PART
I
ITEM
1. BUSINESS
GLOSSARY
OF DEFINED TERMS
In
this Annual Report, each of the following quoted terms has the meanings set forth after such term:
“bitcoin”
— A type of a Digital Asset based on an open source math-based protocol existing on the Bitcoin Network and utilizing cryptographic
security.
“Bitcoin
Exchange”— An electronic marketplace where exchange participants may trade, buy and sell bitcoins based on bid-ask
trading. The largest Bitcoin Exchanges are online and typically trade on a 24-hour basis, publishing transaction price and volume
data.
“Bitcoin
Exchange Market” — The global bitcoin exchange market for the trading of bitcoins, which consists of transactions
on electronic Bitcoin Exchanges.
“Bitcoin
Network” — The online, end-user-to-end-user network hosting the public transaction ledger, known as the Blockchain,
and the source code comprising the basis for the math-based protocols and cryptographic security governing the Bitcoin Network.
“Blockchain”
— The public transaction ledger of the Bitcoin Network on which miners or mining pools solve algorithmic equations allowing
them to add records of recent transactions (called “blocks”) to the chain of transactions in exchange for an award
of bitcoins from the Bitcoin Network and the payment of transaction fees, if any, from users whose transactions are recorded in
the block being added.
“CEA”
— Commodity Exchange Act of 1936, as amended.
“CFTC”
— The US Commodity Futures Trading Commission, an independent agency with the mandate to regulate commodity futures and
option markets in the United States.
“Code”
— The US Internal Revenue Code of 1986, as amended.
“Digital
Asset” — Collectively, all digital assets based upon a computer-generated math-based and/or cryptographic protocol
that may, among other things, be used to buy and sell goods or pay for services. Bitcoins represent one type of Digital Asset.
“DDoS
Attack” — Distributed denial of service attacks are coordinated hacking attempts to disrupt websites, web servers
or computer networks in which an attacker bombards an online target with a large quantity of external requests, thus precluding
the target from processing requests from genuine users.
“Exchange
Act” — The Securities Exchange Act of 1934, as amended.
“FDIC”
— The Federal Deposit Insurance Corporation.
“FinCEN”
— The Financial Crimes Enforcement Network, a bureau of the US Department of the Treasury.
“FINRA”
— The Financial Industry Regulatory Authority, Inc., which is the primary regulator in the United States for broker-dealers.
“Fiat
Currency” — Currency that a government has declared to be legal tender, but is not backed by a physical commodity.
The value of fiat money is derived from the relationship between supply and demand rather than the value of the material that
the money is made of.
“IRS”
— The US Internal Revenue Service, a bureau of the US Department of the Treasury.
“Mining”
— The process by which Bitcoins are created involving programmers solving complex math problems with the computers in the
Bitcoin Network.
“SEC”
— The US Securities and Exchange Commission.
“Securities
Act” — The Securities Act of 1933, as amended.
“SIPC”
— The Securities Investor Protection Corporation.
“Transaction
Verification Services” — Is equivalent to Mining
INTRODUCTION
We
are an early entrant in the Digital Asset market and one of the first U.S. publicly traded companies to be involved with Digital
Assets and blockchain technologies.
OUR
BUSINESS
Subject
to additional financing, the Company plans to create a portfolio of digital assets including bitcoin and other “protocol
tokens” to provide investors a diversified pure-play exposure to the bitcoin and blockchain industries. The Company intends
to acquire digital assets through: open market purchases, participating in initial digital asset offerings (often referred to
as initial coin offerings). Additionally, the Company may acquire digital assets by resuming its transaction verification services
business through outsourced data centers and earning rewards in digital assets by securing their respective blockchains.
Digital
asset blockchains are typically maintained by a network of participants which run servers which secure their blockchain. The market
is rapidly evolving and there can be no assurances that we will remain competitive with industry participants that have or may
have greater resources than us.
Blockchain
Technology and Digital Asset Initiatives
We
are also focused on digital assets and blockchain technologies. Subject to additional financing, we plan to continue to evaluate
other strategic opportunities in this rapidly evolving sector in an effort to enhance shareholder value.
Transaction
Verification Service Business (digital asset mining e.g. bitcoin, Suspended)
We
believe that with additional funding we may be able to resume our transaction verification services business (digital asset mining
e.g. bitcoin) and believe this may provide revenue growth. If we are successful in resuming our transaction verification services
business, we anticipate utilizing outsourced data centers and may diversify operations by securing other blockchains in addition
to bitcoins blockchain.
Transaction
verification entails running ASIC (application-specific integrated circuit) servers or other specialized servers which solve a
set of prescribed complex mathematical calculations in order to add a block to a blockchain and thereby confirm digital asset
transactions. When we are successful in adding a block to the blockchain, we are awarded a fixed number of digital assets for
our effort.
E-commerce
Marketplace (Discontinued)
We
believe our e-commerce marketplace was the first such site to accept bitcoin. However, many new businesses (such as Dell, Microsoft,
Overstock, NewEgg and TigerDirect) opted to accept bitcoin as a form of payment. This posed serious competition for our marketplace
efforts and resulted in reduced consumer interest in our e-commerce marketplace. Although our ecommerce marketplace is still online
we have ceased all development efforts, are no longer marketing it, and do not currently support it.
INDUSTRY
AND MARKET OVERVIEW (BITCOIN AND BLOCKCHAIN TECHNOLOGIES)
Introduction
to Bitcoins and the Bitcoin Network
A
bitcoin is one type of a Digital Asset that is issued by, and transmitted through, an open source, math-based protocol platform
using cryptographic security that is known as the “Bitcoin Network.” The Bitcoin Network is an online, peer-to-peer
user network that hosts the public transaction ledger, known as the “Blockchain,” and the source code that comprises
the basis for the cryptography and math-based protocols governing the Bitcoin Network. No single entity owns or operates the Bitcoin
Network, the infrastructure of which is collectively maintained by a decentralized user base. Bitcoins can be used to pay for
goods and services or can be converted to fiat currencies, such as the US Dollar, at rates determined on Bitcoin Exchanges or
in individual end-user-to-end-user transactions under a barter system.
Bitcoins
are “stored” or reflected on the digital transaction ledger known as the “Blockchain,” which is a digital
file stored in a decentralized manner on the computers of each Bitcoin Network user. The Blockchain records the transaction history
of all bitcoins in existence and, through the transparent reporting of transactions, allows the Bitcoin Network to verify the
association of each bitcoin with the digital wallet that owns them. The Bitcoin Network and Bitcoin software programs can interpret
the Blockchain to determine the exact bitcoin balance, if any, of any digital wallet listed in the Blockchain as having taken
part in a transaction on the Bitcoin Network.
The
Blockchain is comprised of a digital file, downloaded and stored, in whole or in part, on all bitcoin users’ software programs.
The file includes all blocks that have been solved by miners and is updated to include new blocks as they are solved. As each
newly solved block refers back to and “connects” with the immediately prior solved block, the addition of a new block
adds to the Blockchain in a manner similar to a new link being added to a chain. Each new block records outstanding bitcoin transactions,
and outstanding transactions are settled and validated through such recording, the Blockchain represents a complete, transparent
and unbroken history of all transactions on the Bitcoin Network.
The
Bitcoin Network is decentralized and does not rely on either governmental authorities or financial institutions to create, transmit
or determine the value of bitcoins. Rather, bitcoins are created and allocated by the Bitcoin Network protocol through a “mining”
process subject to a strict, well-known issuance schedule. The value of bitcoins is determined by the supply of and demand for
bitcoins in the Bitcoin Exchange Market (and in private end-user-to-end-user transactions), as well as the number of merchants
that accept them. As bitcoin transactions can be broadcast to the Bitcoin Network by any user’s bitcoin software and bitcoins
can be transferred without the involvement of intermediaries or third parties, there are little or no transaction costs in direct
peer-to-peer transactions on the Bitcoin Network. Third party service providers such as Bitcoin Exchanges and bitcoin third party
payment processing services may charge significant fees for processing transactions and for converting, or facilitating the conversion
of, bitcoins to or from fiat currency.
Overview
of the Bitcoin Network’s Operations
In
order to own, transfer or use bitcoins, a person generally must have Internet access to connect to the Bitcoin Network. Bitcoin
transactions between parties occur very rapidly (within several seconds) and may be made directly between end-users without the
need for a third-party intermediary, although there are entities that provide third-party intermediary services. To prevent the
possibility of double-spending a single bitcoin, a user must notify the Bitcoin Network of the transaction by broadcasting the
transaction data to its network peers. The Bitcoin Network provides confirmation against double-spending by memorializing every
transaction in the Blockchain, which is publicly accessible and transparent. This memorialization and verification against double-spending
is accomplished through the bitcoin mining process, which adds “blocks” of data, including recent transaction information,
to the Blockchain.
Brief
Description of Bitcoin Transfers
Prior
to engaging in bitcoin transactions, a user generally must first install on its computer or mobile device a bitcoin software program
that will allow the user to generate a digital “wallet” (analogous to a bitcoin account). Alternatively, a user may
retain a third party to create a digital wallet to be used for the same purpose. Each such wallet includes one or more unique
digital addresses and verification system consisting of a “public key” and a “private key,” which are
mathematically related.
In
a bitcoin transaction, the bitcoin recipient must provide its digital address, which serves as a routing number to the recipient’s
digital wallet on the Blockchain, to the party initiating the transfer. The recipient, however, does not make public or provide
to the sender its related private key. The payor, or “spending” party, does reveal its public key in signing and verifying
its spending transaction to the Blockchain.
Neither
the recipient nor the sender reveal their digital wallet’s private key in a transaction, because the private key authorizes
access to, and transfer of, the funds in that digital wallet to other users. In the data packets propagated from a user’s
bitcoin software program onto the Bitcoin Network to allow transaction confirmation, the sending party must “sign”
its transaction with a data code derived from entering the private key into a “hashing algorithm.” The hashing algorithm
converts the private key into a digital signature, which signature serves as validation that the transaction has been authorized
by the holder of the digital wallet’s private key.
Transaction
Verification (Bitcoin Mining) & Creation of New Bitcoins
Transaction
Verification Process (Mining Process)
The
process by which bitcoins are “mined” results in new blocks being added to the Blockchain and new bitcoins being issued
to the miners. Miners engage in a set of prescribed complex mathematical calculations in order to add a block to the Blockchain
and thereby confirm bitcoin transactions included in that block’s data. Miners that are successful in adding a block to
the Blockchain are automatically awarded a fixed number of bitcoins for their effort; we also refer to this process of receiving
the aforementioned award as transaction verification services. This reward system is the method by which new bitcoins enter into
circulation to the public and is accomplished in the added block through the notation of the new bitcoin creation and their allocation
to the successful miner’s digital wallet. To begin mining, a user can download and run Bitcoin Network mining software,
which, like regular Bitcoin Network software programs, turns the user’s computer into a “node” on the Bitcoin
Network that validates blocks.
All
bitcoin transactions are recorded in blocks added to the Blockchain. Each block contains the details of some or all of the most
recent transactions that are not memorialized in prior blocks, a reference to the most recent prior block, and a record of the
award of bitcoins to the miner who added the new block. In order to add blocks to the Blockchain, a miner must map an input data
set (i.e., a reference to the immediately preceding block in the Blockchain, plus a block of the most recent Bitcoin Network transactions
and an arbitrary number called a “nonce”) to a desired output data set of predetermined length (“hash value”)
using the SHA-256 cryptographic hash algorithm. To “solve” or “calculate” a block, a miner must repeat
this computation with a different nonce until the miner generates a SHA-256 hash of a block’s header that has a value less
than or equal to the current target set by the Bitcoin Network. Each unique block can only be solved and added to the Blockchain
by one miner; therefore, all individual miners and mining pools on the Bitcoin Network are engaged in a competitive process and
are incentivized to increase their computing power to improve their likelihood of solving for new blocks.
The
cryptographic hash function that a miner uses is one-way only and is, in effect, irreversible: hash values are easy to generate
from input data (i.e., valid recent network transactions, Blockchain and nonce), but neither a miner nor participant is able to
determine the original input data solely from the hash value. As a result, generating a new valid block with a header less than
the target prescribed by the Bitcoin Network is initially difficult for a miner, yet other nodes can easily confirm a proposed
block by running the hash function just once with the proposed nonce and other input data. A miner’s proposed block is added
to the Blockchain once a majority of the nodes on the Bitcoin Network confirms the miner’s work, and the miner that solved
such block receives the reward of a fixed number of bitcoins (plus any transaction fees paid by transferors whose transactions
are recorded in the block). Therefore, “hashing” is akin to a mathematical lottery, and miners that have devices with
greater processing power (i.e., the ability to make more hash calculations per second) are more likely to be successful miners
because they can generate more hashes or “entries” into that lottery.
As
more miners join the Bitcoin Network and its processing power increases, the Bitcoin Network automatically adjusts the complexity
of the block-solving equation in an effort to set distribution such that newly-created blocks will be added to the Blockchain,
on average, approximately every ten minutes. Processing power is added to the Bitcoin Network at irregular rates that have grown
rapidly from early 2013 through 2016.
Incentives
for Transaction Verification (Mining)
Miners
dedicate substantial resources to mining. Given the increasing difficulty of the target established by the Bitcoin Network, current
miners must invest in expensive mining devices with adequate processing power to hash at a competitive rate. The first mining
devices were standard home computers; however, mining computers are currently designed solely for mining purposes. Such devices
included ASIC machines built by specialized companies like BitFury, Bitmain Technologies, 21 Inc., Avalon, and BW. Miners also
incur substantial electricity costs in order to continuously power and cool their devices while solving for a new block.
The
Bitcoin Network is designed in such a way that the reward for adding new blocks to the Blockchain decreases over time and the
production (and reward) of bitcoins will eventually cease. Once such reward ceases, it is expected that miners will demand compensation
in the form of transaction fees to ensure that there is adequate incentive for them to continue mining. The amount of transaction
fees will be based upon the structural requirements necessary to provide sufficient revenue to incentivize miners, as counterbalanced
by the need to retain sufficient bitcoin users (and transactions) to make mining profitable.
Though
not free from doubt, bitcoin industry participants have expressed a belief that transaction fees would be enforced through (i)
mining operators collectively refusing to record transactions that do not include a payment of a transaction fee or (ii) the updating
of bitcoin software to require a minimum transaction fee payment. Under a regime whereby large miners require fees to record transactions,
a transaction where the spending party did not include a payment of transaction fees would not be recorded on the Blockchain until
a miner who does not require transaction fees solves for a new block (thereby recording all outstanding transaction records for
which it has received data). If popular bitcoin software for digital wallets were to require a minimum transaction fee, users
of such programs would be required to include such fees; however, because of the open-source nature of the Bitcoin Network, there
may be no way to require that all digital wallets include minimum transaction fees for spending transactions. Alternatively, a
future Bitcoin Network software update could simply build a small transaction fee payment into all spending transactions (e.g.,
by deducting a fractional number of bitcoins from all transactions on the Bitcoin Network as transaction fees).
The
Bitcoin Network protocol already includes transaction fee rules and the mechanics for awarding transaction fees to the miners
that solve for blocks in which the fees are recorded; however, users currently may opt not to pay transaction fees (depending
on the bitcoin software they use) and miners may choose not to enforce the transaction fee rules since, at present, the bitcoin
rewards are far more substantial than transaction fees. On June 8, 2017, transaction fees accounted for approximately 0.91 percent
of miners’ total revenue, though the percentage of revenue represented by transaction fees is not static and fluctuates
based on the number of transactions for which sending users include transaction fees, the levels of those transaction fees and
the number of transactions a miner includes in its solved blocks. Typically, transactions do not have difficulty being recorded
if transaction fees are not included.
Mining
Pools
The
Bitcoin Network’s mining protocol was created in a manner to make it more difficult to solve for new blocks as the processing
power dedicated to mining increases (in order to maintain the 10 minute per block solution time average). Therefore, the difficulty
of finding a valid hash value has grown exponentially since the first blocks were mined. Currently, the likelihood that an individual
acting alone will be able to mine bitcoins is extremely low. As a result, mining “pools” have developed in which multiple
miners act cohesively and combine their processing power to solve blocks. When a pool solves a new block, the participating mining
pool members split the resulting reward based on the processing power they each contributed to solve for such block. Mining pools
provide participants with access to smaller, but steadier and more frequent, bitcoin payouts. The Company monitors the Blockchain
network and, based on the information we collected from our network access, as of June 8, 2017, the largest three mining pools
were, AntPool, BTC.TOP, and an unknown pool, which, when aggregated, represented approximately 40.5 percent of the processing
power on the Bitcoin Network (as calculated by determining the percentage of blocks mined by each such pool over the prior month).
Mathematically
Controlled Supply
The
method for creating new bitcoins is mathematically controlled in a manner so that the supply of bitcoins grows at a limited rate
pursuant to a pre-set schedule. The number of bitcoins awarded for solving a new block is automatically halved every 210,000 blocks.
Thus, the current fixed reward for solving a new block is 12.5 bitcoins per block and the reward will decrease by half to become
6.25 bitcoins around June 2020 (based on estimates of the rate of block solution calculated by BitcoinClock.com). This deliberately
controlled rate of bitcoin creation means that the number of bitcoins in existence will never exceed 21 million and that bitcoins
cannot be devalued through excessive production unless the Bitcoin Network’s source code (and the underlying protocol for
bitcoin issuance) is altered. The Company monitors the Blockchain network and, as of June 8, 2017, based on the information we
collected from our network access 16,380,000 bitcoins have been mined.
