The excitement is real, but so is the risk. Decentralized business model discussions are the talk in board rooms and C-suites around the world. A new market to raise development capital is emerging called initial public coin offerings (IPCO or ICO).\nToken sales and\u00a0crowdsales\u00a0embrace empowering a network of users to participate in a project. Participants are incentivized to get involved\u2014early participation has greater rewards\u2014in anticipation of the project increasing in value.\nAccess to ICOs has significant potential for\u00a0up-side\u00a0benefits with an equally startling downside risk. The main concern of ICO risk is unduly escalated asset values or irrational exuberance. Fed Chairman Alan Greenspan, in The Challenge of Central Banking in a Democratic Society (1996), first introduced the concept of irrational exuberance, defining it as unsustainable investor enthusiasm that drives asset prices to levels of frothiness not supported by fundamentals.\nA sudden interest in investor protection\nHow did we arrive at this highly regulated state? It didn\u2019t happen overnight but was instead a century in the making.\nInvesting was initially reserved only for the wealthy. Greed and deceit\u00a0scared off all but the toughest investors until the early 1900s. As disposable income increased, casual investors needed a place to put their money. The\u00a0Blue Sky Laws\u00a0were first introduced in 1911 and were meant to protect investors from the pump-and-dump schemes of\u00a0worthless securities. This was the first time that sellers of new issues (a security sold to the public) had to register and release the financial details to the public. The 1920s were booming, and just saying the word \u201cstock\u201d was thought to make money.\nThis excitement ended abruptly with the Black Tuesday crash of October 29, 1929. The Dow Jones Industrial Average (DJIA) plummeted 12 percent in the largest one-day drops in stock market history with more than 16 million shares traded in a panicked sell-off, triggering the Great Depression.\nProtecting banks from themselves (Part I: 1933)\nIt wasn\u2019t only individual investors who incurred heavy losses; the banks were prohibited from playing the market with clients\u2019 deposits. The Federal Reserve didn\u2019t lower interest rates, forcing the government to generate alternatives to get the economy back to recovery.\nCongress passed two substantial regulations that FDR signed in 1933: the Glass-Steagall Act and the Securities and Exchange (SEC) Act. Glass-Steagall separated commercial from investment banking, which did two things. First, it prevented securities firms and investment banks from taking deposits. Second, Glass-Steagall kept commercial Federal Reserve member banks from four kinds of transactions: dealing in non-governmental securities for customers; investing in non-investment grade securities for themselves; underwriting or distributing non-governmental securities; and affiliating with companies involved in such activities. The Securities and Exchange Act of 1934 governed the secondary trading of securities (stocks, bonds and debentures). These acts gave the SEC considerable power over Wall Street and required additional financial disclosures and stricter reporting schedules. Additionally, individuals and companies found guilty of fraud now faced civil criminal charges.\nProtecting banks from themselves (Part II: 1975)\nThe Securities Acts Amendments of 1975\u00a0is an often-overlooked but impactful regulatory amendment that imposed an obligation on the SEC to consider the impacts that any new regulation would have on competition, thereby further empowering it. The Act enabled the Regulation National Market System (Regulation NMS) and created the Municipal Securities Rulemaking Board (MSRB).\nCreative and deceptive accounting by Enron, WorldCom and Tyco International resulted in additional regulations, including the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley added teeth in two areas: Section 302 (senior management were required to certify financial statement accuracy under threat of civil and criminal penalty) and Section 404 (guidelines for storage and retention periods and the proper destruction of financial documents).\nDo blockchain tokens fall under federal security laws?\nAre these regulations too far reaching? Maybe. But keep in mind, the catalyst behind these regulations represent historical events we\u2019d prefer not to relive\u2014such as the crash of 2007 to 08, from which the economy still hasn\u2019t fully recovered and which is beyond the scope of the current discussion.\nBefore you fund your company\u2019s development with an ICO, it\u2019s wise to stay clear of ICOs that are more likely to incur heightened scrutiny and regulatory control. Several forward-looking marketplaces\u2014such as ICONOMI and Tokenmarket\u2014are offering ICOs with AML and KYC compliance.\nTwo regulations govern whether a cryptographic blockchain token is considered a security: the\u00a0Securities Act\u00a0and the\u00a0Exchange Act.\n\nSecurities Act of 1933: Section 2(a)(1)\nSecurities Exchange Act of 1934: Section 3(a)(10)\n\nIn\u00a0SEC v. W.J. Howey Co., the Supreme Court concluded that an investment contract fell within the scope of the Securities Act. Howey owned a large citrus grove and sold smaller strips of land to buyers with ten-year service contracts for cultivating,\u00a0harvesting\u00a0and marketing the land, which the buyer (investor) was not involved with in any way. The company allocated net profits to the buyer based on the produce yielded from each strip of land.\nThe\u00a0pivotal question was, \u201cIs the term security referencing any document(s) that provide evidence of a monetary investment in a common enterprise whose profits come only through the labors of others?\u201d\nThe SEC stated this action was a violation of the sale of unregistered securities. The Supreme Court determined that because Howey provided an investment opportunity and the potential to share in the profits of the citrus fruit operation, the document traded was considered a security and therefore fell under SEC scrutiny.\nHowey also defined an \u201cinvestment contract\u201d as:\n\n\u201ca contract, transaction or scheme whereby a\u00a0person invests his money\u00a0in a\u00a0common enterprise\u00a0and is\u00a0led to expect profits\u00a0solely from the efforts of the promoter or a third party, it being immaterial whether the shares in the enterprise are evidenced by formal certificates or by nominal interests in the physical assets employed in the enterprise.\u201d\n\nTherefore, the \u201cHowey test\u201d can be used to determine if an investment instrument is considered an investment contract using a\u00a0four-prong test:\n\nAn investment of money,\nIn a common enterprise,\nWith an expectation of profits,\nSolely from the efforts of others.\n\nThis test is useful when considering whether to participate in an ICO in order to fully grasp your potential legal obligations.\nThe missing link in the Howey test\nThe four-prong test, however, isn\u2019t that straightforward.\u00a0Unfortunately, Howey\u00a0didn\u2019t define the term \u201ccommon enterprise.\u201d Three basic definitions exist:\n\nHorizontal commonality: an enterprise in which the investors\u2019 contributions are pooled, and the future of each investor depends on the success of the overall venture.\nBroad vertical commonality: an enterprise in which the investor is dependent on the promoter\u2019s efforts or expertise for the investor\u2019s returns; requires investor\u2019s fortunes be tied to the efficacy of the manager\u2019s efforts.\nNarrow vertical commonality: an enterprise in which the investor is dependent on the promoter\u2019s efforts or expertise for the investor\u2019s returns; requires that the investor\u2019s profits are tied to the manager\u2019s profits.\n\nAt present, we\u2019re left with more questions than answers, such as these four: are blockchain tokens being sold as crypto-equity? How involved are investors in the project, other than profit sharing? Are the investors passive investors? Does this meet the requirement of a financial security? We don\u2019t have all the answers, but we do know that companies pursuing KYC- and AML-compliant ICOs will be less disrupted as regulatory bodies continue to define the financial security boundaries of tokens, app\u00a0coins\u00a0and protocol tokens\u2014now and into the future. So stay tuned!