Revisiting Cryptocurrency Airdrops

A cryptocurrency airdrop is a distribution of free tokens or coins to holders of a particular cryptocurrency or to individuals who meet certain criteria. It is called an “airdrop” because the tokens or coins are “dropped” or distributed to a large number of people at once. Airdrops are commonly used as a marketing strategy by cryptocurrency projects to raise awareness, generate interest, and reward their existing community members.

However, despite the widespread use of airdrops in launching crypto projects, the origins of airdrops started during the DotCom era.

DotCom Era Free Stock Schemes

During the Dotcom period of the late 1990s, there were companies that offered free stock to investors in exchange for certain actions or participation. During this time, numerous internet startups sought to attract investors and build user bases by offering incentives, including free stock or stock options. Common strategies used by these DotCom startups included:

1. Sign-ups or Registrations: Companies would offer free stock to individuals who signed up for their services or registered on their platforms. This helped the companies grow their user base and generate interest in their offerings.
2. Referrals: Investors were often encouraged to refer friends, family, or acquaintances to invest or sign up for the company’s services. In return, they would receive free stock or additional incentives for successful referrals.
3. Purchasing or Holding Company Stock: Some companies offered free stock to investors who purchased or held a certain amount of their company’s stock. This strategy aimed to increase demand for their stock and create a loyal investor base.
4. Participating in Surveys or Market Research: Companies sometimes offered free stock to investors who participated in surveys or market research activities. This helped the companies gather valuable data and insights while rewarding investors for their involvement.

Ultimately, the SEC would step in and file enforcement actions against both the issuers and free stock recipients and effectively shut own the nascent marketing strategy.

Cryptocurrency Airdrops & Token Offerings

In the early stages of Initial Coin Offerings (and lack of regulatory scrutiny), there were a number of wildly successful airdrops. These included:

1. Ethereum (ETH) and Ethereum Classic (ETC) Airdrop: In 2016, Ethereum conducted a hard fork resulting in two separate blockchains: Ethereum (ETH) and Ethereum Classic (ETC). As a result of the fork, holders of Ethereum received an equal amount of Ethereum Classic tokens. This airdrop created value for Ethereum holders and expanded the cryptocurrency ecosystem.
2. Stellar Lumens (XLM) Airdrop: Stellar, a blockchain platform focused on facilitating cross-border payments, conducted a significant airdrop in 2017. Stellar partnered with several exchanges and distributed a total of 100 billion Lumens (XLM) tokens to Bitcoin holders. The airdrop aimed to promote wider adoption of Stellar’s network and increase awareness of its cryptocurrency.
3. OmiseGO (OMG) Airdrop: OmiseGO, a blockchain project focused on decentralized financial services, conducted an airdrop in 2017. The airdrop rewarded Ethereum holders with OmiseGO tokens (OMG) in proportion to their Ethereum holdings. This airdrop helped raise awareness about OmiseGO and generated interest in its platform.
4. Ontology (ONT) Airdrop: Ontology, a high-performance public blockchain project, conducted an airdrop to NEO token holders in 2018. NEO holders received Ontology tokens (ONT) as part of the airdrop. Ontology aimed to build a comprehensive distributed trust ecosystem and used the airdrop as a way to involve the NEO community in its project.
5. EOS (EOS) Airdrop: EOS, a blockchain platform designed for decentralized applications (dApps), conducted an airdrop to Ethereum holders during its ICO in 2018. EOS distributed its native tokens (EOS) to Ethereum addresses based on a snapshot taken at a specific block height. This airdrop helped raise funds for the EOS project and attracted attention to its platform.

Overwhelmingly, the common airdrop will incentive users to complete relatively menial tasks in exchange for tokens or coins of the early stage project. Common tasks for which individuals can be incentives include:

1. Wallet Creation: Participants may need to create a specific type of wallet that is compatible with the tokens being distributed. For example, if the airdrop involves an Ethereum-based token, participants may need to have an Ethereum wallet address.
2. Social Media Engagement: Airdrops often require participants to engage with the project’s social media accounts, such as following them, liking posts, sharing content, or retweeting. This helps to promote the project and increase its visibility.
3. Referral Programs: Some airdrops have referral programs where participants are encouraged to refer friends or acquaintances to join the airdrop. This can be done through unique referral links or codes provided by the project. Participants may receive additional tokens or rewards for successful referrals.
4. Community Engagement: Airdrops may require participants to join and actively engage with the project’s community on platforms like Telegram, Discord, or other chat forums. This involvement may include contributing to discussions, asking questions, or helping other community members.
5. Verification and KYC: Some airdrops may require participants to verify their identity or go through a Know Your Customer (KYC) process. This is often done to comply with regulatory requirements or prevent abuse of the airdrop by individuals creating multiple accounts.

Legal & Compliance Issues for Issuers Securities Laws

The legality of cryptocurrency airdrops turns on the primary question facing all cryptocurrency sales — is the token or coin a security or utility?

