Napster launched in 1999 and promptly turned the music industry on its head. Anyone with a computer connected to the internet could suddenly share music on an instantaneous peer-to-peer basis with other Napster users. For consumers otherwise reduced to purchasing pre-packaged albums sold from brick and mortar record stores, Napster transcended the very limits of time and space, as well as, apparently, the law. Download any song, any time, from anywhere in the world, absolutely for free — that was the promise. So, naturally, Napster was sued for copyright infringement in 2000, lost, and by 2002 the service was shut down. Napster failed. But not before it demonstrated the power of digital peer-to-peer networks, generating a paradigm shift in content distribution that would change music forever.

The foundational threat Napster posed to the music industry was made possible, in part, by the nature of MP3 files. In digital form a “song” is just a sequence of 1’s and 0’s. If accessible to a global network of digitally interconnected users, that sequence can be copied, shared, and played in an infinite number of places simultaneously. This feature of digital reality — the ability to instantly transmit an endlessly replicable packet of information to multiple destinations at once — is great if you want to pirate music, group chat with friends, or spam people’s news feeds with your political opinions. It is very bad, however, for the prospect of electronic transfers of value.

If a single digital asset (e.g., a digitized dollar, Bitcoin, or stock certificate) can be sent to multiple separate parties at the same time, there is no guarantee of authenticity, and the system breaks down. If those dollars, Bitcoins or shares can be endlessly copied and flooded into the market, there is no guarantee of scarcity, so no guarantee of value, and the system breaks down. One solution is to rely on a labyrinth of governmental and financial institutions serving as trusted third parties to verify transactions and monitor supply. Alternatively, there is blockchain.

Blockchain protocols track the ownership and transfer of digital assets by distributing verification and recordkeeping responsibilities across the entire network of users. The byproduct is an immutable time-stamped ledger, which designates ownership of each discrete digital asset at any current and prior given moment in time. Blockchain thereby ensures that digital assets can be (1) held with the assurance of a stable, predictable supply and (2) reliably transacted on an online peer-to-peer basis, without the need for intermediaries to perform the costly and error-prone process of traditional payment verification. There is a mind bending array of potential applications for this technology.

Initial coin offerings, or “ICOs,” are one of the more promising, and polarizing, applications of blockchain thus far. ICOs couple the power of peer-to-peer networks with blockchain technology to fund and facilitate project development in a profoundly new way — through crowdsourced sales of digital assets known as “tokens.”

Tokens are programmable digital assets with a panoply of potential features and functions. They are assets because their scarcity and authenticity is secured by blockchain. They are programmable because they can be coded to interact with “smart contracts” — i.e., to automatically perform operations or execute transactions upon the occurrence of a verifiable event, without counterparty risk of non-performance. They are digital in that they are issued, recorded, and transferred on blockchain. And their characteristics and uses differ wildly due to the nature of the various networks they can be designed to operate on, as well as the behavior of their users.

In an ICO, issuers use blockchain to sell such tokens to all or some subset of investors around the world. While each ICO differs depending on the product, strategy, and risk appetite of a particular issuer, a ‘typical’ offering proceeds as follows. After a pre-offering phase in which the issuer markets the sale, registers potential purchasers, and develops strategic alliances, the ICO will launch. Once the sale opens, purchasers buy ICO tokens by sending other tokens — typically Bitcoin or Ether — to a “public key” provided by the issuer. These transactions trigger a smart contract, so that in exchange, the ICO tokens are assigned to each purchaser’s account in amounts proportionate to their contribution and in accordance with the pricing dynamics employed by the sale. The offering closes when the funding goal is reached, available token supply is exhausted, or the time limit exceeded.

In this manner, ICOs have raised a remarkable $2.1 billion so far this year. New tokens are created almost daily, with over 1,200 different types now in circulation, and a collective market capitalization of $205 billion. Depending on who you talk to, these figures are either evidence of a remarkable transformation in the fundamental framework of company capitalization, horrifying illustrations of a fraud-riddled bubble about to burst in the face of the investing public, or a some sampling of both. The controversy is understandable. There is a complex matrix of risks assumed and benefits obtained by fundraising on blockchain.

On the one hand, individual ICO issuers can raise hundreds of millions of dollars quickly and inexpensively, without diluting their equity or incurring debt obligations, and simultaneously seed their network with a critical mass of token holders. In the process, underwriters, transfer agents, clearing houses and other intermediaries typically required in capital markets transactions are bypassed. Instead, thanks to blockchain, token sales are conducted instantaneously, on a trusted peer-to-peer basis with practically anyone, anywhere in the world.

On the other hand, ICOs are fraught with risk. The lack of uniform disclosure makes purchaser participation perilous. Fraudsters abound, while even well-intentioned projects have a high, and highly underappreciated, probability of failure. There is no agreed-upon basis for token valuation, and many purchasers buy tokens based on expected resale value rather than fundamental analysis. Moreover, the market is frenzied, as money pours in for tokens with use cases that are dubious at best. Token holders stand to lose a tremendous amount of money, very quickly, and with limited legal recourse.

Weighing these considerations, financial regulators have given few clear mandates as they determine how to toe the line between protecting their constituents on the one hand, and not driving out innovation on the other. At the forefront of this conversation are questions about the role and place for securities regulation as a method of ICO governance. In the context of traditional capital markets transactions, the U.S. securities laws are designed to avail many of the very same risks now implicated by ICOs. But ICOs are not traditional capital markets transactions. They may, but do not always unambiguously, fall within the jurisdictional ambit of the SEC.

Meanwhile, the explosive growth and diversification of the ICO ecosystem proceeds and the question for many prospective issuers is not whether, but how, to best move forward. The fundamental rule is this: if an ICO is subject to the securities laws, it must be registered with the SEC or qualify for an exemption in order to offer or sell its tokens to U.S. investors.

Most ICOs to date have been unregistered and non-exempt. There is a real probability they have therefore broken the law. This raises questions not just about the future of those issuers, but of ICOs as a fundraising model.

If ICOs are attractive merely as a mechanism for illegally conducting an unregulated offering of securities in a manner that is difficult to police, then they are of limited future value to issuers and investors. If today’s ICOs — illegal and destined to fail as some may be — are nonetheless emblematic of a paradigm shift in the way companies access the capital markets, then they may change the future of investing itself.

While there are reasons to think we’ll skew closer to the former scenario, the case for the latter is compelling. It begins with the tokens that are offered and sold. After all, what is a paper stock certificate to a programmable digital asset?

It extends to the ICO offering process. Who needs underwriters, clearing houses and transfer agents, with blockchains and smart contracts?

And it returns to the power of incentivized, open peer-to-peer digital networks to create and exchange value at speeds and scopes that are otherwise unfathomable. What is Sam Goody to Napster?

Indeed, ultimately ICOs could evolve into a full-fledged capital formation platform, usurping the financial industry as we know it today and allowing organizations to digitally promote and distribute value to investors at a fraction of the cost.

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[1] A&M Records, Inc. v. Napster, Inc., 114 F. Supp. 2d 896 (2000). Sean Parker co-founded Napster when he was 19 years old.

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[*this post is not legal advice. it is just some personal reflections made in my purely personal capacity. it is also kind of old. a good deal has happened since i wrote it and facts and figures may have changed. still i hope you enjoy.*]