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What Happens If Cryptocurrency Technologies Are Regulated as Securities?

The SEC is getting serious about initial coin offering (ICO) oversight.

EtheriumNuno Maia / Dreamstime.comOne of the hottest scenes in the cryptocurrency community today revolves around what's known as an "ICO," or initial coin offering. An ICO is a kind of futuristic fundraising round. Rather than relying on regulations and lawyers to guide investment, developers of an upcoming project solicit funds to build out a planned technology platform in exchange for tokens that investors can then trade or use on the platform itself when it is complete. Developers gain access to needed funding in order to make their vision a reality. Investors are rewarded for their early insight with profits and first access to the platform. Everyone wins, and innovation proceeds apace.

At least, this is the ideal. In practice, a lot of ICOs end up being unexpectedly complex works-in-progress (to be extremely charitable) at best and outright scams at the worst. A tiny handful—we're talking maybe two or three—of ICOs seem to have lived up to their promises. Maybe others will follow. But a worrying number of them have unfortunately looked more like fly-by-night get-rich-quick cons hoping to piggyback on the buzz of the cryptoeconomy than an innovative funding mechanism for the technologies of tomorrow.

For these reasons, securities regulators across the world have started to turn a sharp eye to the ICO space, with important implications for the future of this kind of project structure. In the U.S., the Securities and Exchange Commission (SEC) has been closely watching the ICO space for some time, and it has recently signaled that it may undertake more rigorous interventions in coming months.

ICOs in a nutshell

To say that ICOs are going gangbusters is a bit of an understatement: The total number of ICOs grew from a handful in 2014 and 2015, to a few dozen in 2016, to a whopping 343 in 2017. Roughly 300 ICOs have launched in 2018 so far, and we're only halfway through the year. According to CoinDesk's ICO Tracker, ICOs have raised some $14 billion in total funding since the model was launched in 2014. For context, the value of all above-ground silver stocks is around $17 billion.

Why all the fuss? To ICO believers, this mechanism represents the democratization of investment, delivered through blockchain technology. They point out that access to hot-ticket investment opportunities are often limited to the wealthy and well-connected.

Indeed, not everyone is a venture capitalist who receives pitches on potential unicorn businesses every day. And the regulations for getting involved with traditional securities can be hard to surmount: The SEC mandates that certain investment opportunities be limited to those with an income of more than $200K or a net worth of $1 million.

So this group of technologists wants to do away with the rules and lawyers and administrative overhead all together and just fund their ventures by bringing them directly to the people.

Here's how it's supposed to work. Some people think that they can improve or enhance the economics or applications of the original cryptocurrency, bitcoin, but they initially lack the funds to build the actual technology that they imagine. They generally first issue a white paper that describes their vision and provides a rough sketch of how a proposed new technology is going to achieve those goals. This generates buzz and critique, and other people who like that vision and believe in the team behind it have the option to purchase a token in what's called a "pre-mine." The funds raised from this token sale are then supposed to be channeled into development of the platform, sometimes overseen by a non-profit foundation established for this purpose. Token holders are theoretically rewarded for their foresight in the form of future profits, either through the increasing valuation of the token post-launch or a sale to other speculators.

You might be wondering why this kind of fundraising structure is necessary for some cryptocurrency projects, especially when bitcoin required no such hoopla. That's a good question.

In the case of bitcoin, its early obscurity was one of its core strengths. The few people who responded to Satoshi Nakamoto's early announcement on the Cryptography Mailing List included some of the most brilliant minds in digital cash engineering who had attempted similar projects themselves for years. Early bugs were quietly discovered and quickly patched without the pressure and liability of a billions-worth market capitalization at stake.

Satoshi didn't need a multi-million dollar cash infusion to build his technology. He just did it, with the help of the talented open source developers that contributed all over the world. In fact, Satoshi actively discouraged early hype around bitcoin. When Julian Assange was thinking about accepting bitcoin for Wikileaks donations in 2010, Satoshi asked him to hold off, since bitcoin was still "a small beta community in its infancy."

Shrewd scheme or rude scam?

But this kind of patience is a thing of the past in the crypto community. Today, entrepreneurs are eager to get the ball rolling, fast, and figure out the details later. This kind of fervent ambition comes at the cost of increasing the risks for costly public failures and regulatory scrutiny.

The most successful ICO to date is probably Ethereum, whose provenance lays in a very public and somewhat bumpy crowdsale in 2014. The smart contracting platform indeed delivered on the vision that its founder Vitalik Buterin laid out for investors, and today ethers (the platform's cryptocurrency unit) are one of the most valuable altcoins with the second-highest market capitalization to bitcoin.

This is not to say there have been no snafus. In particular, Ethereum's decision to hard fork the protocol in response to a programming error made by a project built on its network, called The DAO, proved controversial in the community and will be interesting to regulators, as we will soon discuss. But in terms of fidelity to vision and demonstrated outcomes, Ethereum is held up as one of the "good" ICOs.

Unfortunately, there are precious few other role models to which to point. The Wall Street Journal recently undertook an investigation of 1,450 ICOs to get an idea of how many were outright frauds. Of these, some 271 were found to have either plagiarized their white paper, stolen stock images and identities to display a fake development team, or used snake oil salesman-like language promising "guaranteed returns" and "instant riches."

And those are just the intentional cons. Other ICOs have started with good intentions and great ambitions, only to find that their dreams extended beyond the skills that so many investors poured good money into backing.

Photo Credit: Nuno Maia / Dreamstime.com

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  • Cy||

    P T Barnum said it best.

  • spiritofjeff||

    If they are regulated as securites, you'd have to pay capital gains every time you bought a coffee with Bitcoin. Insane. US-minted legal tender gold is still on the table at least. That stuff, legally, you wouldn't have to pay capital gains for everyday transactions. There are a few companies out there making legal tender gold-backed cryptos with livestreaming of their vaults, which is really cool. If this bs happens, we'll at least have that.. I don't have any invested but I'm going to once that stuff comes out. But in the meantime I hope to God they don't destroy crypto like this. If they want to tax it, they should have to pass a bill. Bureaucratic power like this cannot continue to be the norm.

  • Vijeta Khurana||

    I think employing cryptocurrency technology for security would be a great idea, with properties like decentralization, transparency, and distributed ledger. However, one also cannot overlook the 2016's DAO event where an additional $50 million was spent due to exploitation in the original Ethereum smart contracts and 2017's Tether data breach case where over $31 million were stolen from their primary wallet. That means, one needs to have a comprehensive understanding of the cryptocurrency technology and the factors associated with investing in the same, which implies consulting with a top ICO consultancy firm.

  • Neha Baluni||

    Good news. Appreciate this post. Thank you for compiling and sharing it.
    We provide breaking coverage for the Mobile App Marketing and update.

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