Modifications
to the Bitcoin Protocol
Bitcoin
is an open source project (i.e., a product whose source code is freely available to the public and that utilizes crowdsourcing
to identify possible issues, problems and defects) and there is no official developer or group of developers that controls the
Bitcoin Network. The Bitcoin Network’s development is overseen by a core group of developers, which varies from time to
time (“Core Developers”). The Core Developers are able to access and can propose alterations to the Bitcoin Network
source code hosted on GitHub, an online service and forum used to share and develop open source code. Other programmers have access
to and can propose changes to the bitcoin source code on GitHub, but the Core Developers have an elevated level of influence over
the process. As a result, the Core Developers are responsible for quasi-official releases of updates and other changes to the
Bitcoin Network’s source code. Users and miners must accept any changes made to the Bitcoin Network (including those proposed
by the Core Developers) by downloading the proposed modification of the source code.
A
modification of the source code is only effective with respect to the bitcoin users and miners that download it. Consequently,
as a practical matter, a modification to the source code (e.g., a proposal to increase the 21 million total limit on bitcoins
or to reduce the average confirmation time target from 10 minutes per block) only becomes part of the Bitcoin Network if accepted
by participants collectively having a substantial majority of the processing power on the Bitcoin Network. If a modification is
accepted only by a percentage of users and miners, a division in the Bitcoin Network will occur such that one network will run
the pre-modification source code and the other network will run the modified source code; such a division is known as a “fork”
in the Bitcoin Network. It should be noted that, although their power to amend the source code is effectively subject to the approval
of users and miners, the Core Developers have substantial influence over the development of the Bitcoin Network and the direction
of the bitcoin community.
Other
Blockchain Technologies
Core
Development of the bitcoin source code has increasingly focused on modifications of the bitcoin protocol to allow non-financial
and next generation uses (sometimes referred to as Bitcoin 2.0 projects). These uses include smart contracts and distributed registers
built into, built atop or pegged alongside the Blockchain. For example, the white paper for Blockstream, a program of which Core
Developers Jeff Garzik and Gregory Maxwell are a part, calls for the use of “pegged sidechains” to develop programming
environments that are built within block chain ledgers that can interact with and rely on the security of the Bitcoin Network
and Blockchain, while remaining independent thereof. We are actively evaluating other Blockchain technologies that relate
to Bitcoin 2.0 projects. At this time, Bitcoin 2.0 projects remain in early stages and have not been materially integrated into
the Blockchain or Bitcoin Network.
Bitcoin
Value
Bitcoins
are an example of a Digital Asset that is not a fiat currency (i.e., a currency that is backed by a central bank or a national,
supra-national or quasi-national organization) and are not backed by hard assets or other credit. As a result, the value of bitcoins
is determined by the value that various market participants place on bitcoins through their transactions.
Exchange
Valuation
Due
to the peer-to-peer framework of the Bitcoin Network and the protocols thereunder, transferors and recipients of bitcoins are
able to determine the value of the bitcoins transferred by mutual agreement or barter with respect to their transactions. As a
result, the most common means of determining the value of a bitcoin is by surveying one or more Bitcoin Exchanges where bitcoins
are publicly bought, sold and traded (i.e., the Bitcoin Exchange Market).
On
each Bitcoin Exchange, bitcoins are traded with publicly disclosed valuations for each transaction, measured by one or more fiat
currencies such as the US Dollar, the Euro or the Chinese Yuan. Bitcoin Exchanges typically report publicly on their site the
valuation of each transaction and bid and ask prices for the purchase or sale of bitcoins. Although each Bitcoin Exchange has
its own market price, it is expected that most Bitcoin Exchanges’ market prices should be relatively consistent with the
Bitcoin Exchange Market average since market participants can choose the Bitcoin Exchange on which to buy or sell bitcoins ( i.e.
, exchange shopping). Arbitrage between the prices on various Bitcoin Exchanges is possible, but the imposition of fees and fiat
currency deposit/withdrawal policies appears to have, at times, prevented an active arbitrage mechanism among users on some Bitcoin
Exchanges. For example, delayed fiat currency withdrawals imposed by Mt. Gox resulted in Mt. Gox trading at a premium of up to
10 to 20 percent for several months through January 2014. In February 2014, Mt. Gox suspended trading, closed its website and
exchange service, and filed for a form of bankruptcy protection from creditors called minjisaisei, or civil rehabilitation, to
allow courts to seek a buyer. In April 2014, Mt. Gox began liquidation proceedings.
Even
in the absence of large trading fees and fiat currency deposit/withdrawal policies, price differentials across Bitcoin Exchanges
remain.
Forms
of Attack Against the Bitcoin Network
Exploitation
of Flaws in the Bitcoin Network’s Source Code
As
with any other computer code, the Bitcoin Network source code may contain certain flaws. Several errors and defects have been
found and corrected, including those that disabled some functionality for users, exposed users’ information, or allowed
users to create multiple views of the Bitcoin Network. Such flaws have been discovered and quickly corrected by the Core Developers
or the bitcoin community, thus demonstrating one of the advantages of open source codes that are available to the public: open
source codes rely on transparency to promote community-sourced identification and solution of problems within the code.
Reports
of flaws in or exploitations of the source code that allow malicious actors to take or create money in contravention of known
Bitcoin Network rules have been exceedingly rare. For example, in 2010, a hacker or group of hackers exploited a flaw in the Bitcoin
Network source code that allowed them to generate 184 billion bitcoins in a transaction and send them to two digital wallet addresses.
However, the bitcoin community and developers identified and reversed the manipulated transactions within approximately five hours,
and the flaw was corrected with an updated version of the bitcoin protocol. Another addressed issue with the Bitcoin Network source
code, “transaction malleability” was addressed by the Core Developers in a March 2013 software update. The Core Developers,
in conjunction with other developers and miners, work continuously to ensure that flaws are quickly fixed or removed.
Greater
than Fifty Percent of Network Computational Power
Malicious
actors can structure an attack whereby such actor gains control of more than half of the Bitcoin Network’s processing power
or “hashrate.” Computer scientists and cryptographers believe that the immense collective processing power of the
Bitcoin Network makes it impracticable for an actor to gain control of computers representing a majority of the processing power
on the Bitcoin Network. During May and June 2014, mining pool GHash.io’s hashing power approached 50 percent of the processing
power on the Bitcoin Network. During a brief period in early June 2014, the mining pool may have controlled in excess of one-half
of the Bitcoin Network’s processing power. Although no malicious activity or abnormal transaction recording was observed,
the incident establishes that it is possible that a substantial mining pool may accumulate close to or more than a majority of
the processing power on the Bitcoin Network. As of June 5, 2017, no single pool controlled more than twenty one percent of the
total processing power.
If
a malicious actor acquired sufficient computational power necessary to control the Bitcoin Network (which amount would be well
in excess of fifty percent), it would be able to engage in double-spending, or prevent some or all transactions from being confirmed,
and prevent some or all other miners from mining any valid new blocks. The malicious actor or group of actors, however, would
not be able to reverse other people’s transactions, change the fixed number of bitcoins generated per new block, or transfer
previously existing bitcoins that belong to other users.
Cancer
Nodes
This
form of attack involves a malicious actor propagating “cancer nodes” to isolate certain users from the legitimate
Bitcoin Network. A target user functionally surrounded by cancer nodes would be put on a separate “network,” allowing
the malicious actor to relay only blocks created by the separate network and thus opening the target user to double-spending attacks.
By using cancer nodes, a malicious actor also can disconnect the target user from the bitcoin economy entirely by refusing to
relay any blocks or transactions. Bitcoin software programs make these attacks more difficult by limiting the number of outbound
connections through which users are connected to the Bitcoin Network.
Manipulating
Blockchain Formation
A
malicious actor may attempt to double-spend bitcoins by manipulating the formation of the Blockchain rather than through control
of the Bitcoin Network. In this type of attack, a miner creates a valid new block containing a double-spend transaction and schedules
the release of such attack block so that it is added to the Blockchain before a target user’s legitimate transaction can
be included in a block. Variations of this form of attack include the “Finney attack,” “race attack,”
and “vector76 attack.” All double-spend attacks require that the miner sequence and execute the steps of its attack
with sufficient speed and accuracy. Users and merchants can dramatically reduce the risk of a double-spend attack by waiting for
multiple confirmations from the Bitcoin Network before settling a transaction. The Bitcoin Network still may be used to execute
instantaneous, low-value transactions without confirmation to the extent the recipient of bitcoins determines that a malicious
miner would be unwilling to carry out a double-spend attack for low-value transactions because the reward from mining would be
higher than the small profit gained from double-spending. Users and merchants can take additional precautions by adjusting their
Bitcoin Network software programs to connect only to other well-connected nodes and to disable incoming connections. These precautions
reduce the risk of double-spend attacks involving manipulation of a target’s connectivity to the Bitcoin Network (as is
the case with vector76 and race attacks).
Historical
Chart of the Price of Bitcoins, 2016-2017
The
price of bitcoins is volatile and fluctuations are expected. Movements may be influenced by various factors, including, but not
limited to, government regulation, security breaches experienced by service providers, as well as political and economic uncertainties
around the world. Since our Transaction Verification Services business records revenue based on the price of earned bitcoins and
we may retain such bitcoins as an asset or as payment for future expenses, the relative value of such revenues may fluctuate,
as will the value of any bitcoins we retain. The following chart illustrates the fluctuating value of the US Dollar exchange rate
for bitcoins for the one-year period ending June 5, 2017, as reported by Blockchain.info:
Uses
of Bitcoins
Global
Bitcoin Market
Global
trade in bitcoins consists of individual end-user-to-end-user transactions, together with facilitated exchange-based bitcoin trading.
A limited market currently exists for bitcoin-based derivatives. There is currently no reliable data on the total number or demographic
composition of users or miners on the Bitcoin Network.
Goods
and Services
Bitcoins
also can be used to purchase goods and services, either online or at physical locations, although reliable data is not readily
available about the retail and commercial market penetration of the Bitcoin Network. In addition to our Company in January 2014,
US national online retailers Overstock.com and TigerDirect began accepting bitcoin payments. Over the course of 2014, computer
hardware and software company Microsoft began accepting bitcoins as online payment for certain digital content, online retailer
NewEgg began accepting bitcoins, and computer hardware company Dell began accepting bitcoins. There are thousands of additional
online merchants that accept bitcoins, and the variety of goods and services for which bitcoins can be exchanged is increasing.
Currently, local, regional and national businesses, including Time Inc., Wikimedia, WordPress, Expedia and Foodler, accept bitcoin.
Bitcoin service providers such as BitPay, Coinbase and GoCoin and online gift card retailer Gyft provide other means to spend
bitcoin for goods and services at additional retailers. There are also many real-world locations that accept bitcoin throughout
the world. In 2014, payments giant PayPal announced a partnership with BitPay, Coinbase and GoCoin to expand their bitcoin-related
services to PayPal’s merchant customers, thereby significantly expanding the reach of bitcoin-accepting merchants. To date,
the rate of consumer adoption and use of bitcoin in paying merchants has trailed the broad expansion of retail and commercial
acceptance of bitcoin. Nevertheless, there will likely be a strong correlation between continued expansion of the Bitcoin Network
and its retail and commercial market penetration.
Anonymity
and Illicit Use
The
Bitcoin Network was not designed to ensure the anonymity of users, despite a common misperception to the contrary. All bitcoin
transactions are logged on the Blockchain and any individual or government can trace the flow of bitcoins from one address to
another. Off-Blockchain transactions occurring off the Bitcoin Network are not recorded and do not represent actual bitcoin transactions
or the transfer of bitcoins from one digital wallet address to another, though information regarding participants in an Off-Blockchain
transaction may be recorded by the parties facilitating such Off-Blockchain transactions. Digital wallet addresses are randomized
sequences of 27-34 alphanumeric characters that, standing alone, do not provide sufficient information to identify users; however,
various methods may be used to connect an address to a particular user’s identity, including, among other things, simple
Internet searching, electronic surveillance and statistical network analysis and data mining. Anonymity is also reduced to the
extent that certain Bitcoin Exchanges and other service providers collect users’ personal information, because such Bitcoin
Exchanges and service providers may be required to produce users’ information in order to comply with legal requirements.
In many cases, a user’s own activity on the Bitcoin Network or on Internet forums may reveal information about the user’s
identity.
Users
may take certain precautions to enhance the likelihood that they and their transactions will remain anonymous. For instance, a
user may send its bitcoins to different addresses multiple times to make tracking the bitcoins through the Blockchain more difficult
or, more simply, engage a so-called “mixing” or “tumbling” service to switch its bitcoins with those of
other users. However, these precautions do not guarantee anonymity and are illegal to the extent that they constitute money laundering
or otherwise violate the law.
As
with any other asset or medium of exchange, bitcoins can be used to purchase illegal goods or fund illicit activities. For example,
Silk Road, an anonymous online marketplace that sold illegal substances prior to its seizure and the arrest of its founder and
operator in October 2013, accepted only bitcoins. The use of bitcoins for illicit purposes, however, is not promoted by the Bitcoin
Network or the user community as a whole. Furthermore, we do not believe our ecommerce platform, which we no longer support or
are developing, has exposure to such uses because the products sold in our marketplace were curated by our management and the
sellers of those products are big box retailers with credible products and retail operations.
Alternative
Digital Assets
Bitcoins
are not the only type of Digital Assets founded on math-based algorithms and cryptographic security, although it was considered
the most prominent as of June 5, 2017. Over 700 other Digital Assets, (commonly referred to as “altcoins”, “tokens”,
“protocol tokens”, or “digital assets”), have been developed since the Bitcoin Network’s inception,
including Ethereum, Ripple, Litecoin, Dash, and Monero. The Bitcoin Network, however, possesses the “first-to-market”
advantage and thus far has captured the majority of the industry’s market share and is secured by a mining network with
significantly more processing power than that of any other Digital Asset.
GOVERNMENT
OVERSIGHT
The
Bitcoin Network is a recent technological innovation and the regulatory schemes to which bitcoin and the Bitcoin Network may be
subject have not been fully explored or developed. For example, the SEC has yet to issue an official statement describing how
it will treat bitcoin for a variety of regulatory purposes, and the CFTC, despite issuing a settlement order determining that
bitcoin is a commodity, has not adopted a policy statement or rule delineating its treatment of bitcoin.
Until
February 2014, the only U.S. federal regulator to release official guidance on bitcoin and the Bitcoin Network was FinCEN, a bureau
of the U.S. Department of the Treasury responsible for the federal regulation of currency market participants. On March 18th,
2013, FinCEN issued interpretive guidance relating to the application of the Bank Secrecy Act to distributing, exchanging and
transmitting “virtual currencies.” More specifically, it determined that a Bitcoin user will not be considered a money
service business (“MSB”) or be required to register, report and perform recordkeeping; however, an administrator or
exchanger of bitcoin must be a registered money services business under FinCEN’s money transmitter regulations. As a result,
Bitcoin Exchanges that deal with U.S. residents or otherwise fall under U.S. jurisdiction are required to obtain licenses and
comply with FinCEN regulations. FinCEN released additional guidance on January 30, 2014, April 29, 2014, October 27, 2014 and
August 14, 2015, clarifying that most miners, software developers, hardware manufacturers, escrow service providers and investors
in bitcoin would not be required to register with FinCEN on the basis of such activity alone, but that Bitcoin Exchanges, payment
processors and convertible Digital Asset administrators would likely be required to register with FinCEN on the basis of the activities
described in the October 2014 and August 2015 letters.
Although
the SEC has not opined on the legal characterization of bitcoin as a security, it has taken various actions against persons or
entities misusing bitcoin in connection with fraudulent schemes (i.e., Ponzi schemes), inaccurate and inadequate publicly disseminated
information, and the offering of unregistered securities. Clarity regarding the treatment of bitcoin was obtained on September
17, 2015, when the CFTC instituted and settled the
Coinflip
case. The
Coinflip
order found that the respondents
(i) conducted activity related to commodity options transactions without complying with the provisions of the CEA and CFTC regulations,
and (ii) operated a facility for the trading of swaps without registering the facility as a SEF or DCM. The
Coinflip
order
was significant as it is the first time the CFTC determined that bitcoin and other virtual currencies are properly defined as
commodities under the CEA. Based on this determination, the CFTC applied CEA provisions and CFTC regulations that apply to transactions
in commodity options and swaps to the conduct of the bitcoin derivatives trading platform. Also of significance, is that the CFTC
appears to have taken the position that bitcoin is not encompassed by the definition of currency under the CEA and CFTC regulations.
The CFTC defined bitcoin and other “virtual currencies” as “a digital representation of value that functions
as a medium of exchange, a unit of account, and/or a store of value, but does not have legal tender status in any jurisdiction.
Bitcoin and other virtual currencies are distinct from ‘real’ currencies, which are the coin and paper money of the
United States or another country that are designated as legal tender, circulate, and are customarily used and accepted as a medium
of exchange in the country of issuance.”
The
CFTC affirmed its approach to the regulation of bitcoin and bitcoin-related enterprises on June 2, 2016, when the CFTC settled
charges against Bitfinex, a Bitcoin Exchange based in Hong Kong. In its Order, the CFTC found that Bitfinex engaged in “illegal,
off-exchange commodity transactions and failed to register as a futures commission merchant” when it facilitated borrowing
transactions among its users to permit the trading of bitcoin on a “leveraged, margined or financed basis” without
first registering with the CFTC.
