called coins or tokens.

The coins or tokens they buy are cryptocurrency created by the companies or individuals launching the ICO.

In the best case, the coins or tokens will gain value as the business or project the ICO investors are funding becomes successful and more people use the coins or tokens.

The ICO could also be structured in a way that gives investors a dividend (a share in a company’s profit) without the coins or tokens representing equity, as stocks do.

The coins or tokens also could gain value if investors and others are able to use them to buy the product or service provided by the company that launched the ICO.

A Question of Regulation
What forms the ICOs in Arkansas will take is yet to be seen, but the companies that say they’ve been hired as consultants are known quantities.

MobX is a team of senior software engineers that has designed and developed more than 300 mobile apps and served more than 20 million users.

The company also develops new cryptocurrencies and mobile wallets to hold cryptocurrencies.

Freedom Coin was formed in February 2017 as a consulting firm focused on bitcoin and blockchain technology, the technology that supports bitcoin and other cryptocurrencies. The firm has also installed a bitcoin ATM at the Simmons Tower in downtown Little Rock and plans to install more throughout the state.

Both have opinions about how regulated ICOs are.

MobX founder and CEO Scott Davis said the ICO his company is working on is being registered with the SEC and will comply with regulations for securities.

It may be the first ICO to register with the SEC.

Freedom Coin Inc. executives said some ICOs are not subject to existing SEC regulations because a coin or token is not a security if it’s not tied to an organization’s equity.

Co-founder and CEO Chris Sweeney and K.C. Surrett, president and CFO, cited bitcoin as an example. They said bitcoin’s value depends on its use. Bitcoins do not represent ownership in the development group that created the cryptocurrency, as a stock would. Instead, demand for bitcoin determines its value.

The SEC has taken legal action against fraudulent ICOs and released a “Statement on Cryptocurrencies and Initial Coin Offerings” on Dec. 11 that addresses the question of whether a coin or token is a security.

The statement cites this example: “A token that represents a participation interest in a book-of-the-month club may not implicate our securities laws, and may well be an efficient way for the club’s operators to fund the future acquisition of books and facilitate the distribution of those books to token holders. In contrast, many token offerings appear to have gone beyond this construct and are more analogous to interests in a yet-to-be-built publishing house with the authors, books and distribution networks all to come.”

The statement continues, “It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens. Prospective purchasers are being sold on the potential for tokens to increase in value — with the ability to lock in those increases by reselling the tokens on a secondary market — or to otherwise profit from the tokens based on the efforts of others. These are key hallmarks of a security and a securities offering.”

SEC Chairman Jay Clayton wrote in the statement that most of the structures for ICOs he’d seen promoted involved the offer and sale of securities.

One uncertainty that still exists is whether investors in ICOs must be “accredited.” An accredited investor must have earned $200,000 a year in income for the past two years, earned $300,000 a year with his or her spouse or have a net worth of $1 million and meet other criteria.

ICOs are structured like initial public offerings. If all the rules for IPOs are applied to ICOs, then the answer is yes, ICO investors must be accredited.

Several professionals said the SEC should clarify its policy and effectively put it in place.

One issue with implementation is that ICOs are not being registered with the SEC, and that makes it difficult for the commission to keep tabs on them.

The MobX and Freedom Coin executives agree that ICOs should be regulated, but they said regulation that is too heavy handed could result in their demise.

MobX’s key piece of advice, Davis said, is to speak with a lawyer who understands SEC filings.

An attorney can help the ICO make any disclosures to investors that it needs to make to avoid being prosecuted as fraudulent and to offer protections for its investors.

Attorney Jamie Fugitt with PPGMR Law PLLC in Little Rock said he would advise any ICO to voluntarily comply with SEC regulations because doing so could protect a company from an audit or investigation down the road — especially in Arkansas, which has an active Securities Department.

Fugitt’s speciality is representing entrepreneurs, investors and technology startups; helping organize and form businesses; helping with private investment and other financing transactions; and helping with company operations.

There is always an interest in creative ways to raise money that may be easier and less regulated, Fugitt said.

A Roller-Coaster Ride
While ICOs are a brand new trend, professionals are split on what their future looks like.

Maf Sonko, founder and CEO of Little Rock startup LumoXchange, and Brett Amerine, managing member of the Tonic Fund Group and COO of Startup Junkie Consulting in Fayetteville, believe ICOs may burn out.

Although Amerine expects cryptocurrencies to replace dollars in 30 to 40 years, he is bearish on the whole space in the short term.

But Blanco with Consumer Reports, Davis with MobX and Sweeney and Surrett of Freedom Coin believe ICOs are here to stay.

Davis is also optimistic that the cryptocurrency market they inhabit will become less volatile over time. “The awareness is causing a lot of the volatility right now. So many people are buying in, and then they’re getting scared when things don’t go as well as they think, and they panic sell and that drops the price,” he said.

“It’s the awareness that’s creating its own sort of roller-coaster behavior right now. It’ll smooth out and it’ll start to go up at a high pace again, but until that mass adoption appeal kind of goes away, that’s going to happen for a few more months.”

But Jeff Standridge, co-founder of Cadron Creek Capital in Conway and a well-known member of the state’s startup community, said ICOs “scare the heck out of me” right now because “there’s literally no value behind” the coins or tokens.

He also said he might change his mind about ICOs if the market solidifies so that he knows the coins or tokens could eventually be traded later for something of value.

Standridge and Amerine both compared ICOs to the dot-com bubble of the 1990s, when investors spent millions on overvalued stocks in online companies that had yet to turn a profit. Many lost a lot of money when the dot-coms failed.

How It Might Work
MobX of Little Rock, which is helping a Little Rock company launch an initial coin offering in the next few weeks, explained in some detail how that process would work.

Founder and CEO Scott Davis said the first step is to hire a lawyer to make any disclosures that may be required by the U.S. Securities & Exchange Commission.

The next step is to create the coin or token that will be sold in exchange for capital.

The ICO creates a token using blockchain technology. Blockchain refers to a digital ledger of transactions that can be accessed by anyone, but the ledger’s transactions can’t be altered after they are recorded.

Davis said one way an ICO could create the coin or token is with blockchain technology called Ethereum, which supports a cryptocurrency, a digital or virtual currency, called Ether. (Bitcoin is supported by a slightly different blockchain technology.)

Creating a token with Ethereum is quick and easy; it doesn’t require a lot of development work, Davis said. The coin could be on the market within a day.

“The easiest approach for someone to do an ICO is to create it on the Ethereum blockchain using what’s referred to as smart contracts,” he said. “Those allow you to issue decentralized rules that automate the process of investing. Someone buys your coin, they automatically get these tokens issued and it’s all part of the public ledger.”

But there is another option. An ICO can “fork” an existing currency, like bitcoin, to create its coin or token. Forking involves modifying the existing currency by putting a new label on coins, changing what they’re worth, creating a customized wallet to hold them, changing how many coins are issued, changing when they’re issued, allowing investors who buy the coins to receive a dividend and more.

Forking takes more time, up to six weeks for the ICO’s customization to meet industry expectations, Davis said. It could also require the company engaging in the ICO to have a development team. The upside is that the company can have more control over its coin.

Another step in the process is to have a marketing plan. For one, the ICO should be accompanied by a white paper detailing the project the fundraising will support. The ICO should also identify the online exchanges its coins will be listed on.