On May 3, 2021, blockchain-based trading platform operator INX Ltd. announced it had completed its initial public offering of digital tokens, raising approximately $85 million in the IPO from over 7,200 institutional and retail investors. The INX IPO is the first SEC registered offering of digital tokens, and represents another major milestone for blockchain asset markets. At least two digital token offerings under Regulation A+ have previously been completed after being qualified by the SEC. And just three weeks before the INX digital token IPO, cryptocurrency exchange operator Coinbase Global, Inc. completed a direct listing, albeit of its common stock[1], not digital tokens.
In its prospectus included in its F-1 registration statement, INX stated it is focusing its business operations on two emerging blockchain asset classes: cryptocurrencies and security tokens.
A “cryptocurrency” is a digital representation of value that functions as a medium of exchange, a unit of account or a store of value. Cryptocurrencies are generally used a substitute for fiat currencies as a means of paying for goods or services or transferring value. Bitcoin and ether are examples of well-known cryptocurrencies. In its prospectus, INX stated emphatically that a cryptocurrency is not a “security” as that term is defined under the federal securities laws.
The INX prospectus defined a “security token” (a term not used by the SEC) as a blockchain asset that falls within the definition of a security under the federal securities laws. The SEC staff has acknowledged that determining whether a blockchain asset is a security can require a careful analysis of the nature of the blockchain asset and how it is offered and sold. Further, the SEC staff acknowledged that a blockchain asset that is initially sold as a security may, at a later point, no longer meet the characteristics of a security.
INX’s stated business objective is to establish two trading platforms and a security token that provide regulatory clarity to the blockchain asset industry. It plans to achieve that goal by differentiating between security and non-security blockchain asset classes and providing trading opportunities for each class.
U.S. persons may only trade INX tokens on either a registered securities exchange or an alternative trading system, in each case that has accepted the INX tokens for trading or quotation. To date, no registered securities exchange or alternative trading system has done so.
The INX token has both security and utility attributes. The security features are twofold: a right to receive an annual pro rata distribution of 40% of INX’s cumulative adjusted net operating cash flow, and a right to a liquidation preference equal to the ratable portion of a cash fund equal to 75% of the net proceeds from the IPO in excess of $25 million, triggered upon a failure to launch cryptocurrency trading or a liquidation event.
The utility features of the INX token consist of a discount of at least 10% on transaction fees on the INX securities trading platform when INX tokens are used to pay fees, and a passive tiered trading fee discount program on the INX digital trading platform based upon the number of INX tokens held in customers’ private wallets.
To the extent the INX tokens are securities, they are not voting securities and the token holders are not stockholders. No INX token holder will have the right to vote, or otherwise participate in INX’s general meeting of stockholders. An INX token holder will possess none of the rights that a common stockholder would ordinarily be entitled to. INX token holders will not participate in, or benefit from, significant corporate transactions in which INX is a party, such as a merger, sale of INX or sale of its assets. Furthermore, directors are nominated and elected by INX’s stockholders, and INX’s directors have no fiduciary obligations to act in the interests of token holders.
The road to completion of the INX IPO was anything but smooth. After filing its initial draft registration statement confidentially with the SEC in January 2018, INX filed a total of sixteen amendments (five of which related to the confidential filing) during a two plus year SEC review process as it sought to respond to a bevy of comments from the SEC staff. But in going through that review process, the INX IPO could help bring much needed clarity to the market for blockchain asset markets, help issuers and regulators better distinguish between security tokens and cryptocurrencies and lead to clearer rules for the offer and sale of each.
[1] “Satoshi Nakamoto” is identified on the facing page of Coinbase’s S-1 as among those who should receive copies of any SEC correspondence, along with the blockchain address “1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa”, the genesis address for bitcoin. Satoshi Nakamoto is the name used by the presumed pseudonymous person or persons who developed bitcoin, authored the bitcoin white paper and devised the first blockchain database.
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