On
March 25, 2014, the IRS released guidance on the treatment of virtual convertible currencies, such as bitcoin, for U.S. federal
income tax purposes. The guidance, the first issued by a U.S. government agency regarding the asset classification of bitcoin,
classified bitcoin as “property” that it is not currency for U.S. federal income tax purposes. The guidance clarified
that bitcoin could be held as capital assets and that holders of bitcoin were required to track gains and losses relating to their
cost basis at acquisition and their amount realized upon sale or other disposition of the bitcoin. The IRS also clarified that
bitcoin received as payment (e.g., as wages or, in the case of a miner, as a reward for solving a block) is included in the recipient’s
taxable income based on the fair market value of bitcoin when received. The IRS may revisit its treatment of Digital Assets, including
seeking enforcement of existing guidance or issuing new guidance, in response to recommendations in a September 2016 report by
the U.S. Treasury Inspector General for Tax Administration.
31
The asset classification of bitcoin by the IRS is not
controlling on other government agencies for purposes other than those relating to U.S. federal income tax.
On
June 26, 2014, the U.S. Government Accountability Office publicly released a report to the Committee on Homeland Security
and Government Affairs that summarized regulatory, law enforcement and consumer protection assessments regarding the Bitcoin economy
and Bitcoin in general. The report recommended that the U.S. Consumer Financial Protection Bureau participate in inter-agency
working groups on Bitcoin to assess how the agency might address Bitcoin-related consumer protection issues. The report echoed,
in part, a May 7, 2014 investor alert published by the SEC that highlighted fraud and other concerns relating to certain investment
opportunities denominated in bitcoin and fraudulent and unregistered investment schemes targeted at participants in online Bitcoin
forums. In the fall of 2014, the SEC is reported to have initiated an inquiry into the sale of unregistered securities denominated
in bitcoin or altcoins, and into the sale of “crypto-equity” (i.e., tokens for use on altcoin programming platforms),
although the Company has not verified the scope or veracity of such reports due to the confidentiality of such inquiries.
As
of April 2016, the U.S. Congress, U.S. Senate Committee on Homeland Security and Government Affairs, U.S. Senate Committee on
Banking, Housing and Urban Affairs, the CFTC, the New York State Department of Financial Services (“NYSDFS”),
and the Conference of State Bank Supervisors had initiated formal inquiries into or held hearings on Digital Assets, including
bitcoin, and possible regulation thereof. Members of the private sector and representatives of the Department of Justice, Secret
Service and FinCEN (among other government agencies) had participated in such inquiries and hearings.
U.S.
state regulators, including the California Department of Financial Institutions, NYSDFS, Virginia Corporation Commission, Idaho
Department of Financial Services and Washington State Department of Financial Institutions, have similarly released interpretations
or mandates that Bitcoin Exchanges and similar Bitcoin service providers register on a state-level as MTs or MSB. In June 2014,
the State of California adopted legislation that would formally repeal laws that could be interpreted as making illegal the use
of bitcoin or other Digital Assets as a means of payment. In February 2015, a bill was introduced in the California State Assembly
to establish a licensing regime for businesses engaging in virtual currencies. In September 2015, the bill was ordered to become
an inactive file and as of the date of this registration statement there hasn’t been further consideration by the California
State Assembly. As of August 2016, the bill was withdrawn from consideration for vote for the remainder of the year.
In
July 2014, the NYSDFS proposed the first US regulatory framework for licensing participants in “virtual currency business
activity.” The proposed regulations, known as the “BitLicense,” are intended to focus on consumer protection
and, after the closure of an initial comment period that yielded 3,746 formal public comments and a reproposal, the NYSDFS issued
its final “BitLicense” regulatory framework in June 2015. The “BitLicense” regulates the conduct of businesses
that are involved in “virtual currencies” in New York or with New York customers and prohibits any person or entity
involved in such activity to conduct activities without a license. The “BitLicense” requires, among other things,
that licensees are adequately capitalized, maintain detailed books and records, adopt anti-money laundering policies, ensure they
have robust cyber security policies and incorporate a variety of other compliance policies. As of January 2017, the NYSDFS
has granted a “BitLicense” to three (3) market participants.
On
December 16, 2014, the Conference of State Bank Supervisors released for public comment a proposed model regulatory framework
for state regulation of participants in “virtual currency activities.” Although similar in some regards, the proposed
model framework does not track completely the BitLicense regulations in New York. The Conference of State Bank Supervisors proposed
framework is a non-binding model and would have to be independently adopted, in sum or in part, by state legislatures or regulators
on a case-by-case basis. In numerous other states, including Connecticut, North Carolina, New Hampshire and New Jersey, legislation
is being proposed or has been introduced regarding the treatment of bitcoin and other Digital Assets.
In
addition, various foreign jurisdictions may adopt laws, regulations or directives that affect Bitcoin. In October 2012, the European
Central Bank issued a report on “virtual currency” schemes indicating that Bitcoin may become the subject of regulatory
interest in the European Union. In August 2013, the German Ministry of Finance released an interpretation that labeled bitcoin
to be a form of private money or a unit of account that is not recognized as a full currency, but is subject to German tax laws.
A ruling by the Court of Justice of the European Union on October 22, 2015 found that a bitcoin exchange’s trading of bitcoin
for conventional currency (such as Euros or Swedish Krona) and vice versa was subject to value added tax (“VAT”) rules
because it constituted the supply of services for consideration. However, the court also found that bitcoin could qualify for
an exception reserved for transactions related to currency, bank notes, and other legal tender, and thus the bitcoin trading could
be exempted from VAT. The ruling shows that bitcoin tax treatment in the European Union has moved more closely in-line with that
of conventional currency. Foreign government bodies have also initiated public inquiries similar to those taken by US government
bodies, including public hearings on Digital Assets, including bitcoin, held by both the French and Canadian Senates. In October
2015, the European Court of Justice determined that exchanging transactions in Digital Assets are exempt from value-added taxes
in the same manner as traditional currencies. In July 2016, the European Commission released a draft directive that proposed applying
counter-terrorism and anti-money laundering regulations to virtual currencies, and in September 2016, the European Banking authority
advised the European Commission to institute new regulation specific to virtual currencies, with amendments to existing regulation
as a stopgap measure.
On
December 5, 2013, the People’s Bank of China and five Chinese ministries released a notice that restricted Bitcoin activity
among its financial and payment institutions while classifying bitcoin as a “virtual commodity” that was legal to
own and speculate in. Over the subsequent six (6) months, news reports from China indicated that many banking institutions and
third-party payment processors in China had received private guidance leading them to close Bitcoin Exchange bank accounts that
held Chinese Yuan on behalf of exchange customers. As a result, though the Chinese government has not banned the use of bitcoin
or the holding of bitcoin, the effective result of the public and private notices has been to severely restrict the operation
of Chinese Bitcoin Exchanges through the limitation of customers’ ability to deposit or withdraw Chinese Yuan with or from
the exchanges. During the second half of 2014, Chinese Bitcoin Exchanges again began to accept deposits of Chinese Yuan through
the use of third-party payment providers, and trading activity returned to higher levels. In January 2016, the People’s
Bank of China, China’s central bank, disclosed that it has been studying a state-backed electronic monetary system and potentially
had plans for its own state-backed electronic money. In January 2017, the People’s Bank of China announced that it had found
several violations, including margin financing and a failure to impose anti-money laundering controls, after on-site inspections
of two China-based Bitcoin Exchanges. In response to the Chinese regulator’s oversight, the three largest China-based Bitcoin
Exchanges, OKCoin, Huobi, and BTC China, started charging trading commission fees to suppress speculative trading and prevent
price swings which resulted in a significant drop in volume on these exchanges.
In
Russia, state agencies and prosecutors have released guidance or statements that have hampered the growth of Bitcoin. In January
2014, anonymous electronic transfers were restricted to de minimis sums; although Bitcoin transactions are not truly anonymous,
this measure has been taken to apply to the Bitcoin Network. Additionally, a central bank statement warned of the association
of Bitcoin and money laundering and terrorist activity. In early February, a prosecutor implied that the use of Bitcoin and bitcoin
themselves were not legal tender and were illegal, although whether this amounted to a ban on Bitcoin has been questioned. In
April 2016, it was reported that the Russian Finance Ministry was considering proposing regulations that would prohibit the issuance
of all Digital Assets or their use in exchange for goods or services in Russia. However, in July 2016, in a significant change
in tone, the Russian Ministry of Finance indicated it supports a proposed law that bans bitcoin domestically but allows for its
use as a foreign currency.
After
the United States, China and Russia were among the next tier of large Bitcoin-using jurisdictions as of late 2013. The impact
of the restrictions has been seen in a decline of Chinese investment activity in bitcoin and a reduction in the number of Bitcoin
nodes operating in Russia had continued into late 2014, despite a pickup in trading volume on Chinese Bitcoin Exchanges. Less
active Bitcoin jurisdictions in Iceland (conversion between bitcoin and krona prohibited), Vietnam (financial services firms prohibited
from interacting with Bitcoin) and Bolivia (use of bitcoin prohibited by the Central Bank of Bolivia) have more severely restricted
the use of bitcoin with little impact on the global growth of Bitcoin. Similarly, the reported ban on decentralized Digital Assets
in Ecuador (made in advance of plans to introduce a government backed electronic cash system) have had no visible impact on the
Bitcoin Network due to limited use of bitcoin in Ecuador.
While
jurisdictions such as Germany and China have taken a preliminary regulatory stance on Bitcoin, countries such as India have declined
to apply regulation to Bitcoin when afforded the opportunity. In June 2014, the Swiss government elected not to regulate Bitcoin
use and issued guidance on the further development and future application of laws to Bitcoin-related activity in Switzerland.
Among others, Australia, Finland and the Netherlands have joined Canada and Germany among the foreign countries releasing formal
or informal tax guidance regarding Bitcoin income or operations.
Due
in part to its international nature and the nascent stage of regulation, along with the limited experience with Bitcoin of, and
language barriers between, international journalists, information regarding the regulation of Bitcoin in various jurisdictions
may be incomplete, inaccurate or unreliable. For example, news of the People’s Bank of China notice release on December
5, 2013 was followed by days of confusion relating to difficulty in interpreting and analyzing the content of the release. In
another instance, on July 29, 2013, a Bitcoin service business in Thailand announced that, in a meeting with the Bank of Thailand,
regulators from the Foreign Exchange Administration and Policy Department had functionally banned Bitcoin activity in the country,
leading to widespread reporting of a blanket ban. Later reporting, however, questioned whether the Bank of Thailand regulators
had the authority, or ever expressed the intention, to ban all Bitcoin use in Thailand. Additionally in the first quarter of 2014,
the Bank of Thailand issued a warning to its citizens regarding the risks of Bitcoin and stated that it is not a currency. Despite
these announcements, bitcoin exchanges continue to operate in Thailand converting bitcoin to and from Thai baht.
In
April 2015, the Japanese Cabinet approved proposed legal changes that would reportedly treat Bitcoin and other Digital Assets
as included in the definition of currency. These regulations would, among other things, require market participants, including
exchanges, to meet certain compliance requirements and be subject to oversight by the Financial Services Agency, a Japanese regulator.
These changes were approved by the Japanese Diet in May 2016 and became effective in April 2017.
As
both the regulatory landscape develops and journalistic familiarity with bitcoin increases, mainstream media’s understanding
of Digital Assets and the regulation thereof may improve. Regulation of Digital Assets varies from country to country as well
as within countries. An increase in the regulation of Digital Assets may affect our proposed business by increasing compliance
costs or prohibiting certain or all of our proposed activities.
COMPETITION
Blockchain
Technology and Digital Assets Initiatives
Subject
to raising additional capital, the Company’s Digital Asset initiatives will compete with other industry participants that
focus on investing in and securing the blockchains of bitcoin and other Digital Assets. Market and financial conditions, and other
conditions beyond the Company’s control, may make it more attractive to invest in other entities, or to invest in bitcoin
or Digital Assets directly.
Transaction
Verification Service Business (digital asset mining e.g. bitcoin, Suspended)
While
our current Transaction Verification Services business is suspended we anticipate that if we resuming our operations, which is
subject to additional financing, our current and future competition is centered on the following areas:
●
|
Vertically
integrated companies such as Bitfury, 21 Inc., Bitmain Technologies, Avalon, and BW which design and build ASIC servers and
are engaged in transaction verification services through the use of their own ASIC servers; and
|
|
|
●
|
Companies
that are engaged in transaction verification services which may have lower operating costs than our future operations.
|
Our
potential competitors may have greater resources, longer histories, more intellectual property, greater hashing capacity, and
lower cost operations. They may secure better terms from ASIC server suppliers, deploy ASIC servers faster than us, and devote
more resources to technology infrastructure. Other companies also may enter into business combinations or alliances that strengthen
their competitive positions.
ASSETS
The
Company’s sole asset is its human capital specifically Mr. Allen and Mr. Handerhan, who have extensive market knowledge
and long-standing business relationships within the industry. Our continued success depends solely on their continued service.
See “Risk Factors” below.
INTELLECTUAL
PROPERTY AND TRADE SECRETS
We
have no intellectual property assets or licenses and rely upon the experience of our two executive officers in the Digital Assets
business as it has evolved.
GROWTH
STRATEGY
Transaction
Verification Services Growth Strategy
We
believe that with additional funding we may be able to resume our transaction verification services business (digital asset mining
e.g. bitcoin) and believe this may provide revenue growth. If we are successful in resuming our transaction verification services
business, we anticipate utilizing outsourced data centers and may diversify operations by securing other blockchains in addition
to bitcoins blockchain.
EMPLOYEES
We
currently have 2 full-time employees, who have been compensated at below market levels since inception including fiscal year 2014,
2015, 2016 and 2017 (through May). As a condition to the April 2015 Subscription Agreement amendment, the Company could not pay
each of its two officers and sole employees, Mr. Allen and Mr. Handerhan, cash compensation, whether in base salary or bonus,
in excess of $50,000 per year until such time as the Company has paid the investors in the April 2015 financing $187,330. As a
condition to the May 2017 financing, the Company may not pay each of its two officers and sole employees, Mr. Allen and Mr. Handerhan,
cash compensation, whether in base salary or bonus, in excess of $50,000 per year, including accrued and unpaid salaries,
until such time as the Company has filed this report. See “Risk Factors” below and Item 7. Financial Statements and
Supplementary Data.
ITEM
1A. RISK FACTORS
Not
applicable to smaller reporting companies. However, our principal risk factors are described under “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations.”
ITEM
2. PROPERTIES.
As
of the date of this report the Company did not have any owned or leased properties.
Corporate
Office Space
Our
corporate headquarters was located at 1901 N Moore St, Suite 700 Arlington, VA 22209; this space was being sub-let and was paid
for in full through May 31, 2016 and subsequently extended on a month-to-month basis for $500 per month from June 1, 2016 through
December 31, 2016. After December 31, 2016 the Company was not party to any lease agreements for corporate office space and its
employees have been working virtually. The Company is paying each of Mr. Allen and Mr. Handerhan $500 per month to cover out of
pocket expenses associated with phone, internet and office space.
Transaction
Verification Services Facility (Closed)
Our
transaction verification services business was located in North Carolina where we leased space in an 83,000 square foot former
hosiery manufacturing plant which we re-purposed for our transaction verification servers. The lease was cancelled on September
1, 2016 and we forfeited our security deposit of $10,000.
ITEM
3. LEGAL PROCEEDINGS.
From
time to time, we are party to certain legal proceedings that arise in the ordinary course and are incidental to our business.
We know of no material, active or pending legal proceedings
against us.
ITEM
4. MINE SAFETY DISCLOSURES.
Not
applicable.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Note
1 – Organization and Description of Business and Recent Developments
BTCS
Inc. (formerly Bitcoin Shop, Inc.), a Nevada Corporation (the “Company”) was incorporated in 2008. In February 2014,
the Company entered the business of hosting an online ecommerce marketplace where consumers can purchase merchandise using Digital
Assets, including bitcoin and is currently focused on blockchain and Digital Asset ecosystems. In January 2015, the Company began
a rebranding campaign using its BTCS.COM domain (shorthand for Blockchain Technology Consumer Solutions) to better reflect its
broadened strategy. The Company released its new website which included broader information on its strategy. In late 2014 we shifted
our focus towards our transaction verification service business, also known as bitcoin mining, though in mid-2016 we ceased our
transaction verification services operation at our North Carolina facility due to capital constraints. Although our ecommerce
marketplace is still online we are no longer developing, marketing or supporting it.
The
Company is an early entrant in the Digital Asset market and one of the first U.S. publicly traded companies to be involved with
Digital Assets and blockchain technologies. Subject to additional financing, the Company plans to create a portfolio of digital
assets including bitcoin and other “protocol tokens” to provide investors a diversified pure-play exposure to the
bitcoin and blockchain industries. The Company intends to acquire digital assets through: open market purchases, participating
in initial digital asset offerings (often referred to as initial coin offerings). Additionally, the Company may acquire digital
assets by resuming its transaction verification services business through outsourced data centers and earning rewards in digital
assets by securing their respective blockchains.
