How to Launch a Crypto Startup in 2023 – Part 1

Greetings, everyone! This is Roman from Degovrned. As a part of my routine, I carry out 3-4 individual consultations each week, where I often encounter some of the same questions. To address this, I’ve decided to write a series of articles addressing these prevalent queries. Additionally, I’ll be including templates and useful links organized by topic to aid you in your crypto startup journey.

Before we dive into the details, there’s one caveat. This article, being the first in the series, aims to cater to the most general type of crypto startup, without considering the nuances of specific business models. Certainly, an NFT studio’s legal requirements will differ from a custodial wallet’s needs. But, let’s start by discussing the questions that pertain to the vast majority of crypto ventures.

As you can see from the above charts, crypto startups face unique corporate and administrative challenges from the very beginning.

1. Whether to Build in Public or Anonymously

Many crypto founders prefer to maintain some level of anonymity, with levels varying from the simple use of nicknames on social media to the adoption of robust Operational Security (OpSec) measures. The measures you decide to take depend on your background and motives. For a comprehensive look at various OpSec methods, this compilation is an excellent resource.

However, if your plan involves deceiving someone to make illicit gains, you’ll eventually be exposed, especially if the amount is significant. History is littered with examples of such deceptions unraveled.

On a more reassuring note, it’s entirely feasible to secure the privacy of your data for reasons of personal safety or to sidestep unsolicited inquiries from unknown entities. As long as your intentions are sincere, a substantial degree of anonymity is maintainable.

Uniquely in the crypto industry, retaining anonymity doesn’t necessarily raise eyebrows. As this recent article in Fortune demonstrates (caution: paywall), investors may still back projects even when the founders remain undisclosed.

Say goodbye to your anonymity if you need to start a company, open a bank account, register a trademark, or enter into an ordinary contract with someone. In other words, when you need to interact with the real world.

We had a case in our practice where an international client who always sought to maintain maximum anonymity became a victim of fraudsters. To recover the money, it was necessary to file a lawsuit in a US court, where judges, to put it mildly, are not very inclined to consider claims from anonymous plaintiffs. Therefore, a choice had to be made: anonymity or legal protection.

While plenty of crypto projects with anonymous founders exist and even secure investments, one shouldn’t harbor the illusion that anonymity can be sustained indefinitely.

2. Decide on Whether You Need a Licence

Just last week, a client reached out to me on Telegram, seeking my evaluation of another firm’s proposal for the corporate structure of a custodial crypto wallet with portfolio rebalancing capabilities. The attorneys in question had suggested registering four companies simultaneously: in the UK, UAE, Hong Kong, and the US. Further, it was recommended that the US company “register with the SEC” for ICO purposes and file a Form S-1, typically associated with companies preparing for an IPO.

This proposal entirely overlooked the licensing prerequisites that pertain to the business model in question. It involves at least two activities—custodial wallets and investment advisory services—that are subject to regulation in most developed jurisdictions.

When in the process of launching a project, it’s essential first to determine whether you require a license. To comprehend which business areas typically come under regulation, let’s examine European licenses set to be introduced next year as part of the Market in Crypto Assets regulation (“MiCA”):

• Operation of a trading platform for crypto-assets
• Custody and administration of crypto-assets on behalf of third parties
• Exchange of crypto-assets for funds
• Exchange of crypto-assets for other crypto-assets
• Execution of orders for crypto-assets on behalf of third parties
• Placing of crypto-assets
• Providing transfer services for crypto-assets on behalf of third parties
• Reception and transmission of orders for crypto-assets on behalf of third parties
• Providing advice on crypto-assets
• Providing portfolio management for crypto-assets

If your type of activity falls into one of the categories above, make a note for yourself: sooner or later, you will need to get a license. While licensing comes with its own set of costs and obligations—such as regular reporting and a minimum capital requirement—it also offers numerous advantages. These include a simplified process for opening a bank account, the ability to integrate payment providers, smoother interactions with platforms like AppStore and Google Play, and more.

But do not rush to spend money on licenses and consultants until you test your product hypotheses, which can usually be done before getting a license.

3. Instead of Seeking a Low-Tax Jurisdiction, Look for Crypto-Friendly Banks

If you’re enticed with a proposal to register in the UAE under the pretext of it being a “crypto-friendly” nation, it’s best to steer clear of such ill-informed advice. No bank in Dubai currently (May 2023) deals with crypto startups, and the UAE has yet to establish any crypto-specific licensing regulations.