In general, if a cryptocurrency airdrop involves the distribution of tokens or coins that are classified as securities, it may be subject to securities regulations in certain jurisdictions. In such cases, the project conducting the airdrop would need to comply with relevant securities laws, which could include registration requirements, disclosure obligations, and restrictions on who can participate.

The fundamental issue is that, no matter how menial, the actions that individuals take are a form of consideration which is paid for by tokens or coins. Thus, such transactions may implicate Rule 701 and Regulation D under the Securities Act. Rule 701 provides an exemption for compensatory stock offerings by private companies, while Regulation D provides exemptions for certain private placements based on the offering size and the status of investors. Even if a company qualifies for an exemption, it must still provide adequate disclosures to the recipients of the stock. This includes information about the company’s financials, business operations, risks, and other relevant details that would be material to the recipient’s investment decision.

In my experience, overwhelmingly token or coin issuers will not supplement their airdrop with a private placement memorandum or something comparable to meet the requirements of Rule 701 or Regulation D. At the same time, overwhelmingly, the issuers believe that they are not offering a token or coin that could be classified as a security.

Money Transfer Laws

The requirement for companies offering cryptocurrency airdrops to register as a money service business (MSB) with the U.S. Financial Crimes Enforcement Network (FinCEN) depends on the specific circumstances and activities involved in the airdrop. f the airdrop involves the transfer of significant value or is considered a money transmission activity, it is possible that the company conducting the airdrop may fall under the definition of an MSB and have registration obligations with FinCEN. Money transmission generally refers to the transfer of funds between parties or the conversion of one form of currency into another.

The practical implication of having to register as an MSB is the requirement that the issuer perform AML & KYC checks on all airdrop participants, which many be impractical insomuch that you have a multitude of people performing relatively small tasks for relative small benefit.

Legal and Compliance Issuers for Airdrop Participants

The overriding concern for airdrop participants who promote a token or coin that whether that token or coin is deemed a security. If a person promotes a security token or any investment opportunity in exchange for consideration, they are generally required to disclose that they have been compensated.

Under Section 17(b) of the Securities Act, it is unlawful for any person to promote the sale of a security without disclosing the receipt of any compensation, directly or indirectly, for such promotion. This requirement applies to both monetary and non-monetary compensation, such as shares of stock or other securities. Moreover, Section 10(b) of the Securities Exchange Act and Rule 10b-5 issued by the Securities and Exchange Commission (SEC) prohibit fraudulent and deceptive practices in connection with the purchase or sale of securities. This includes the obligation to disclose any material information, such as the receipt of compensation, that a reasonable investor would consider important in making an investment decision. Finally, SEC Staff Legal Bulletin №14A clarifies that promoters, including individuals and entities engaged in investor relations activities, should clearly disclose their compensation arrangements in promotional materials, public statements, and other communications.

Notably, celebrities such as Kim Kardashian has faced regulatory penalties for failing to disclose compensation for crypto-related projects that she promoted on her social media.

Conclusion

Cryptocurrency airdrops can be wildly successful and have traditionally been an integral feature for launching early stage blockchain ventures. However, as with nearly all regulatory crypto interpretations, the efficacy of conducting an airdrop comes down to the determination as to whether the token or coin in question is a security or not.

As always, be sure to reach out to me with any questions or book a meeting here.

About Adam Tracy

Adam Tracy is a payments expert and entrepreneur who specializes in payment systems, blockchain technology, digital currencies, and other emerging technologies. He is the founder of Blockrunner, LLC that provides consulting services to clients in the blockchain, payments and cryptocurrency arenas.

Tracy has been involved in the payments industry as an attorney, consultant and entrepreneur since 2005, while he was become an expert in blockchain and cryptocurrency since its advent in 2013. Tracy has worked with a wide range of clients, including startups, established businesses, and investor — both in the United States and worldwide. He has advised clients on a wide range of compliance, legal and operational issues related to payment transfer systems, crypto token generation and architecture, cryptocurrency exchanges, regulatory licensing, smart contracts, and other blockchain applications.

In addition to his consulting work, Tracy has founded several companies in the payments, blockchain and cryptocurrency space, including a digital asset hedge fund, licensed electronic money institution and a blockchain-based tokenization platform. He is also a proponent of decentralized finance (DeFi) and has been involved in various DeFi projects.

Tracy is also a frequent speaker and writer on blockchain and cryptocurrency topics. He has been featured in a wide range of publications, including Forbes, Hollywood Reporters, CNBC, Reuters, CoinDesk, and Bitcoin.com.

Find Adam: https://linktr.ee/adamtracy

Blockrunner, LLC., is a financial services match-making marketplace and consulting company. We are not a bank, FI/NBFI, Payment Service Provider, deposit taking institution, trust, or money services business of any kind. We are not regulated by any financial regulator. Banking, Payment, Processing, and Licensing services are provided by our participating members. This website is for informational purposes only and does not constitute legal advice. If you need legal advice, please consult a licensed attorney in your jurisdiction.

Originally published at http://adamtracy.io on June 5, 2023.