On
July 20, 2016, BTCS Digital Manufacturing (“DM”), a wholly owned subsidiary the Company suspended its North Carolina
transaction verification services facility operations. The recent reduction in the block reward from 25 bitcoins to 12.5 bitcoins,
often referred to as the halving, coupled with the facilities cooling system failing, has resulted in DM being unable to meet
certain of its financial commitments. The Company has subsequently ceased operations at DM.
On
August 8, 2016, DM discovered that its facility in North Carolina was broken into and certain of its equipment and approximately
165 Bitmain transaction verification servers leased from CSC Leasing Company (“CSC”) were stolen. The value of the
stolen equipment owned by the Company was not material. The Company reported the theft to local authorities as well its insurance
company regarding next steps. The Company received payment from the insurance company in the amount of approximately $85,000 and
has assigned the payment to the benefit of CSC as part of the settlement agreement with CSC the Company’s equipment finance
provider which owned the stolen serves.
Reverse
Stock Split and Amendment to Certificate of Incorporation
On
February 13, 2017, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of
Nevada to implement a reverse stock split at a ratio of one-for-60. The reverse stock split became effective immediately.
On
February 15, 2017, the Company’s Common Stock began trading on the OTCQB under the symbol “BTCSD.” On approximately
March 15, 2017, the Common Stock resumed trading under the symbol “BTCS.”
The
Reverse Stock Split reduced the number of outstanding shares of Common Stock from 952,756,004 shares to 15,879,262 shares as of
December 31, 2016. All per share amounts and outstanding shares of Common Stock including stock options, restricted stock and
warrants, have been retroactively adjusted in these consolidated financial statements for all periods presented to reflect the
1-for-60 Reverse Stock Split. Further, exercise prices of stock options and warrants have been retroactively adjusted in these
consolidated financial statements for all periods presented to reflect the 1-for-60 Reverse Stock Split. Numbers of shares of
the Company’s preferred stock and convertible securities were not affected by the Reverse Stock Split; however, the conversion
ratios have been adjusted to reflect the Reverse Stock Split.
Note
2 – Basis of Presentation
The
accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, BCSLLC and
DM. The Company maintains its books of account and prepares consolidated financial statements in accordance with Generally Accepted
Accounting Principles in the United States of America (“U.S. GAAP”). The Company’s fiscal year ends on December
31. All significant intercompany balances and transactions have been eliminated in consolidation.
Note
3 - Liquidity, Financial Condition and Management’s Plans
The
Company has commenced its planned operations but has limited operating activities to date. The Company has financed its operations
since inception using proceeds received from capital contributions made by its members and proceeds in financing transactions.
On June 6, 2016, the Company, entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with
certain institutional investors (the “Purchasers”), pursuant to which the Purchaser subscribed for up to $375,000
of a 20% Original Issue Discount Junior Secured Convertible Notes (the “Junior Notes”). The aggregate principal amount
of the Junior Notes issued at the initial close was $125,000 and the Company received $100,000 after giving effect to the 20%
original issue discount. In June 2016, the Company issued 68,750 shares of Common Stock for the cash exercise of warrants resulting
in aggregate proceeds of approximately $92,000. On December 6, 2016, the Company issued a total of $220,002 Convertible Promissory
Notes (the “December 2016 Notes”) to three accredited investors. The December 2016 Notes were issued in connection
with a loan of $200,002 and the cancellation of two $10,000 promissory notes previously issued by the Company to two of the investors.
Notwithstanding,
the Company has limited revenues, limited capital resources and is subject to all of the risks and uncertainties that are typical
of an early stage enterprise. Significant uncertainties include, among others, whether the Company will be able to raise the capital
it needs to finance its longer term operations and whether such operations, if launched, will enable the Company to sustain operations
as a profitable enterprise.
Our
working capital needs are influenced by our level of operations, and generally decrease with higher levels of revenue. The Company
used approximately $0.8 million of cash in its operating activities for the year ended December 31, 2016. The Company incurred
$44.2 million net loss for the year ended December 31, 2016. The Company had cash of approximately $95,000 and a working
capital deficiency of approximately $45.3 million at December 31, 2016, which includes $23.2 million for the fair value of derivative
liabilities and $14.9 million for the fair value of derivative liabilities for shortfall of shares. The Company expects to incur
losses into the foreseeable future as it undertakes its efforts to execute its business plans.
The
Company will require significant additional capital to sustain its short-term operations and make the investments it needs to
execute its longer term business plan. The Company’s existing liquidity is not sufficient to fund its operations and anticipated
capital expenditures for the foreseeable future. The Company is currently seeking to obtain additional debt or equity financing,
however there are currently no commitments in place for further financing nor is there any assurance that such financing will
be available to the Company on favorable terms, if at all.
Because
of recurring operating losses, net operating cash flow deficits, and an accumulated deficit, there is substantial doubt about
the Company’s ability to continue as a going concern for one year from the issuance of the financial statements. The consolidated
financial statements have been prepared assuming the Company will continue as a going concern. The Company has not made adjustments
to the accompanying consolidated financial statements to reflect the potential effects on the recoverability and classification
of assets or liabilities should the Company be unable to continue as a going concern.
The
Company continues to incur ongoing administrative and other operating expenses, including public company expenses, in excess of
revenues. While the Company continues to implement its business strategy, it intends to finance its activities by:
●
|
managing
current cash and cash equivalents on hand from the Company’s past debt and equity offerings by controlling costs,
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|
|
●
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seeking
additional financing through sales of additional securities
|
Note
4 - Summary of Significant Accounting Policies
A
summary of the significant accounting policies applied in the preparation of the accompanying consolidated financial statements
is as follows:
Concentration
of Cash
The
Company maintains cash balances at two financial institutions in checking accounts and money market accounts. The Company considers
all highly liquid investments with original maturities of three months or less when purchased to be cash and cash equivalents.
As of December 31, 2016 and 2015, the Company had $95,000 and 125,000 in cash and cash equivalents. The Company has not experienced
any losses in such accounts and believes it is not exposed to any significant credit risk on cash.
Digital
Currencies Translations and Remeasurements
The
Company accounts for digital currencies, which it considers to be an operating asset, at their initial cost and subsequently remeasures
the carrying amounts of digital currencies it owns at each reporting date based on their current fair value. The changes in the
fair value of digital currencies are included as a component of income or loss from operations. The Company currently classifies
digital currencies as a current asset. Digital currencies are considered a crypto-currency and the Company receives deposits in
various kinds of digital currencies including but not limited to bitcoins, litecoins and dogecoins from customer trade transactions.
The Company when necessary, will issue refunds in digital currencies and, at its discretion, make payments to vendors in digital
currencies, if and when such vendors accept digital currencies as payment.
The
Company obtains the equivalency rate of bitcoins to USD from various exchanges including, Bitstamp and Coinbase. The equivalency
rate obtained from these sources represents a generally well recognized quoted price in an active market for bitcoins, which market
and related database are accessible to the Company on an ongoing basis.
Property
and Equipment
Property
and equipment consists of leasehold improvements, computer, equipment and office furniture and fixtures, all of which are recorded
at cost. Depreciation and amortization is recorded using the straight-line method over the respective useful lives of the assets
ranging from three to five years. Long-lived assets are reviewed for impairment whenever events or circumstances indicate that
the carrying amount of these assets may not be recoverable.
Due
to the financial nature of the Company, the Company impaired all fixed assets and recorded an approximately $236,000 impairment
charge in June 2016.
Intangible
Asset
The
Company has applied the provision of ASC topic 350-50-50 Intangible - Goodwill and Other/Website Development Costs, in accounting
for its costs incurred to purchase its website. Capitalized website costs are being amortized by the straight line method over
an estimated useful life of three (3) years. Amortization cost was approximately $5,000 for the years ended December 31, 2016
and 2015.
Investments
Shares
in Group undertakings are stated at cost less any provision for impairment.
The
Company assesses investments for impairment whenever events or changes in circumstances indicate that the carrying value of an
investment may not be recoverable. If any such indication of impairment exists, the Company makes an estimate of the recoverable
amount. If the recoverable amount of the cash-generating unit is less than the value of the investment, the investment is considered
to be impaired and is written down to its recoverable amount. An impairment loss is recognized immediately in the profit and loss
account. During the year ended 2016, the Company recorded impairment loss of approximately $2.3 million.
Derivative
Instruments
We
account for free-standing derivative instruments and hybrid instruments that contain embedded derivative features in accordance
with ASC Topic 815, Accounting for Derivative Instruments and Hedging Activities, or ASC 815, as well as related interpretations
of this topic. In accordance with this topic, derivative instruments and hybrid instruments are recognized as either assets or
liabilities in the balance sheet and are measured at fair values with gains or losses recognized in earnings. Embedded derivatives
that are not clearly and closely related to the host contract are bifurcated and are recognized at fair value with changes in
fair value recognized as either a gain or loss in earnings. We determine the fair value of derivative instruments and hybrid instruments
based on available market data using appropriate valuation models, giving consideration to all of the rights and obligations of
each instrument. The Company used a Monte Carlo model to separately value the Warrants issued in connection with the convertible
notes in order to take into account the possibility of an adjustment to the exercise price associated with new rounds of financing
in the future.
Reclassifications
Certain
reclassifications have been made in prior years’ consolidated financial statements to conform to the current year’s
presentation.
Use
of Estimates
In
preparing financial statements in conformity with U.S. GAAP, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of expenses during the reporting period. Due to inherent uncertainty involved in making
estimates, actual results reported in future periods may be affected by changes in these estimates. On an ongoing basis, the Company
evaluates its estimates and assumptions. These estimates and assumptions include valuing equity securities in share-based payment
arrangements, estimating the provision for income taxes, estimating the fair value of equity instruments recorded as derivative
liabilities, useful lives of depreciable assets and whether impairment charges may apply.
Revenue
Recognition
The
Company follows the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 104
for revenue recognition and Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition.”
Accordingly, the Company records revenue when persuasive evidence of an arrangement exists, services have been rendered or product
delivery has occurred, the selling price to the customer is fixed or determinable and collectability of the revenue is reasonably
assured.
Transaction
Verification Servers
Revenue
earned from bitcoin processing activities (“Transaction Verification Services”), commonly termed ‘mining’
activities, is recognized at the fair value of the bitcoins received as consideration on the date of actual receipt.
The
Company generates revenue by performing computer processing activities for bitcoin generation. In the digital-currency industry
such activity is generally referred to as Transaction Verification Services or bitcoin mining. The Company receives consideration
for performing such transaction verification activities in the form of bitcoins. Revenue is recorded upon the actual receipt of
bitcoins.
Expenses
consist of utilities paid to cover our electric costs, rent for our facility and personnel to run our facility. The expenses related
to our Transaction Verification Services activities are affected by the level of activities and not the ultimate generation of
bitcoins. The Company expenses these costs as they are incurred.
Income
Taxes
The
Company recognizes income taxes on an accrual basis based on tax positions taken or expected to be taken in its tax returns. A
tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax filing
that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions are recognized only when it
is more likely than not (i.e., likelihood of greater than 50%), based on technical merits, that the position would be sustained
upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted
approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. Income taxes
are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for
the expected future tax consequences of events that have been recognized in the Company’s financial statements or tax returns.
A valuation allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more than likely
not be realized. Should they occur, the Company’s policy is to classify interest and penalties related to tax positions
as income tax expense. Since the Company’s inception, no such interest or penalties have been incurred.
Fair
Value of Financial Instruments
Financial
instruments, including cash and cash equivalents, accounts and other receivables, accounts payable and accrued liabilities are
carried at cost, which management believes approximates fair value due to the short-term nature of these instruments. The Company
measures the fair value of financial assets and liabilities based on the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. The Company maximizes the use of observable inputs and minimizes
the use of unobservable inputs when measuring fair value.
The
Company uses three levels of inputs that may be used to measure fair value:
Level
1 - quoted prices in active markets for identical assets or liabilities
Level
2 - quoted prices for similar assets and liabilities in active markets or inputs that are observable
Level
3 - inputs that are unobservable (for example, cash flow modeling inputs based on assumptions)
Employee
Stock-Based Compensation
The
Company accounts for stock-based compensation in accordance with ASC 718 Compensation - Stock Compensation (“ASC 718”).
ASC 718 addresses all forms of share-based payment (“SBP”) awards including shares issued under employee stock purchase
plans and stock incentive shares. Under ASC 718 awards result in a cost that is measured at fair value on the awards’ grant
date, based on the estimated number of awards that are expected to vest and will result in a charge to operations.
Advertising
Expense
Advertisement
costs are expensed as incurred and included in marketing expenses. Advertising expenses amounted to approximately $11,000 and
$15,000 for the years ended December 31, 2016 and 2015, respectively.
Net
Loss per Share
Basic
loss per share is computed by dividing the net income or loss applicable to common shares by the weighted average number of common
shares outstanding during the period. Net income (loss) attributable to common stockholders includes the effect of the deemed
capital contribution on extinguishment of preferred stock and the deemed dividend related to the immediate accretion of beneficial
conversion feature of convertible preferred stock. Diluted earnings per share is computed using the weighted average number of
common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the
incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of
the Company’s convertible preferred stock and warrants (using the if-converted method). Diluted loss per share excludes
the shares issuable upon the conversion of preferred stock and the exercise of stock options and warrants from the calculation
of net loss per share if their effect would be anti-dilutive.
The
following financial instruments were not included in the diluted loss per share calculation as of December 31, 2016 and 2015 because
their effect was anti-dilutive:
|
|
As
of December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Warrants to purchase
common stock
|
|
|
268,788,732
|
|
|
|
486,723
|
|
Convertible notes
|
|
|
50,198,041
|
|
|
|
80,555
|
|
Favored Nations
|
|
|
108,747,774
|
|
|
|
-
|
|
Total
|
|
|
427,734,547
|
|
|
|
567,278
|
|
Preferred
Stock
The
Company applies the guidance enumerated in ASC 480 “Distinguishing Liabilities from Equity” when determining the classification
and measurement of preferred stock. Preferred shares subject to mandatory redemption (if any) are classified as liability instruments
and are measured at fair value. The Company classifies conditionally redeemable preferred shares (if any), which includes preferred
shares that feature redemption rights that are either within the control of the holder or subject to redemption upon the occurrence
of uncertain events not solely within the Company’s control, as temporary equity. At all other times, the Company classifies
its preferred shares in stockholders’ equity. The Company’s preferred shares do not feature any redemption rights
within the holders’ control or conditional redemption features not within the Company’s control as of December 31,
2016. Accordingly, all issuances of preferred stock are presented as a component of consolidated stockholders’ equity.
Series
C Convertible Preferred Stock
The
Company has evaluated the Series C Convertible Preferred Stock (“Preferred Stock”) conversion component of the Private
Placement and determined it should be considered an “equity host” and not a “debt host” as defined by
ASC 815, Derivatives and Hedging. This evaluation is necessary in order to determine if any embedded features require bifurcation
and, therefore, separate accounting as a derivative liability. The Company’s analysis followed the “whole instrument
approach,” which compares an individual feature against the entire preferred stock instrument which includes that feature.
The Company’s analysis was based on a consideration of the Preferred Stock’s economic characteristics and risks and
more specifically evaluated all the stated and implied substantive terms and features including (i) whether the Preferred Stock
included redemption features, (ii) whether the preferred stockholders were entitled to dividends, (iii) the voting rights of the
Preferred Stock and (iv) the existence and nature of any conversion rights. As a result of the Company’s determination that
the Preferred Stock is an “equity host,” the embedded conversion feature is not considered a derivative liability.
Fair
Value Option
As
permitted under FASB ASC 825,
Financial Instruments,
(“ASC 825”), the Company has elected the fair value option
to account for its convertible notes that were issued during the year ended December 31, 2016. ASC 825 requires that the entity
record the financial asset or financial liability, including those instruments when the fair value options is elected at fair
value rather than historical cost at a discounted carrying amount with changes in fair value recorded in the statement of operations.
In addition, it requires that upfront costs and fees related to items for which the fair value option is elected be recognized
in earnings as incurred and not deferred.
Adoption
of Recent Accounting Pronouncements
In
August 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
No. 2015-15, Interest - Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with
Line-of-Credit Arrangements, which clarifies the treatment of debt issuance costs from line-of-credit arrangements after the adoption
of ASU No. 2015-03, Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. In particular, ASU
No. 2015-15 clarifies that the SEC staff would not object to an entity deferring and presenting debt issuance costs related to
a line-of-credit arrangement as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of
such arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company adopted
ASU No. 2015-15 during the first quarter of fiscal 2016, and its adoption did not have a material impact on its consolidated financial
statements.
Recent
Accounting Pronouncements
In
May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, an updated standard on revenue recognition.
ASU No. 2014-09 provides enhancements to the quality and consistency of how revenue is reported by companies while also improving
comparability in the financial statements of companies reporting using International Financial Reporting Standards or U.S. GAAP.
The main purpose of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers
in amounts that reflect the consideration to which a company expects to be entitled in exchange for those goods or services. The
new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously
addressed comprehensively and improve guidance for multiple-element arrangements. In July 2015, the FASB voted to approve a one-year
deferral of the effective date of ASU No. 2014-09, which will be effective for the Company in the first quarter of fiscal year
2019 and may be applied on a full retrospective or modified retrospective approach. The Company is evaluating the impact of implementation
and transition approach of this standard on its financial statements.