Indeed, Dubai is home to many crypto traders and investors, thanks to its zero-tax regime for individuals. But beyond that, the benefits are sparse. The complexities of the UAE’s unique public legal system, where local lawyers jealously safeguard their expertise like a hen protecting its golden egg, is a topic best left unexplored here.

Georgia is another case in point. Despite knowing a few successful instances of crypto companies securing bank accounts in this country, these are more anomalies than the norm.

Until quite recently, I might have advised a company to register either in the US or in an offshore jurisdiction familiar to US banks, like the British Virgin Islands (BVI) or Panama. Subsequently, they could approach American crypto banks such as Silvergate, Signature, or Metropolitan Commercial Bank. But just a few weeks ago, under regulatory pressure, these banks literally ceased working with crypto.

Given these circumstances, if access to banking infrastructure is a must for your operations, you should turn towards European banks, specifically those in Switzerland and Gibraltar. Check out this post in our Telegram channel for more details.

However, if a bank account isn’t an immediate necessity, the US and the BVI remain viable options. Registering a company in the US costs around $1,000-2,000, while in the BVI, it stands at roughly $5,000. You can set up these entities through Degoverned.

4. How to Privately Issue Tokens to Investors (Non-Publicly)

After registering a legal entity for a crypto startup, fortunate founders move on to secure early-stage financing. Suppose investors are keen on funding your project. Which legal instrument should you employ for a private token issuance?

Many may be familiar with the concept of SAFT, or Simple Agreement for Future Tokens, a prevalent practice during 2017-18. Though the frequency of SAFT transactions has somewhat diminished today, they certainly haven’t disappeared. A standard SAFT document contains a variety of clauses that sway the contract’s benefits towards either party involved: the investor or the issuer (the startup). If you’re considering entering into a SAFT, I highly recommend perusing this SAFT legal checklist for a thorough understanding.

For a deeper understanding of the original SAFT, you can visit the SAFT Project website where you can also download a template. Be aware, however, that contemporary SAFTs significantly diverge from this model, and there’s currently no universally accepted template.

Present-day, early-stage crypto financing transactions often involve the issuance of both equity and future token rights. To achieve this, two instruments are employed in unison: the Simple Agreement for Future Equity (SAFE) and the Token Warrant Agreement (TWA).

You’ve likely already encountered ample information about YC’s SAFE. If not, refer to this comprehensive guide on SAFE.

With a TWA, the investor obtains a right to a portion of future tokens, if and when they’re issued. The company isn’t obliged to issue tokens, but if it chooses to do so, the investor is entitled to a predefined allocation. The crux of a TWA lies in determining the share of tokens owed to the investor. These shares usually oscillate between two benchmarks: (1) a share corresponding to the number of common or preferred stock in the company’s capital, and (2) 20-30% of the said equity share.

For instance, if an investor is entitled to 5% of shares via SAFE, then upon token issuance, the investor would receive between 1% and 5% of the total token issuance. More often than not, the allocated proportion tends towards the lower end of this range.

In TWAs, this stipulation is referred to as the Holder’s Portion and is articulated as follows:

As Degoverned, you can generate and download a simple TWA template that can be used as a starting point.

Besides SAFT and TWA, there exist Token Sale Agreements (TSA), albeit less frequently. Here’s how these instruments interrelate:

5. How to Issue Tokens Publicly?

The era of wild ICOs is undoubtedly a thing of the past. However, this doesn’t imply that crypto startups have ceased issuing tokens to a broad audience. Nowadays, public token issuance either takes place through a sale on a launchpad or via an airdrop.

In the former scenario, the project sells tokens in exchange for cryptocurrency, thereby raising funds for development. In the latter, tokens are distributed free of charge* and are allocated to early users.

However, sometimes it’s not entirely accurate to label airdrops as "free of charge," given that users invest their time and attention, which can indeed be quantified monetarily and carries tangible value for the project. As a matter of fact, the US regulator clarified this by stating that airdrops may constitute the sale of securities in return for users’ marketing efforts.

Most public token sales are conducted via specific platforms known as launchpads, with Coinlist being the most notable. Launchpads undertake a host of crucial tasks, ranging from vetting projects and investors to facilitating subsequent token listings on exchanges. Moreover, launchpads offer assistance with the legal structuring of the transaction.

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That’s all for now. Stay tuned for future articles delving into the legal aspects of NFTs, regulatory risks, taxes, exchange listings, and other intricacies of launching crypto startups. If you’re eager to learn more about these topics right away, consider following Degoverned on Telegram or Twitter.