Written by Alan Yong, CEO, DNotes Global
Over the last couple of years, initial coin offerings (ICOs) have proven to be a truly revolutionary and inclusive tool for capital formation. Unfortunately, they have also drawn all the wrong kinds of attention and are now a real source of controversy in many circles. Their unregulated, Wild West nature has led several countries to ban them altogether. Meanwhile, in countries that haven’t taken such drastic measures, ICOs are receiving greater scrutiny from government regulators. The question that many in the cryptocurrency industry must now ask is simple: where do we go from here?
If you are thinking about participating in an initial coin offering in any way – as an investor, a legal advisor, or a company contemplating your own ICO launch – I urge you to take a few moments to consider that question. I have serious concerns about the current state of initial coin offerings and believe that their future viability as a fundraising tool may be in jeopardy if current trends continue unabated.
ICOs Are a Tremendous Tool for Capital Formation – But Change is Needed
However, I have been consistent in expressing my thoughts on this subject. I have praised the ICO for its innovative approach to helping even the smallest startups raise the capital they need for their businesses. It’s difficult for most people to comprehend just how revolutionary the initial coin offering concept is, and how it enables virtually anyone around the world to participate in a digitalized crowdfunding effort and potentially enjoy investment returns that were previously unthinkable for the average small investor.
When we consider the many advantages ICOs can offer, they represent a superior option for fundraising when compared to traditional capital formation strategies and tools. For example:
- Low-Cost, High-Power, Funding Package. It costs very little to launch a new coin, thanks to the ingenious blockchain technology that underpins digital tokens
- Instantaneous Global Reach and Participation. In a digital world, this type of digitalized fundraising allows startups in need of capital to reach out to everyone around the globe
- Immediate Liquidity. Once a coin is listed on a cryptocurrency exchange, investors have access to trading capabilities that provide immediate liquidity
- Immediate Exit Strategy. Venture capitalists often wait several years before they can get their money back, either through a buyout or IPO
- No middle man. There is no need for intermediaries, and thus no one collecting fees or commissions. That can offer substantial cost savings for everyone involved in an ICO
- Allows for micro-investment. An ICOs very nature provide an opportunity for even small retail investors to participate.
At the same time, however, I have been skeptical of the approach that many in the crypto industry have adopted with respect to regulation and compliance with existing laws. Of course, that has always been the case with new technologies, unfortunately. Anyone old enough to remember the Internet revolution will see parallels to the way that industry resisted regulation in its early days. That was not abnormal, of course, since most industries are at least somewhat leery of government regulation. And we really shouldn’t be surprised that the cryptocurrency industry has a similar attitude toward regulatory compliance.
Still, there are problems that must be addressed if the ICO is to continue to exist in countries around the world. Governments take a dim view of those who openly flout the law, and eventually those governments react – and do so vigorously. Take American law, for example. In the United States, regulators have made their positions well-known when it comes to initial coin offerings. According to the U.S. Securities and Exchange Commission Chairman Jay Clayton, every ICO that he has seen to date meets the definition of a security under U.S. law. More importantly, he has said that the agency has no intention of changing that definition to accommodate this new capital formation tool. More importantly, lawmakers would need to act before the securities laws on the book can be changed.
The Scrutiny Has Already Intensified
What does that mean for ICOs and the industry that so often relies upon them for its fundraising? It’s simple: if the SEC has decided that every ICO is a security, then those coin offerings must be conducted in compliance with existing securities laws and regulations. That means properly registering them with the SEC or obtaining an exemption that allows them to avoid registration. There is no gray area here. The industry will comply, or the government will move to make them comply.
In fact, governments are already acting. China banned ICOs last year. South Korea followed suit. And on it goes. While the U.S. has yet to ban initial coin offerings, 2018 has seen a rash of reports confirming that the agency is conducting an ongoing probe of companies that have launched unregistered ICOs. Earlier this year, we learned that the agency had subpoenaed dozens of technology companies that launched their own ICOs, as well as their lawyers and advisers. According to those reports, regulators wanted information related to the ICO sale structures and investor identities.
It is easy to understand why the regulators would be undertaking such a probe. A Satis Group study earlier this year concluded that roughly 80 percent of ICOs have been scams, according to Investopedia. Even more disheartening, only 8 percent of those offerings ever reached the stage where the offered tokens eventually made it to the cryptocurrency exchanges for trading.
If the results of that study are even close to being accurate, then it’s little wonder that the SEC is investigating the industry’s use of initial coin offerings. Add to that the fact that Chairman Clayton has been clear about the agency’s position on ICOs, and the future becomes all-too predictable. The regulators are going to take strong action if the industry doesn’t get into compliance – and quickly.
The Solution is Simple
The good news is that this is not a difficult problem or one that the industry is incapable of solving. The solution is simple, if we take heed of the regulators’ prior warnings. For example, Chairman Clayton told the U.S. Senate banking committee early in 2018 that, as of February 6th, the agency had not seen a single ICO register with the SEC. Not one. And what was his take on that failure to register? He said,
“Many ICOs are being conducted illegally. Their promoters and other participants are not following our security laws. Some people say that’s because the law isn’t clear. I do not buy that for a moment.”
In my opinion, we would be unwise to wait for a new set of regulations specific to the industry. The regulators have made it clear that they are not going to redefine securities laws. Instead, they clearly view ICOs as securities, and demand that all coin offerings be issued in accordance with existing regulations. From their perspective, that means registering with the SEC or obtaining an exemption.
I believe that it would be a mistake to be complacent or allow ourselves to be deluded into believing that this problem will go away if we just ignore it. The Chairman is on record stating that unregistered ICOs are being conducted illegally. As an industry, it is in our interest to acknowledge that stated position and accept it as a call to action. If we don’t take steps to comply with those laws and regulations, the government will do it for us.
Again, I firmly believe that initial coin offerings are a tremendously amazing capital formation tool that can benefit companies and individuals throughout the world. The digital currency industry and regulators need to work together to ensure that this tool survives. For the cryptocurrency industry, that will almost certainly mean greater attention to complying with securities laws and other legal requirements. That compliance would give the regulators the assurances they need to confidently apply a light touch to oversight of the industry. If we can manage this cooperation successfully, we can ensure that this amazing technology and its fundraising innovations continues to create new opportunities for small investors, startups, and individuals around the globe.