In
August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements-Going Concern, which defines management’s
responsibility to assess an entity’s ability to continue as a going concern, and requires related footnote disclosures if
there is substantial doubt about its ability to continue as a going concern. ASU No. 2014-15 is effective for the Company for
the fiscal year ending on June 30, 2017, with early adoption permitted. The Company is currently evaluating the impact of adopting
ASU No. 2014-15 and its related disclosures.
In
November 2015, FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes. ASU No. 2015-17 requires that deferred
tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU No. 2015-17 is effective
for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years.
The Company is currently evaluating the impact that ASU No. 2015-17 will have on its balance sheet and financial statement disclosures.
In
January 2016, FASB issued ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. ASU No.
2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income; simplifies
the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment
to identify impairment; eliminates the requirement for public business entities to disclose the method(s) and significant assumptions
used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance
sheet; requires public business entities to use the exit price notion when measuring the fair value of financial instruments for
disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in
the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure
the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation
of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the
accompanying notes to the financial statements and clarifies that an entity should evaluate the need for a valuation allowance
on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.
ASU No. 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods
within those fiscal years. The Company is currently evaluating the impact that ASU No. 2016-01 will have on its financial statements
and related disclosures.
In
February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes FASB ASC Topic 840, Leases (Topic 840) and
provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The
new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the
principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether
lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively.
A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than twelve
months regardless of classification. Leases with a term of twelve months or less will be accounted for similar to existing guidance
for operating leases. The standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption
permitted upon issuance. The adoption of this standard is not expected to have a material impact on the Company’s consolidated
financial position and results of operations.
In
March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations
(“ASU 2016-08”). The purpose of ASU 2016-08 is to clarify the implementation of guidance on principal versus agent
considerations. The amendments in ASU 2016-08 are effective for interim and annual reporting periods beginning after December
15, 2017. The Company is currently assessing the impact of ASU 2016-08 on the consolidated financial statements and related disclosures.
In
March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718), Improvements to Employee Share-Based
Payment Accounting (“ASU 2016-09”). Under ASU 2016-09, companies will no longer record excess tax benefits and certain
tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax
deficiencies as income tax expense or benefit in the income statement and the APIC pools will be eliminated. In addition, ASU
2016-09 eliminates the requirement that excess tax benefits be realized before companies can recognize them. ASU 2016-09 also
requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing
activity. Furthermore, ASU 2016-09 will increase the amount an employer can withhold to cover income taxes on awards and still
qualify for the exception to liability classification for shares used to satisfy the employer’s statutory income tax withholding
obligation. An employer with a statutory income tax withholding obligation will now be allowed to withhold shares with a fair
value up to the amount of taxes owed using the maximum statutory tax rate in the employee’s applicable jurisdiction(s).
ASU 2016-09 requires a company to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory
income tax withholding obligation as a financing activity on the statement of cash flows. Under current U.S. GAAP, it was not
specified how these cash flows should be classified. In addition, companies will now have to elect whether to account for forfeitures
on share-based payments by (1) recognizing forfeitures of awards as they occur or (2) estimating the number of awards expected
to be forfeited and adjusting the estimate when it is likely to change, as is currently required. The amendments of this ASU are
effective for reporting periods beginning after December 15, 2016, with early adoption permitted but all of the guidance must
be adopted in the same period. The Company is currently assessing the impact that ASU 2016-09 will have on its consolidated financial
statements.
In
April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customer (“ASU 2016-10”). The new guidance
is an update to ASC 606 and provides clarity on: identifying performance obligations and licensing implementation. For public
companies, ASU 2016-10 is effective for annual periods, including interim periods within those annual periods, beginning after
December 15, 2016. The Company is currently evaluating the impact that ASU 2016-10 will have on its consolidated financial statements.
In
June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments
(“ASU 2016-13”). ASU 2016-13 requires that expected credit losses relating to financial assets measured on an amortized
cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU 2016-13 limits the amount
of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value
and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective
on January 1, 2020. Early adoption will be available on January 1, 2019. The Company is currently evaluating the effect that the
updated standard will have on its consolidated financial statements and related disclosures.
In
August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments,
which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain
cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal
years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including
adoption in an interim period. The Company is currently evaluating the impact of this new pronouncement on its consolidated statements
of cash flows.
In
January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill
Impairment. ASU No. 2017-04 removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation.
A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed
the carrying amount of goodwill. This standard will be effective for the Company beginning in the first quarter of fiscal year
2021 is required to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed
on testing dates after January 1, 2017. The Company is currently evaluating the impact this standard will have on its consolidated
financial statements.
Note
5 – Property and Equipment
Property
and equipment consist of the following at December 31, 2016 and December 31, 2015:
|
|
December
31, 2016
|
|
|
December
31, 2015
|
|
Equipment
|
|
$
|
-
|
|
|
$
|
109,493
|
|
Computer
|
|
|
-
|
|
|
|
3,086
|
|
Leasehold improvements
|
|
|
-
|
|
|
|
242,091
|
|
Transaction verification
servers
|
|
|
-
|
|
|
|
451,281
|
|
Total cost
|
|
|
-
|
|
|
|
805,951
|
|
Accumulated depreciation
and amortization
|
|
|
-
|
|
|
|
(316,531
|
)
|
|
|
|
|
|
|
|
|
|
Property and
equipment, net
|
|
$
|
-
|
|
|
$
|
489,420
|
|
Depreciation
expense was approximately $177,000 and $298,000 for the years ended 2016 and 2015, respectively.
During
the year ended 2016, the Company purchased fixed assets of approximately $15,000, sold fixed assets amounting to approximately
$89,000, resulting in net loss on sale of fixed assets of $1,531.
Due
to the financial nature of the Company, the Company impaired all fixed assets and recorded an approximately $236,000 impairment
charge in June 2016.
Note
6 – Intangible Assets
The
Company’s intangible assets with finite lives consist of capitalized website costs. For all periods presented, all of the
Company’s identifiable intangible assets were subject to amortization. The net carrying amounts related to acquired intangible
assets as of December 31, 2016 are as follows:
|
|
Net
Carrying Amount
|
|
|
Weighted
average
amortization
period (years)
|
|
Website at January 1, 2015,
net
|
|
$
|
10,700
|
|
|
|
2.59
|
|
Amortization
expenses
|
|
|
(4,625
|
)
|
|
|
|
|
Website at December 31, 2015, net
|
|
$
|
6,075
|
|
|
|
1.59
|
|
Amortization
expenses
|
|
|
(5,156
|
)
|
|
|
|
|
Website at December
31, 2016, net
|
|
$
|
919
|
|
|
|
0.59
|
|
The
Company has applied the provision of ASC topic 350-50-50 Intangible - Goodwill and Other/Website Development Costs, in accounting
for its costs incurred to purchase its website. Capitalized website costs are being amortized by the straight line method over
an estimated useful life of three (3) years. Amortization cost was approximately $5,000 for the years ended December 31, 2016
and 2015.
Note
7 – Stockholders’ Equity
Reverse
Stock Split and Amendment to Certificate of Incorporation
On
February 13, 2017, the Company filed a Certificate of Amendment to its Articles of Incorporation with the Secretary of State of
Nevada to implement a reverse stock split at a ratio of one-for-60. The reverse stock split became effective immediately.
On
February 15, 2017, the Company’s Common Stock began trading on the OTCQB under the symbol “BTCSD.” On approximately
March 15, 2017, the Common Stock resumed trading under the symbol “BTCS.”
The
Reverse Stock Split reduced the number of outstanding shares of Common Stock from 952,756,004 shares to 15,879,262 shares as of
December 31, 2016. All per share amounts and outstanding shares of Common Stock including stock options, restricted stock and
warrants, have been retroactively adjusted in these consolidated financial statements for all periods presented to reflect the
1-for-60 Reverse Stock Split. Further, exercise prices of stock options and warrants have been retroactively adjusted in these
consolidated financial statements for all periods presented to reflect the 1-for-60 Reverse Stock Split. Numbers of shares of
the Company’s preferred stock were not affected by the Reverse Stock Split; however, the conversion ratios have been adjusted
to reflect the Reverse Stock Split.
2015
Activities
On
January 19, 2015 (the “Closing Date”), the Company sold an aggregate of 72,167 Units (“January Units”)
in a private placement (the “Private Placement”) of its securities to certain investors (the “Investors”)
at a purchase price of $6.0 per Unit pursuant to subscription agreement (the “Subscription Agreements”) for an aggregate
purchase price of $433,000. Each Unit in the Private Placement consists of (i) one share of common stock, par value $0.001 per
share (the “Common Stock”) and (ii) a warrant to purchase 2.5 shares of Common Stock at an exercise price of $6.0
per share. The January Units are subject to a “Most Favored Nations” provision and the Warrants are subject to price
protection in the event of lower priced issuances for a period of twenty-four months from the Closing Date in the event the Company
issues Common Stock or securities convertible into or exercisable for shares of Common Stock at a price per share or conversion
or exercise price per share which shall be less than $6.0 per share, subject to certain customary exceptions. Additionally, the
shares of Common Stock issued as part of the Unit and issuable upon exercise of the Warrants are subject to demand and piggy back
registration rights. The Warrant may be exercised on a cashless basis in the event there is no effective registration statement
covering the resale of the Common Stock issuable upon exercise of the Warrants. The Warrants may be called for cancelation by
the Company if: (i) the price per share exceeds $12.0 for 15 consecutive trading days, and (ii) the average daily dollar trading
volume for such 15 consecutive trading days exceeds $50,000 per trading day. Because of the “Most Favored Nations”
and call provision discussed above, the net value to shareholders’ equity is 0. The fair value of all components of the
January Units was $956,930 ($649,500 attributed to the unit warrants, and $303,100 attributed to the derivative liability component
with “Most Favored Nations” Provision), and because this transaction was entered into under duress. Accordingly, the
Company recorded an initial charge of $519,600 on issuance of the January Units in accordance with ASC 820-10-30-3A (see Note
9 for assumptions).
Charles
Allen, the Company’s Chief Executive Officer, and Michal Handerhan, the Company’s Chief Operating Officer each purchased
834 Units in the Private Placement.
On
January 23, 2015, DM, purchased one hundred Spondoolies S35 Digital Asset mining servers from Spondoolies Tech Ltd. (“Spondoolies”)
for $218,500 (the “Purchase Price”) pursuant to a purchase order agreement (the “Purchase Agreement”).
$25,000 of the total Purchase Price was paid in the form of 4,167 shares of the Company’s Common Stock.
On
January 26, 2015, the Company entered into a Share Redemption Agreement and Release (the “Redemption Agreement”) with
Charles Kiser, its Executive Vice President pursuant to which Mr. Kiser agreed to return an aggregate of 4,167 shares of the Company’s
Common Stock, held by him to the Company for cancellation in consideration for an aggregate payment of $2,500.
On
February 18, 2015, the Company issued 5,449 and 1,198 shares of Common Stock at a per share price of $15.6, to Sichenzia Ross
Friedman Ference LLP (“SRFF”) and Alliance Funds LLC (“AF”), respectively. The shares were issued pursuant
to conversion agreements (the “Conversion Agreements”) for an aggregate conversion amount of $103,694 (the “Conversion
Amount”). The Conversion Amount was in consideration for settling outstanding legal and investor relation fee balances
of $85,000 and $18,694 owed to SRFF and Capital Markets Group an affiliate of AF, respectively. The Common Stock was subject
to price protection in the event of lower priced issuances for a period of one year from the Conversion Date in the event the
Company issues Common Stock or securities convertible into or exercisable for shares of Common Stock at a price per share or conversion
or exercise price per share which shall be less than $15.6 per share, subject to certain customary exceptions. Additionally, the
shares of Common Stock issued are subject to demand and piggy back registration rights.
On
February 20, 2015, DM, purchased used Digital Asset mining servers comprised primarily of Spondoolies hardware for $14,480 (the
“Purchase Price”) pursuant to a purchase agreement (the “Purchase Agreement”). The Purchase Price was
paid in the form of 928 shares of the Company’s restricted Common Stock at a per share price of $15.6. Additionally, the
shares of Common Stock issued are subject to demand and piggy back registration rights.
On
March 5, 2015, the Company issued of 2,564 shares of Common Stock at a per share price of $15.6, to Chord Advisors, LLC. The shares
were issued pursuant to a conversion agreement (the “Conversion Agreement”) for an aggregate conversion amount of
$40,000 (the “Conversion Amount”). The Conversion Amount was in consideration for settling a balance of $30,000 and
for the prepayment of $10,000 for advisory services for March 2015 and April 2015. The Common Stock was subject to price
protection in the event of lower priced issuances for a period of one year from the Conversion Date in the event the Company issues
Common Stock or securities convertible into or exercisable for shares of Common Stock at a price per share or conversion or exercise
price per share which shall be less than $15.6 per share, subject to certain customary exceptions. Additionally, the shares of
Common Stock issued are subject to demand and piggy back registration rights.
On
March 26, 2015 the Company acquired 166,756 shares (an additional 2% equity ownership) of Coin Outlet from Eric Grill,
Coin Outlet’s CEO, for 11,699 shares of the Company’s common stock. The fair value of the common stock was $154,433
on the issuance date.
On
April 20, 2015 (the “April Closing Date”), the Company sold an aggregate of 128,472 units (each a “April Unit”)
in a private placement (the “April Private Placement”) of its securities to certain investors at a purchase price
of $18.0 per April Unit pursuant to subscription agreements for an aggregate purchase price of $2,312,500. Each April Unit in
the April Private Placement consists of (i) one share of Common Stock and (ii) a warrant to purchase 1.4 shares of Common Stock
at an exercise price of $22.5 per share (“April Warrant”). Charles Allen, the Company’s Chief Executive Officer
and Michal Handerhan, the Company’s Chief Operating Officer each purchased 1,111 April Units for $20,000 per executive in
the April Private Placement. The April Units are subject to a “Most Favored Nations” provision and the April Warrants
are subject to price protection in the event of lower priced issuances for a period of twenty-four months from the April Closing
Date in the event the Company issues Common Stock or securities convertible into or exercisable for shares of Common Stock at
a price per share or conversion or exercise price per share which shall be less than $18.0 per share, subject to certain customary
exceptions. Additionally, the shares of Common Stock issued as part of the April Unit and issuable upon exercise of the April
Warrants are subject to demand and piggy back registration rights. The April Warrant may be exercised on a cashless basis in the
event there is no effective registration statement covering the resale of the Common Stock issuable upon exercise of the April
Warrants. The April Warrants may be called for cancelation by the Company if: (i) the price per share exceeds $56.28 for 15 consecutive
trading days, and (ii) the average daily dollar trading volume for such 15 consecutive trading days exceeds $200,000 per trading
day. Because of the “Most Favored Nations” and call provision discussed above, the net value to shareholders’
equity is 0. The fair value of all components of the April Units was $2,843,811 ($1,878,957 attributed to the unit warrants, and
$964,854 attributed to the derivative liability component with “Most Favored Nations” Provision), and because this
transaction was entered into under duress, the Company recorded an initial loss of $531,311 on issuance of the April Unit in accordance
with ASC 820-10-30-3A (see Note 9 for assumptions).
On
April 20, 2015, the Company issued an aggregate of 6,979 shares of Common Stock to its advisory board members. Each of the nine
members of the advisory board received 775 shares of common stock. The fair value of the Common stock on the issuance date was
$102,585.
On
May 12, 2015, the Company agreed to convert accrued and unpaid salaries owed to Charles Allen, the Company’s Chief Executive
Officer, and Michal Handerhan, the Company’s Chief Operating Officer (collectively the “Employees”) into shares
of Common Stock pursuant to conversion agreements (collectively, the “Salary Conversion Agreements”). The Company
recorded $25,000 accrued salaries as of March 31, 2015. Charles Allen converted $25,000 of accrued and unpaid salary for the months
of March 2015 and April 2015 into 833 shares of Common Stock at a per share price of $30.0. Michal Handerhan converted $25,000
of accrued and unpaid salary for the months of March 2015 and April 2015 into 833 shares of Common Stock at a per share price
of $30.0.
During
the quarter ended June 30, 2015, the Company issued a total 2,856 shares of Common Stock at a per share price of $18.6 to certain
vendors. The shares were issued pursuant to a conversion agreement for an aggregate conversion amount of $53,230. The conversion
amount was in consideration for advisory services.
On
June 16, 2015, the Company issued 758 shares of Common Stock to a vendor for construction works provided in our North Carolina
facility. The fair value of the Common Stock on the issuance date was $9,146, and was capitalized as leasehold improvement.
During
the quarter ended September 30, 2015, the Company issued 7,950 shares of Common Stock to various independent contractors for services
provided at its facility in North Carolina and investor relations services. The weighted average fair value of the common stock
on the issuance date was $10.8 per share.
On
October 14, 2015, the Company issued 2,701 shares of Common Stock to ATG Capital LLC for its cashless warrants exercise.
On
October 29, 2015, the Company issued 667 shares of Common Stock at a per share price of $18.0 to RK Equity Advisors LLC. The shares
were issued pursuant to a conversion agreement for an aggregate conversion amount of $12,000. The conversion amount was in consideration
for financial advisory services. The fair value of the Common Stock on the issuance date was $4,400.
On
November 20, 2015, the Company issued 1,333 shares of Common Stock at a per share price of $18.0 to RK Equity Advisors LLC. The
shares were issued pursuant to a conversion agreement for an aggregate conversion amount of $24,000. The conversion amount was
in consideration for financial advisory services. The fair value of the Common Stock on the issuance date was $8,800.
2016
Activities
On
June 3, 2016, the Company and investors from a private placement as of April 20, 2015 (the “Subscription Agreement”)
entered into an amendment agreement (the “Amendment Agreement”).
Pursuant
to the Amendment Agreement, the Company agreed to pay, on a pro-rata basis to all subscribers that purchased Units in the Offering,
and in proportion to the respective Units purchased by each subscriber, pursuant to the Subscription Agreement, an aggregate $250,000
(“Payment”) upon the occurrence of the following events and in the amounts and on payment dates set forth in connection
with such events: (i) in the event of a closing of any one or more equity or debt financing resulting in aggregate gross proceeds
from the date of this Amendment of $350,000 or less, a payment towards the then-remaining Payment equal to ten-percent (10%) of
such gross proceeds shall be made within three (3) business days of the closing of any such equity or debt financing; (ii) in
the event of a closing of any one or more equity or debt financing resulting in aggregate gross proceeds from the date of this
Amendment of $350,000 or more but less than $1,000,000, a payment towards the then-remaining Payment equal to twenty-percent (20%)
of such gross proceeds shall be made within three (3) business days of the closing of any such equity or debt financing; (iii)
at any of the Company’s fiscal-year-ends payment will be made in the amount of available cash prior to any payments of bonuses
payable to Mr. Allen, the Company’s CEO, CFO and Chairman, and Mr. Handerhan, the Company’s COO, Secretary and Director;
and (iv) upon closing of any one or more equity or debt financing resulting in aggregate gross proceeds from the date of this
Amendment of $1,000,000 or more, a payment of all then-remaining Payment within three (3) business days of the closing of any
such equity or debt financing.
In
consideration for the Payment, the Subscribers agreed to limit any remedies currently due, if any, or to which they may be entitled
in the future, under the “Favored Nations Provision” of the Subscription Agreement, to the additional issuance of
Common Stock of the Company and warrants (“Warrants”) to purchase Common Stock up to the Common Stock and Warrants
that would not result in each respective Subscriber beneficially owning over 4.99% of the Company’s issued and outstanding
Common Stock.
On
June 8, 2016, the Company and an investor (the “Investor”) holding a warrant dated January 19, 2015 (the “Warrant”)
to purchase 38,750 shares (the “Warrant Shares”) of the Company’s Common Stock entered into a warrant exercise
agreement (the “Exercise Agreement”).
Pursuant
to the Exercise Agreement, the Company agreed to accept as full payment for 8,333 of the Warrant Shares, an aggregate exercise
price equal to $27,500 (the “Exercise Price”) and the Investor irrevocably agreed to exercise the Warrant and deliver
the Exercise Price within 2 days of the Exercise Agreement.
Over
the course of June 8, 2016 through June 28, 2016, the Company issued 68,750 shares of Common Stock for the cash exercise of warrants
resulting in aggregate proceeds of $91,765 to the Company; this includes the $27,500 received in connection with the Exercise
Agreement mentioned above.
Over
the course of June 8, 2016 and June 28, 2016, the Company issued a total of 1,039,013 shares of the Company’s Common Stock
for: i) the conversion of $890,179 of principal and accrued interest on the Senior Notes, and ii) the cashless exercise of the
2016 Warrants.
Over
the course of July 1, 2016 through August 1, 2016, the Company issued a total of 12,146,820 shares of the Company’s Common
Stock for: i) the conversion of $822,685 of principal and accrued interest on the Senior Notes, and ii) the cashless exercise
of warrants. The issuances were exempt from registration pursuant to Rule 506 under Regulation D, the investors are sophisticated
and familiar with our operations, and there was no solicitation in connection with the issuances.
None
of the securities were sold through a broker-dealer and accordingly, there were no placement agent commissions involved.
No registration rights were granted to any of the purchasers. Following these issuances, there were 16,095,929 shares of our Common
Stock issued and outstanding.
As
a result of the Senior Note conversions, the Company became obligated to issue, subject to certain limitations, the following
additional securities: (i) 108,747,774 shares of Common Stock pursuant to “favored nations” provisions in certain
common stockholder subscription agreements which includes those anti-dilution shares of Common Stock previously disclosed; (ii)
warrants to purchase 171,349,405 shares of Common Stock pursuant to “favored nations” provisions in certain common
stockholder subscription agreements which includes those anti-dilution warrants previously disclosed, and (iii) warrants to purchase
97,423,579 shares of Common Stock pursuant to the terms of the warrants issued on December 16, 2016 which includes those
anti-dilution warrants previously disclosed. The Company also lowered the conversion price of the Company’s outstanding
Senior Notes and Junior Notes to $0.0252.
Stock
Purchase Warrants
The
following is a summary of warrant activity for the year ended December 31, 2016:
|
|
Number
of Warrants
|
|
Outstanding as of December
31, 2015
|
|
|
486,723
|
|
Ratchet warrants issued due to price
reset
|
|
|
271,641,648
|
|
Cashless warrant exercise
|
|
|
(3,270,888
|
)
|
Warrants exercise
for cash
|
|
|
(68,750
|
)
|
Outstanding
as of December 31, 2016
|
|
|
268,788,733
|
|
Note
8 - Investment at Cost
Coin
Outlet
On
January 19, 2015, the Company entered into a Convertible Note Purchase Agreement (the “Purchase Agreement”) with Coin
Outlet, Inc. (“Coin Outlet”) pursuant to which the Company purchased a convertible promissory note in the principal
amount of $100,000 (the “Coin Outlet Note”). The Coin Outlet Note accrues interest at 4% per annum and matures on
January 31, 2016. The Coin Outlet Note will convert, on or before the maturity date, upon the occurrence of Coin Outlet’s
next equity financing (or series of financings) in which Coin Outlet receives gross proceeds of at least $1 million (the “Trigger
Financing”). Upon the occurrence of a Trigger Financing, all outstanding principal on the Coin Outlet Note (and, at the
Coin Outlet’s option, accrued but unpaid interest thereon), will convert into such Coin Outlet securities sold in the Trigger
Financing at a price per share equal to 80% of the per share price of the securities sold in the Trigger Financing (the “Note
Conversion Price”). In the event the Note Conversion Price exceeds the quotient of (x) $6 million divided by (y) Coin Outlet’s
fully diluted capitalization (as calculated in the Coin Outlet Note) (such quotient, the “Fully Diluted Value”), then
the Note Conversion Price shall equal the per share price of the securities sold in the Trigger Financing and Coin Outlet shall
issue such additional number of shares of Coin Outlet to the Company such that the average purchase price per share of Coin Outlet
common stock (including shares of Coin Outlet common stock issuable upon conversion of the Coin Outlet Note into the Trigger Financing)
is equal to the Fully Diluted Value.
On
March 26, 2015 the Company acquired 166,756 shares (an additional 2% equity ownership) of Coin Outlet Inc. (“Coin Outlet”)
from Eric Grill, Coin Outlet’s CEO, for11,699 shares of the Company’s Common Stock (“Coin Outlet Investment”).
The Company now owns approximately 4.2% of Coin Outlet’s equity and has the ability to own up to 11% upon exercise of its
previously issued option and warrant. Mr. Grill entered into a lock-up agreement with the Company with respect to his shares,
pursuant to the lockup agreement Mr. Grill is prohibited from the sale of any his shares until after February 5, 2017.
As
of March 31, 2015, the Company assessed the carrying amount of this investment for potential impairment and determined that this
investment is not recoverable due to uncertainties regarding the stability of digital currency markets and steady price decline
in the US dollar equivalent of Bitcoins throughout 2015. The Bitcoin Price Index was $319.70 and $243.39 as of December 31, 2014
and March 31, 2015, respectively. Total impairment was $254,433 for the Coin Outlet Note and Coin Outlet Investment. The fair
value of investment was measured under Level 3 on a non-recurring basis.
Spondoolies
On
May 12, 2015, the Company entered into a Series B Preferred Share Purchase Agreement (the “Share Purchase Agreement”)
and the Management Rights Letter (the “Rights Letter”) with Spondoolies a Bitcoin equipment manufacturer, by way of
a joinder agreement (the “Joinder Agreement”) pursuant to which the Company purchased 29,092 Series B Preferred Shares
of Spondoolies (the “Series B Shares”) for an aggregate purchase price of $1,500,000 (the “Investment”).
After giving effect to the Investment, the Company owns approximately 6.6% of Spondoolies’ equity on a fully diluted basis.
The Series B Preferred Shares are convertible into Spondoolies’ ordinary shares by dividing the original issuance price
of the Series B Preferred Shares ($51.56) by the initial conversion price ($51.56) (the “Conversion Price”). Until
Spondoolies consummates a “Qualified IPO” (as defined substantially as an initial firm commitment underwritten public
offering of Spondoolies’ ordinary shares with net proceeds to Spondoolies of not less than $40 million), the Series B Preferred
shares are subject to anti-dilution protection in the event Spondoolies issues ordinary shares or securities convertible into
or exercisable for ordinary shares at a price per share or conversion or exercise price per share which shall be less than Conversion
Price then in effect, subject to certain customary exceptions. The Conversion Price is subject to adjustment in the event of stock
splits, stock dividends, combination of shares and similar recapitalization transactions. The Series B Shares are also entitled
to certain preemptive rights, and a liquidation preference in the event of dissolution of Spondoolies. The Series B Preferred
Shares are automatically convertible into ordinary shares of Spondoolies upon the occurrence of a Qualified IPO. In connection
with the Company’s purchase of the Series B Preferred Shares, the Company and Spondoolies executed the Rights Letter which
provided the Company with certain rights, including inspection rights, and information rights with respect to Spondoolies financial
statements, appurtenant to the Investment.
On
May 12, 2015, the Company and Spondoolies entered into a letter agreement (the “Letter Agreement”) to clarify and
expand upon certain terms related to a proposed merger (“Proposed Merger”) contained in the LOI. Under the terms of
the Letter Agreement, Spondoolies agreed to provide to the Company: (i) certain exclusivity rights for a period of nine months
(the “Term”) with respect to any proposals or offers from, or enter into any agreements with, any third party relating
to (a) any investment in, or acquisition of, equity interests of Spondoolies or (b) any possible sale or other disposition of
all or any material portion of assets of Spondoolies; (ii) a breakup fee of $50,000 payable by Spondoolies, if the Proposed Merger
is not consummated during the Term as a result of certain circumstances; (iii) a breakup fee of $1,000,000 if the Proposed Merger
was not consummated because the approval of Spondoolies’ board of directors or shareholders for the Proposed Merger was
not obtained and a competing deal is consummated, during the Term; and (iv) Spondoolies agreed to continue to sell its products
to the Company for a period of 3 years, if the Proposed Merger was not consummated and Spondoolies continues to design and manufacture
ASIC Digital Asset mining hardware.
On
September 21, 2015, the Company, Spondoolies, and Shareholders of Spondoolies (the “Selling Shareholders”) entered
into a Share Purchase Agreement, dated as of September 21, 2015, (the “Agreement”) pursuant to which the Company shall
purchase all the shares in Spondoolies (the “Spondoolies Shares”) from the Selling Shareholders so that Spondoolies
will be a wholly-owned subsidiary of the Company after the closing of the transactions contemplated by the Agreement (the “Transaction”).
In
exchange for the Spondoolies Shares, the Selling Shareholders will receive either shares of the Company’s common stock or
shares of the Company’s Series A preferred stock, convertible into the Company’s common stock as described below (collectively,
the “Company’s Securities”). After the completion of the Transaction, the Company’s shareholders will
own a 54.4% to 55.4% stake in the combined company and Spondoolies’ shareholders will own a 44.6% to 45.6% of the combined
company, based on the number of the Company’s securities outstanding immediately following the Transaction. The ownership
range was a function of the Company’s liquidation preference associated with its existing $1.5 million investment in Spondoolies.
The final ownership percentages will be determined prior to closing.
In
addition to standard closing conditions, the closing of the Transactions will not occur until the Selling Shareholders receive
rulings from the Israeli Tax Authority confirming, among other things, that the Selling Shareholders may defer the payment of
applicable Israeli taxes with respect to the Company’s securities received by each Selling Shareholder until the Company’s
securities are sold by the Selling Shareholder, and the approval of the transaction by the Israeli Office of Chief Scientist.
The Company cannot predict the exact timing of the consummation of the merger and can provide no assurances that the merger will
be consummated.
On
December 15, 2015, the Company entered into a Series B Preferred Share Purchase Agreement (the “Spondoolies Share Purchase
Agreement”) with Spondoolies, by way of a joinder agreement (the “Joinder Agreement”) pursuant to which the
Company purchased 14,546 Series B Preferred Shares of Spondoolies (the “Series B Shares”) for an aggregate purchase
price of $750,000 (the “Investment”) or approximately 3% of Spondoolies’ equity on a fully diluted basis. After
giving effect to the Investment and the Company’s prior investment of $1,500,000 on May 12, 2015, the Company owns approximately
9.6% of Spondoolies’ equity on a fully diluted basis.
The
Company had total investment of approximately $2.3 million to Spondoolies as of December 31, 2015.
On
May 5, 2016, the Company was informed that, on May 4, 2016, a hearing was held in the district court in Beersheva, Israel during
which certain parties sought appointment of a temporary liquidator for Spondoolies. As a result of the liquidation the Company
is no longer pursuing the acquisition of Spondoolies. The Company assessed impairment for the Spondoolies investment and determined
that this investment is not recoverable and as such fully impaired.
During
the year ended 2016, the Company recorded impairment loss of approximately $2.3 million.
Note
9 – Notes Payable
On
January 19, 2015, Michal Handerhan, the Company’s Chief Operating Officer and an investor loaned the Company $20,000 and
$45,000 respectively pursuant to Promissory Notes (the “Notes”). The Notes bear interest at the rate of 2% per annum
and mature on December 31, 2015. The Notes may be prepaid, at the option of the Company, without premium or penalty, in whole
or in part at any time or from time to time prior to the in maturity. In May 2015, the Company repaid $20,000 to Mr. Handerhan
on his Notes. On May 31, 2017 the holder of the $45,000 Promissory Note agreed to waive all rights it was entitled to with
respect to the default on the Promissory Note for a onetime payment of $54,000 (the “Payment”) which includes principal
and accrued interest since January 19, 2015, provided that the Payment is paid on or before June 30, 2017 (the “Payment
Deadline”). If the Payment is not made on or before the Payment Deadline then the default interest rate shall be thirty
percent per year.
On
December 16, 2015, the Company, entered into a Securities Purchase Agreement with certain institutional investors (the “Purchasers”),
pursuant to which the Company issued to the Purchasers for an aggregate subscription amount of $1,450,000: (i) 5% Original Issue
Discount Senior Secured Convertible Notes (the “Notes”); and (ii) warrants (the “Warrants”) to purchase
112,778 shares of the Company’s common stock, par value $0.001 per share at an exercise price of $22.50 The aggregate principal
amount of the Notes is $1,450,000 and the Company received $1,377,500 after giving effect to the 5% original issue discount. The
Notes bear interest at a rate equal to 10% per annum (which interest rate is increased to 24% per annum upon the occurrence of
an Event of Default (as defined in the Notes)), have a maturity date of September 16, 2016 and are convertible (principal, and
interest) at any time after the issuance date of the Notes into shares of the Company’s Common Stock at a conversion price
equal to $18.00 per share, subject to adjustment as set forth in the Notes. The Notes provides for two amortization payments on
the six-month and seven-month anniversary of the issue date with each amortization payment being one third of the total outstanding
principal and interest, if the amortization payments are made in cash then the payment is an amount equal to 120% of the applicable
amortization payment. The Notes become payable within three days of the Company consummating a fully underwritten offering.
The
Notes contain certain covenants, such as restrictions on the incurrence of indebtedness, creation of liens, payment of restricted
payments, redemptions, payment of cash dividends and the transfer of assets. The Notes also contain certain adjustment provisions
that apply in connection with any stock split, stock dividend, stock combination, recapitalization or similar transactions. In
addition, subject to limited exceptions, the Purchaser will not have the right to convert any portion of the Notes if the Purchaser,
together with its affiliates, would beneficially own in excess of 4.99% of the number of shares of the Company’s Common
Stock outstanding immediately after giving effect to its conversion. The Purchaser may not convert into or otherwise beneficially
own in excess of 9.99% of the number of shares of the Company’s Common Stock outstanding immediately after giving effect
to its conversion.
Due
to the complexity and number of embedded features within the convertible note and as permitted under ASC 825, the Company elected
to account for the convertible notes and all the embedded features (collectively, the “hybrid instrument”) under the
fair value option. ASC 825 requires the entity to record the financial asset or financial liability at fair value rather than
at historical cost with changes in fair value recorded in the statement of operations. In addition, it requires that upfront costs
and fees related to items for which the fair value option is elected be recognized in earnings as incurred and not deferred. On
the initial measurement date of December 16, 2015, the fair value of the hybrid instrument was estimated at $1,777,408. Because
this transaction was entered into under duress, the Company recorded an initial loss of $952,060 on issuance of the convertible
notes in accordance with ASC 820-10-30-3A.
The
Company used a Monte Carlo model to separately value the Warrants issued in connection with the convertible notes in order to
take into account the possibility of an adjustment to the exercise price associated with new rounds of financing in the future.
The most likely exercise price of the Warrants was estimated under various stock price scenarios and the noteholders’ payoffs
were computed under each scenario. The present value of the mean of such payoffs represents the value of the warrant on any given
valuation date. When the stock price was simulated in the model, the possible scenarios were always between the valuation date
stock price and the initial exercise price of $22.50. As a result, the Company estimated the fair value of the warrant liability
on the issuance date to be $537,152.
On
June 6, 2016, the Company, entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with
certain institutional investors (the “Purchasers”), pursuant to which the Purchaser subscribed for up to $375,000
of a 20% Original Issue Discount Junior Secured Convertible Notes (the “Junior Notes”). The aggregate principal amount
of the Junior Notes issued at the initial close is $125,000 and the Company received $100,000 after giving effect to the 20% original
issue discount. The lead investor was granted the option to require the Company to sell the Purchasers up to two additional Junior
Notes in the principal amount of $125,000 during each of the periods that begin with the Initial Closing Date and end (i) on or
before 45 days from the Initial Closing Date, and (ii) on or before 90 days from the Initial Closing Date.
The
Junior Notes bear no interest except in the event of default which interest rate is 24% per annum upon the occurrence of an Event
of Default (as defined in the Junior Notes), have a maturity date of December 5, 2016 and are convertible (principal, and interest)
at any time after the issuance date of the Junior Notes into shares of the Company’s Common Stock at a conversion price
equal to $18.00 per share. If an Event of Default has occurred, the Junior Note shall be convertible at 60% of the lowest closing
price during the prior twenty (20) trading days of the Company’s Common Stock.
The
Junior Notes contains certain covenants, such as restrictions on the incurrence of indebtedness, creation of liens, payment of
restricted payments, redemptions, payment of cash dividends and the transfer of assets. The Junior Notes also contains certain
adjustment provisions that apply in connection with any stock split, stock dividend, stock combination, recapitalization or similar
transactions. In addition, subject to limited exceptions, each Purchaser will not have the right to convert any portion of the
Junior Note if such Purchaser, together with its affiliates, would beneficially own in excess of 4.99% of the number of shares
of the Company’s Common Stock outstanding immediately after giving effect to its conversion.
In
connection with the Company’s obligations under the Junior Notes, the Company and its subsidiaries (the “Subsidiaries”)
entered into a Security Agreement, Pledge Agreement and Subsidiary Agreement with the lead investor, as agent, pursuant to which
the Company and the Subsidiaries granted a lien on all assets of the Company (the “Collateral”) excluding permitted
indebtedness, for the benefit of the Purchasers, to secure the Company’s obligations under the Junior Notes. Upon an Event
of Default (as defined in the Junior Notes), the Purchaser may, among other things, collect or take possession of the Collateral,
proceed with the foreclosure of the security interest in the Collateral or sell, lease or dispose of the Collateral.
As
a result of the Senior Note conversions, the Company became obligated to issue, subject to certain limitations, the following
additional securities: (i) 108,747,774 shares of Common Stock pursuant to “favored nations” provisions in certain
common stockholder subscription agreements which includes those anti-dilution shares of Common Stock previously disclosed; and
(ii) warrants to purchase 268,788,732 shares of Common Stock pursuant to “favored nations” provisions in certain common
stockholder subscription agreements which includes those anti-dilution warrants previously disclosed. These figures do not reflect
additional warrants to purchase Common Stock issuable to certain investors pursuant to the terms of the warrants issued on December
16, 2016 which includes those anti-dilution warrants previously disclosed. The Company also lowered the conversion price of the
Company’s outstanding Junior Notes and Senior Notes to $0.0252. As of December 31, 2016, the Company does not have sufficient
authorized and unreserved shares to fulfill its obligations with respect to the issuance of new shares of Common Stock. While
no assurances can be made, the Company intends to seek shareholder approval to adjust the Company’s capitalization.
As
of the December 31, 2016 the Company did not have sufficient shares of Common Stock to fulfill its obligations with respect to
its Notes and warrants and has booked a derivative liability of $14,915,419 to account for the shortfall.
As
of December 31, 2016, the Company was in default on its Senior Notes and Junior Notes. On March 9, 2017, the Company completed
a securities exchange offer (the “Note Offer”) with its three convertible note holders (the “Note Holders”).
Pursuant to the Note Offer the Note Holders agreed to exchange i) $868,897 of 5% Original Issue Discount 10% Senior Convertible
Note Due September 16, 2016, originally issued in December 2015 and all accrued interest and liquidated damages owed (collectively
the “Senior Notes”), ii) $175,000 of 20% Original Issue Discount Junior Convertible Notes Due December 5, 2016, originally
issued in June 2016 and all accrued interest and liquidated damages owed (collectively the “Junior Notes”), iii) $220,002
of 8% Convertible Notes Due June 6, 2017, originally issued in December 2016 and all accrued interest owed (collectively the “Convertible
Notes”), and iv) 97,423,579 warrants (the “Senior Warrants”) for 845,631 shares of Series B Convertible Preferred
Stock (the “Preferred”). After giving effect to the Note Offer the Company no longer has any Senior Notes, Junior
Notes or Convertible Notes outstanding.
Note
10 – Fair Value Measurements
The
Company’s assets and liabilities recorded at fair value have been categorized based upon a fair value hierarchy.
The
following table presents information about the Company’s liabilities measured at fair value on a recurring basis and the
Company’s estimated level within the fair value hierarchy of those assets and liabilities as of December 31, 2016 and 2015:
|
|
Fair
value measured at December 31, 2016
|
|
|
|
Total
carrying
value at
|
|
|
Quoted
prices in active markets
|
|
|
Significant
other observable inputs
|
|
|
Significant
unobservable inputs
|
|
|
|
December
31, 2016
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
|
(Level
3)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital
Currencies
|
|
$
|
199
|
|
|
$
|
199
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
23,231,938
|
|
|
|
|
|
|
|
|
|
|
$
|
23,231,938
|
|
Derivative liabilities
for shortfall of shares
|
|
$
|
14,915,419
|
|
|
|
|
|
|
|
|
|
|
$
|
14,915,419
|
|
Convertible notes
at fair value
|
|
$
|
3,283,034
|
|
|
|
|
|
|
|
|
|
|
$
|
3,283,034
|
|
|
|
Fair
value measured at December 31, 2015
|
|
|
|
Total
carrying
value at
|
|
|
Quoted
prices in active markets
|
|
|
Significant
other observable inputs
|
|
|
Significant
unobservable inputs
|
|
|
|
December
31, 2015
|
|
|
(Level
1)
|
|
|
(Level
2)
|
|
|
(Level
3)
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital
Currencies
|
|
$
|
17,036
|
|
|
$
|
17,036
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$
|
3,794,153
|
|
|
|
|
|
|
|
|
|
|
$
|
3,794,153
|
|
Convertible notes
at fair value
|
|
|
1,781,156
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,781,156
|
|
There
were no transfers between Level 1, 2 or 3 during the years ended December 31, 2016 and 2015.
The
following table presents additional information about Level 3 assets and liabilities measured at fair value. Both observable and
unobservable inputs may be used to determine the fair value of positions that the Company has classified within the Level 3 category.
As a result, the unrealized gains and losses for assets and liabilities within the Level 3 category may include changes in fair
value that were attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable
long-dated volatilities) inputs.
Changes
in Level 3 liabilities measured at fair value for the years ended December 31, 2016 and 2015:
Derivative liabilities Balance - January
1, 2015
|
|
$
|
-
|
|
Fair value of derivative
liability on date of issuance (January 19, 2015)
|
|
|
952,600
|
|
Fair value of derivative liability on
date of issuance (April 20, 2015)
|
|
|
2,843,811
|
|
Fair value of derivative liability on
date of issuance (April 20, 2015)
|
|
|
537,152
|
|
Change in fair value of derivative liability
|
|
|
(482,666
|
)
|
Cashless warrants
exercise related to derivative liability (October 15, 2015)
|
|
|
(56,744
|
)
|
Derivative liabilities Balance - December
31, 2015
|
|
$
|
3,794,153
|
|
Change in fair value of derivative liability
|
|
|
(5,921,409
|
)
|
Reclassification from derivative liability
|
|
|
92,601
|
|
Fair value adjustments
for warrant liabilities
|
|
|
25,266,593
|
|
Derivative liabilities
Balance - December 31, 2016
|
|
$
|
23,231,938
|
|
Convertible notes
at fair value Balance - January 1, 2015
|
|
$
|
-
|
|
Fair value of senior
convertible notes on date of issuance (December 16, 2015)
|
|
|
1,777,408
|
|
Change in
fair value of senior convertible notes
|
|
|
3,748
|
|
Convertible notes at fair value
- December 31, 2015
|
|
$
|
1,781,156
|
|
Addition of convertible notes
|
|
|
320,002
|
|
Conversion of notes into common stock
|
|
|
4,208,546
|
|
Gain on extinguishment of debt
|
|
|
(837,369
|
)
|
Change in fair value of convertible
notes (including OID discount)
|
|
|
(2,096,700
|
)
|
Reclassification
to derivative liability
|
|
|
(92,601
|
)
|
Convertible
notes at fair value - December 31, 2016
|
|
$
|
3,283,034
|
|
Derivative liabilities for shortfall
of shares Balance - January 1, 2016
|
|
$
|
-
|
|
Change
in fair value of derivative liability shortfall of shares
|
|
|
14,915,419
|
|
Derivative liabilities
for shortfall of shares Balance - December 31, 2016
|
|
$
|
14,915,419
|
|
The
Company’s derivative liabilities are measured at fair value using the Monte Carlo simulation valuation methodology. A summary
of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in measuring the Company’s
derivative liabilities that are categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2016 is
as follows:
Warrant
Liabilities
Date
of valuation
|
|
December
31, 2016
|
Strike Price
|
|
0.03 - 60.0
|
Volatility
|
|
118% - 230%
|
Risk-free interest rate
|
|
0.35% - 2.23%
|
Contractual life (in years)
|
|
0.10 to 3.96
|
Dividend yield (per share)
|
|
0
|
Derivative
Liabilities for shortfall of shares
Date
of valuation
|
|
December
31, 2016
|
Strike Price
|
|
0.0252
|
Volatility
|
|
268.69%
|
Risk-free interest rate
|
|
1.78%
|
Contractual life (in years)
|
|
3.75
|
Dividend yield (per share)
|
|
0%
|
Senior
Convertible Notes at Fair Value
Date
of valuation
|
|
December
31, 2016
|
Strike Price
|
|
0.0252
|
Volatility
|
|
300.42% - 328.04%
|
Risk-free interest rate
|
|
0.51% - 0.63%
|
Dividend yield (per share)
|
|
0%
|
The
development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the
responsibility of the Company’s Management.
Note
11 – Stock Based Compensation
2014
Equity Incentive Plan
On
January 30, 2014, the Board of Directors of the Company approved and authorized the adoption of the 2014 Equity Incentive Plan
(the “2014 Plan”). The purpose of the 2014 Plan is to promote the success of the Company and to increase stockholder
value by providing an additional means through the grant of awards to attract, motivate, retain and reward selected employees
and other eligible persons. The 2014 Plan provides for the grant of incentive stock options, nonqualified stock options, restricted
stock, restricted stock units, stock appreciation rights and other types of stock-based awards to the Company’s employees,
officers, directors and consultants. Pursuant to the terms of the 2014 Plan, either the Board or a board committee is authorized
to administer the plan, including determining which eligible participants will receive awards, the number of shares of common
stock subject to the awards and the terms and conditions of such awards. Unless earlier terminated by the Board, the Plan shall
terminate at the close of business on January 30, 2024. Up to 258,395 shares of common stock are issuable pursuant to awards under
the 2014 Plan.
Compensation
expense for all stock-based awards is measured on the grant date based on the fair value of the award and is recognized as an
expense, on a straight-line basis, over the employee’s requisite service period (generally the vesting period of the equity
award). The fair value of each option award is estimated on the grant date using a Black-Scholes option valuation model. Stock-based
compensation expense is recognized only for those awards that are expected to vest using an estimated forfeiture rate. The Company
estimates pre-vesting option forfeitures at the time of grant and reflects the impact of estimated pre-vesting option forfeitures
in compensation expense recognized. For options and warrants issued to non-employees, the Company recognizes stock compensation
costs utilizing the fair value methodology over the related period of benefit.
The
cancellation and reissuance of these stock options was treated as a modification and, accordingly, total stock-based compensation
expense related to these awards increased $6,349,113, which will be recognized over the new vesting period.
Stock
Option Activity
On
July 2, 2015, the Company entered into Option Cancellation and Release Agreements with each of Charles Allen, its Chief Executive
Officer, Chief Financial Officer and Chairman, and Michal Handerhan, its Chief Operating Officer and corporate secretary (collectively,
the “Company Option Holders”) pursuant to which the Company Option Holders agreed to return options to purchase up
to 207,500 shares in the aggregate of the Company’s Common Stock, par value $0.001 per share, with an exercise price of
$6.00. The Company Option Holders canceled their options without replacement, and the amortization of the unrecognized stock compensation
expenses were accelerated on July 2, 2015 for a total $3,629,804.
Total
stock-based compensation expense was approximately $0 and $6.4 million for the years ended December 31, 2016 and 2015, respectively.
There
are no stock options outstanding as of December 31, 2016.
|
|
Number
of Options
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Weighted
Average
Grant
Date Fair
Value per
Share
|
|
|
Average
Remaining Contractual
Life
|
|
|
Average
Intrinsic
Value
|
|
Outstanding
at January 1, 2015
|
|
|
207,500
|
|
|
$
|
6.00
|
|
|
$
|
0.60
|
|
|
|
8.0
|
|
|
$
|
-
|
|
Canceled
|
|
|
(207,500
|
)
|
|
|
6.00
|
|
|
|
0.60
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
as of December 31, 2015
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding
as of December 31, 2016
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Note
12
- Employment
Agreements
Charles
W. Allen
On
July 2, 2015, we entered into an Option Cancellation and Release Agreement with Charles Allen pursuant to which Mr. Allen voluntarily
agreed to return to us for cancellation, an eight year non-qualified stock option under the Company’s 2014 Plan to purchase
up to an aggregate of 158,334 shares of the Company’s common stock with a per share exercise price of $6.00, held by him.
On
June 22, 2017, we entered into an employment agreement with Charles Allen (the “Allen Employment Agreement”),
whereby Mr. Allen agreed to serve as our Chief Executive Officer and Chief Financial Officer for a period of two (2) years, subject
to renewal, in consideration for an annual salary of $245,000. Additionally, under the terms of the Allen Employment Agreement,
Mr. Allen shall be eligible for an annual bonus if we meet certain criteria, as established by the Board of Directors. Mr. Allen
shall be entitled to participate in all benefits plans we provide to our senior executive. We shall reimburse Mr. Allen for all
reasonable expenses incurred in the course of his employment. The Company shall pay the Executive $500 per month to cover telephone
and internet expenses. If the Company does not provide office space to the Executive the Company will pay the Executive an additional
$500 per month to cover expenses in connection with their office space needs.
Michal
Handerhan
On
July 2, 2015, we entered into an Option Cancellation and Release Agreement with Michal Handerhan pursuant to which Mr. Handerhan
voluntarily agreed to return to us for cancellation, an eight year non-qualified stock option under the 2014 Plan to purchase
up to an aggregate of 49,167 shares of the Company’s common stock with a per share exercise price of $6.00, held by him.
On
June 22, 2017, we entered into an employment agreement with Michal Handerhan (the “Handerhan Employment Agreement”),
whereby Mr. Handerhan agreed to serve as our Chief Operating Officer and Secretary for a period of two (2) years, subject to renewal,
in consideration for an annual salary of $190,000. Additionally, under the terms of the Handerhan Employment Agreement, Mr. Handerhan
shall be eligible for an annual bonus if we meet certain criteria, as established by the Board of Directors. Mr. Handerhan shall
be entitled to participate in all benefits plans we provide to our senior executive. We shall reimburse Mr. Handerhan for all
reasonable expenses incurred in the course of his employment. The Company shall pay the Executive $500 per month to cover telephone
and internet expenses. If the Company does not provide office space to the Executive the Company will pay the Executive an additional
$500 per month to cover expenses in connection with their office space needs.
The
terms of the Allen Employment Agreement and Handerhan Employment Agreement (collectively the “Employment Agreements”)
provide each of Messrs. Allen and Handerhan (the “Executives”) certain, severance and change of control benefits if
the Executive resigns from the Company for good reason or the Company terminates him other than for cause. In such circumstances,
the Executive would be entitled to a lump sum payment equal to (i) the Executive’s then-current base salary, and (ii) payment
on a pro-rated basis of any bonus or other payments earned in connection with any bonus plan to which the Executive was a participant.
In addition, the severance benefit for the Executives the employment agreements include the Company continuing to pay for medical
and life insurance coverage for up to one year following termination. If, within eighteen months following a change of control
(as defined below), the Executive’s employment is terminated by the Company without cause or he resigns from the Company
for good reason, the Executive will receive certain severance compensation. In such circumstances, the cash benefit to the Executive
will be a lump sum payment equal to two times (i) his then-current base salary and (ii) his prior year cash bonus and incentive
compensation. Upon the occurrence of a change of control, irrespective of whether his employment with the Company terminates,
each Executive’s stock options and equity-based awards will immediately vest.
A
“change of control” for purposes of the Employment Agreements means any of the following: (i) the sale or partial
sale of the Corporation to an un-affiliated person or entity or group of un-affiliated persons or entities pursuant to which such
party or parties acquire shares of capital stock of the Corporation representing at least twenty five (25%) of the fully diluted
capital stock (including warrants, convertible notes, and preferred stock on an as converted basis) of the Corporation; (ii) the
sale of the Corporation to an un-affiliated person or entity or group of such persons or entities pursuant to which such party
or parties acquire all or substantially all of the Corporation’s assets determined on a consolidated basis, or (iii) Incumbent
Directors (Mr. Allen and Mr. Handerhan) cease for any reason, including, without limitation, as a result of a tender offer, proxy
contest, merger or similar transaction, to constitute at least a majority of the board of directors of the Company.
Additionally,
pursuant to the terms of the Employment Agreements, we have agreed to execute and deliver in favor of the Executives an indemnification
agreement and to maintain directors’ and officers’ insurance with terms and in the amounts commensurate with our senior
executive.
Note
13 - Related Party Transactions
On
December 18, 2014, Charles Allen, the Company’s Chief Executive Officer contributed $7,990 of brand new Digital Asset mining
hardware at cost in exchange for a promissory note (the “Allen Note”). The Allen Note bears interest at a rate of
2% per year and is due on December 31, 2015. The Allen Note may be prepaid, at our option, without premium or penalty, in whole
or in part at any time or from time to time prior to the Allen Note maturity. On February 10, 2015, the Company paid back $3,000
on the Allen Note. On May 8, 2015, the Company paid in full the remaining balance of the promissory note issued to Charles Allen,
including $4,990 in principal and $48 in accrued interest.
On
January 19, 2015, Michal Handerhan, the Company’s Chief Operating Officer loaned the Company $20,000 pursuant to Promissory
Notes (the “Handerhan Note”). The Handerhan Note bears interest at the rate of 2% per annum and matures on December
31, 2015. The Handerhan Note may be prepaid, at the option of the Company, without premium or penalty, in whole or in part at
any time or from time to time prior to the Handerhan Note maturity. On February 17, 2015, the Company paid back $3,000. On May
4, 2015, the Company repaid $10,000 in principal of the promissory note issued to Michal Handerhan. On May 13, 2015, the Company
paid in full the remaining balance of the promissory note issued to Michal Handerhan, including $7,000 in principal and $108 in
accrued interest.
On
January 19, 2015 (the “Closing Date”), the Company sold an aggregate of 72,167 units (each a “January Unit”)
in a private placement (the “January Private Placement”) of its securities to certain investors at a purchase price
of $6.00 per January Unit pursuant to subscription agreements for an aggregate purchase price of $433,000. Charles Allen,
the Company’s Chief Executive Officer, and Michal Handerhan, the Company’s Chief Operating Officer, each purchased
834 January Units in the January Private Placement for $5,000 per executive.
On
April 20, 2015 (the “Closing Date”), the Company sold an aggregate of 128,472 units (each a “April Unit”)
in a private placement (the “April Private Placement”) of its securities to certain investors at a purchase price
of $18.00 per April Unit pursuant to subscription agreements for an aggregate purchase price of $2,312,500. Charles Allen,
the Company’s Chief Executive Officer and Michal Handerhan, the Company’s Chief Operating Officer each purchased 1,111
April Units for $20,000 per executive in the April Private Placement.
On
May 12, 2015, the Company agreed to convert accrued and unpaid salaries owed to Charles Allen, the Company’s Chief Executive
Officer, and Michal Handerhan, the Company’s Chief Operating Officer (collectively the “Employees”) into shares
of Common Stock pursuant to conversion agreements (collectively, the “Salary Conversion Agreements”). The Company
recorded $25,000 accrued salaries as of March 31, 2015. Charles Allen converted $25,000 of accrued and unpaid salary for the months
of March 2015 and April 2015 into 834 shares of Common Stock at a per share price of $30.00. Michal Handerhan converted $25,000
of accrued and unpaid salary for the months of March 2015 and April 2015 into 834 shares of Common Stock at a per share price
of $30.00.
On
February 19, 2016, the Company entered into a securities escrow agreement (the “Securities Escrow Agreement”) with
Charles Allen its Chief Executive Officer, Chief Financial Officer and Chairman, and Michal Handerhan, its Chief Operating Officer
and corporate secretary (collectively, the “Principal Stockholders”). Pursuant to the Securities Escrow Agreement
and for the benefit of the Company’s public shareholders the Principal Stockholders voluntarily agreed to place stock certificates
representing 400,000 shares of Common Stock (the “Escrow Shares”) into escrow.
The
return of 200,000 escrowed shares (the “Listing Escrow Shares”) to the Principal Stockholders shall be based upon
the successful listing of the Company’s Common Stock on a National Stock Exchange on or before December 31, 2016 (the “Listing
Condition”). The Listing Escrow Shares will be returned to the Company for cancelation for no consideration if the Company
fails to achieve the Listing Condition. The return of 200,000 escrowed shares (the “Merger Escrow Shares”) to the
Principal Stockholders shall be based upon the successful consummation of the merger with Spondoolies on or before December 31,
2016 (the “Merger Condition”). The Merger Escrow Shares will be returned to the Company for cancelation for no consideration
if the Company fails to achieve the Merger Condition.
Pursuant
to the June 3, 2016 Amendment Agreement (as defined in Note 7 ) the Principal Stockholders each received $86 in connection
with their pro-rata portion of the Payment (as defined in Note 7 ). In April 2015, the Principal Stockholders each
subscribed for $20,000 in the Subscription Agreement (as defined in Note 7) for an aggregate of $40,000.
On
January 30, 2017, the Company received 24,000,000 shares of Common Stock for cancelation for no consideration (the “Escrow
Shares”). The Escrow Shares were placed in escrow by Charles Allen our Chief Executive Officer, Chief Financial Officer
and Chairman, and Michal Handerhan, our Chief Operating Officer and corporate secretary (collectively, the “Principal Stockholders”)
pursuant a securities escrow agreement dated February 19, 2016 (the “Securities Escrow Agreement”).
Pursuant
to the Securities Escrow Agreement and for the benefit of the Company’s public shareholders the Principal Stockholders voluntarily
agreed to place stock certificates representing the Escrow Shares into escrow. The Company failed to list the Company’s
Common Stock on a national securities exchange on or before December 31, 2016 and failed to consummated the merger with Spondoolies-Tech
Ltd. on or before December 31, 2016. The escrow agent returned the shares to the Company for cancelation for no consideration.
Note
14 – Commitments and Contingencies
On
May 28, 2015 the Company entered an operating sub-lease agreement ending on May 31, 2016 for its headquarters in Arlington, Virginia.
Prepaid expenses include $12,000 of fixed minimum lease payment that was prepaid through May 31, 2016. The sub-lease was subsequently
extended on a month-to-month basis for $500 per month from June 1, 2016 through December 31, 2016. After December 31, 2016 the
Company was not party to any lease agreements for corporate office space and its employees have been working virtually. The Company
is paying each of Mr. Allen and Mr. Handerhan $500 per month to cover out of pocket expenses associated with phone, internet and
office space.
Note
15 - North Carolina Facility
On
January 28, 2015, DM entered into a commercial lease agreement (the “Lease”). The term of the Lease commenced on January
28, 2015 and ends on January 25, 2017. The annual rental fee for the first and second year will be $58,271 and $66,750, respectively.
The Company also has the option to purchase the property during the second year of the Lease term for a purchase price of $775,000
less the $10,000 security deposit and all lease payments.
On
July 20, 2016, DM suspended its North Carolina transaction verification services facility operations. The recent reduction in
the block reward from 25 bitcoins to 12.5 bitcoins, often referred to as the halving, coupled with the facilities cooling system
failing, has resulted in DM being unable to meet certain of its financial commitments. The Company has subsequently ceased operations
at DM.
On
August 8, 2016, DM discovered that its facility in North Carolina was broken into and certain of its equipment and approximately
165 Bitmain transaction verification servers leased from CSC were stolen. The value of the stolen equipment owned by the Company
does not appear to be material. The Company reported the theft to local authorities as well its insurance company regarding next
steps. The Company received payment from the insurance company in the amount of approximately $85,000 and has assigned the payment
to the benefit of CSC as part of the settlement agreement with CSC the Company’s equipment finance provider which owned
the stolen serves.
On
September 1, 2016, DM gave cancelation notice to the landlord with respect to the Lease of its North Carolina facility.
Note
16 – Income Taxes
The
Company had no income tax expense due to operating loss incurred for the years ended December 31, 2016 and 2015.
The
tax effects of temporary differences and tax loss and credit carry forwards that give rise to significant portions of deferred
tax assets and liabilities at December 31, 2016 and 2015 are comprised of the following:
|
|
As
of December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
|
Net-operating
loss carryforward
|
|
$
|
3,116,646
|
|
|
$
|
1,177,872
|
|
Stock-based
compensation
|
|
|
-
|
|
|
|
7,695,805
|
|
Other
|
|
|
1,478
|
|
|
|
316,736
|
|
Total
Deferred Tax Assets
|
|
|
3,118,124
|
|
|
|
9,190,413
|
|
Valuation
allowance
|
|
|
(3,118,124
|
)
|
|
|
(9,190,413
|
)
|
Deferred
Tax Asset, Net of Allowance
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
For
the years ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Federal
|
|
|
|
|
|
|
|
|
Current
|
|
$
|
-
|
|
|
$
|
-
|
|
Deferred
|
|
|
-
|
|
|
|
3,066,159
|
|
State
|
|
|
|
|
|
|
|
|
Current
|
|
|
-
|
|
|
|
-
|
|
Deferred
|
|
|
3,118,124
|
|
|
|
491,036
|
|
Valuation
allowance
|
|
|
(3,118,124
|
)
|
|
|
(3,557,196
|
)
|
Income
tax provision
|
|
$
|
-
|
|
|
$
|
-
|
|
At
December 31, 2016, the Company had net operating loss carry forwards for federal and state tax purposes of approximately $7.9
million which expires in 2036. Prior to the merger, the Company had generated net operating losses, which the Company’s
preliminary analysis indicates would be subject to significant limitations pursuant to Internal Revenue Code Section 382. The
Company has not completed its IRC Section 382 Valuation, as required and the NOL’s because of potential Change of Ownerships
might be completely worthless. Therefore, Management of the Company has recorded a Full Valuation Reserve, since it is more likely
than not that no benefit will be realized for the Deferred Tax Assets.
In
assessing the realization of deferred tax assets, management considers whether it is more likely than not that some portion or
all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income during the period in which those temporary differences become deductible. Management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income and taxing strategies in making this assessment. In case
the deferred tax assets will not be realized in future periods, the Company has provided a valuation allowance for the full amount
of the deferred tax assets at December 31, 2016. The valuation allowance decreased by approximately $6.1 million as of December
31, 2016.
The
expected tax expense (benefit) based on the U.S. federal statutory rate is reconciled with actual tax expense (benefit) as follows:
|
|
For
the years ended December 31,
|
|
|
|
2016
|
|
|
2015
|
|
Statutory
Federal Income Tax Rate
|
|
|
(34.0
|
)%
|
|
|
(34.0
|
)%
|
State Taxes, Net of Federal
Tax Benefit
|
|
|
(5.4
|
)%
|
|
|
(5.4
|
)%
|
Other
|
|
|
|
|
|
|
4.2
|
%
|
Change
in Valuation Allowance
|
|
|
39.4
|
%
|
|
|
35.2
|
%
|
Income
Taxes Provision (Benefit)
|
|
|
-
|
%
|
|
|
-
|
%
|
The
Company has not identified any uncertain tax positions requiring a reserve as of December 31, 2016.
Note
17 - Subsequent Events
The
Company evaluates events that have occurred after the balance sheet date but before the consolidated financial statements are
issued. Based upon the evaluation, the Company did not identify any recognized or non-recognized subsequent events that would
have required adjustment or disclosure in the consolidated financial statements other than disclosed.
On
February 28, 2017, the Company issued 4,370 shares of Common Stock in connection with the 60:1 reverse stock split resulting from
the rounding up of fractional shares of Common Stock to the whole shares of Common Stock.
On
March 9, 2017, the Company completed a securities exchange offer (the “Note Offer”) with its three convertible note
holders (the “Note Holders”). Pursuant to the Note Offer the Note Holders agreed to exchange i) $868,897 of 5% Original
Issue Discount 10% Senior Convertible Note Due September 16, 2016, originally issued in December 2015 and all accrued interest
and liquidated damages owed (collectively the “Senior Notes”), ii) $175,000 of 20% Original Issue Discount Junior
Convertible Notes Due December 5, 2016, originally issued in June 2016 and all accrued interest and liquidated damages owed (collectively
the “Junior Notes”), iii) $220,002 of 8% Convertible Notes Due June 6, 2017, originally issued in December 2016 and
all accrued interest owed (collectively the “Convertible Notes”), and iv) 97,423,579 warrants (the “Senior Warrants”)
for 845,631 shares of Series B Convertible Preferred Stock (the “Preferred”).
On
March 9, 2017, as a result of the Note Offer becoming effective, a securities exchange offer made to the Company’s January
19, 2015 investors (the “January Offer”) was accepted by certain of those investors (the “January Investors”).
Pursuant to the January Offer the January Investors agreed to exchange i) 12,052,344 shares of common stock owed pursuant to the
favored nations provision of the January 19, 2015 subscription agreement (the “January Agreement”), and ii) 30,130,861
warrants owed pursuant to the favored nations provision of the January Agreement for 210,919 shares of Preferred.
On
March 9, 2017, as a result of the Note Offer becoming effective, a securities exchange offer made to the Company’s April
19, 2015 investors (the “April Offer”) was accepted by certain of those investors (the “April Investors”).
Pursuant to the April Offer, the April Investors agreed to exchange i) 20,110,699 shares of Common Stock owed pursuant to the
favored nations provision of the April 19, 2015 subscription agreement (the “April Agreement”), and ii) 28,154,980
warrants owed pursuant to the favored nations provision of the April Agreement for 52,311 shares of Preferred.
On
March 15, 2017, the Company filed a Certificate of Designation for the Preferred with the Secretary of State of the State of Nevada.
The Preferred Certificate of Designation provides authorization for the issuance of 1,108,861 shares of Preferred, par value $0.001.
On
March 22, 2017, the Company entered into a Settlement Agreement and Note (the “CSC Agreement”) with CSC Leasing Company
(“CSC”) with respect to the equipment lease schedule entered into between CSC and the Company (the “CSC Lease”).
Pursuant to the CSC Agreement the Company has agreed to: i) issue CSC 833,333 shares of the Company’s common stock (the
“Shares”), and ii) pay CSC $200,000 (the “Cash Payment”).
Between
March 15, 2017 and June 5, 2017, the Company issued 24,628,136 shares of Common Stock for the cashless exercise of 37,948,307
warrants.
Between
March 28, 2017 and June 8, 2017, the Company issued 32,402,600 shares of Common Stock upon the conversion of 162,013 shares of
Series B Convertible Preferred stock.
On
April 26, 2017, the Company entered into a Settlement Agreement with RK Equity Advisors, LLC, and Pickwick Capital Partners, LLC
(collectively “RKPCP”) pursuant to which the Company terminated the engagement letter with RKPCP including all provisions
and any obligations to pay future fees. As consideration for the termination the Company issued Pickwick Capital Partners, LLC
125,000 shares of Common Stock.
On
May 25, 2017 the Company raised $1 million in cash from four institutional investors in exchange for the issuance of $1,111,111
of a new class of Series C Convertible Preferred Stock (“Series C”) and three types of warrants as described below.
The 79,368 Series C shares are initially convertible into 15,873,600 shares of common stock. The Series C is convertible at $0.7
per share or approximately $0.063 per share after giving effect to the additional $111,111, subject to reduction in the
event of future sales of equity securities and common stock equivalents (with customary exemptions) at a lower price. The Company
is subject to a number of customary covenants and a restriction on the incurrence of indebtedness for one year. Within 120 days,
the Company has agreed to file a registration statement covering the common stock issuable upon exercise of the registrable securities
described below. The registration statement will cover 47,302,176 shares of common underlying the Series A Warrants, Additional
Warrants, and Bonus Warrants, which warrants are described below:
15,873,600
Series A Warrants exercisable at $0.085 per share, subject to adjustment, over a five-year period;
15,714,288
Additional Warrants exercisable at $0.085 per share, subject to adjustment, over a period which is the earlier of (i) one-year
after the effective date of a registration statement covering the warrant shares, or (ii) three years from the date of issuance.
The Additional Warrants are callable by the Company for nominal consideration if the common stock trades above $0.17 per share
and the daily volume is more than $50,000 for at least 20 trading days;
15,714,288
Bonus Warrants exercisable at $0.17 per share, over a three-year period. The Bonus Warrants are also callable for nominal consideration
but the threshold price is more than $0.30 per share.
On
May 31, 2017 the holder of the $45,000 Promissory Note agreed to waive all rights they’re entitled to with respect to the
default on the Promissory Note for a onetime payment of $54,000 (the “Payment”) which includes principal and accrued
interest since January 19, 2015, provided that the Payment is paid on or before June 30, 2017 (the “Payment Deadline”).
If the Payment is not made on or before the Payment Deadline then the default interest rate shall be thirty percent per year.