Will New SEC Regulations Spur Blockchain and Cryptocurrency Growth?

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Thousands of ICOs (Initial Coin Offerings) have raised billions of dollars in funds to spur blockchain-related technology growth. Of those, however, at least $1B in just 271 ICOs that were analyzed contained red flags — from fake executives to plagiarized documents, according to a Wall Street Journal analysis. Based on this report, NewtonX conducted a series of 7 interviews with a former SEC regulator, the CEO of a company that recently had a successful ICO, and five executives who are considering investing in blockchain technology. This series of interviews revealed that due in part to confusing regulation, investors are highly wary of ICOs, and believe that the impetus for due diligence lies too heavily on consumers instead of regulators.

ICOs are controversial, because they are essentially selling securities with no guarantee of a product to back them. Some consumers believe, however, that ICOs democratize funding away from VCs and towards “retail investors,” because the buy-in is significantly lower, allowing the average person to have access to the same gains that a VC would. In an ICO, unlike an IPO, you aren’t buying any equity in the company, but are instead “pre-ordering” tokens/coins that will in theory one day have value or use when the product/platform launches. The problem is, the average person does not have access to the same due diligence tools that a VC firm does — not just in terms of paperwork and records, but also in terms of actually meeting the supposed founders of the company. Centra Tech. Inc., the now infamous example of an ICO gone wrong, raised more than $32 million from thousands of investors last year with fictional executives leading the charge, and false claims backing the product.

To distance themselves from these scandals, many companies have moved away from the ICO terminology, and instead refer to it as a “token sale,” wherein coins are sold as “utility tokens” that have a function within the company’s product.

Even so, investors are wary and the SEC is scrambling to build out comprehensive regulations for coin offerings.

The Current State Of Coin Regulation in the U.S.

In June of 2018, the SEC appointed Valerie Szczepanik, a veteran SEC attorney, as Division of Corporation Finance and senior adviser for Digital Assets and Innovation, or “Crypto Czar,” as the media has come to refer to her. In her position, she will rationalize U.S. securities laws to cryptocurrencies, and develop regulatory oversight.

The same month, the SEC determined that cryptocurrencies can be deemed securities in the case of tokens in an ICO, and issued a warning that many ICOs may be violating securities laws. Because this only occurred a month ago, there’s still some uncertainty as to what this means from a regulation standpoint. Some ICOs may fall under the SEC’s jurisdiction of enforcing federal securities laws, but some tokens may not — Bitcoin, for instance, is not deemed a security as it is comparable to a sovereign currency. Tokens that act as digital assets, however, may be defined as company securities. Currently, however, most ICOs seem to have fallen outside the strict framework of regulation that governs IPOs, and therefore haven’t filed the official paperwork that typically accompanies equity securities.

The SEC has been intent in recent months on catching and exposing fake ICOs — but the crackdown has largely focused on fraud, an illegal activity that can occur in any industry. The SEC set up a fake ICO to educate investors at howeycoins.com, but has otherwise issued few protections beyond fraud protection. Soon, this won’t be enough: The Wall Street Journal found that of 1,450 white papers (a document that details mission statements, team biographies, and the product offerings), 111 of them repeated verbatim sections from other whitepapers. Many of them also explicitly offered financial rewards without any risk — a violation of SEC regulations.

This recent crackdown, coupled with pervasive ambiguity as to what cryptocurrencies qualify as securities, has led many would-be ICOs to instead offer “token sales.” Utility tokens allow buyers direct access to a company’s products or services, and are generally exempt from SEC regulations.

Why Volatile Regulation Has Stymied Industry Growth

The majority of ICOs are not elaborate schemes with fake executives designed to steal investor money; rather, they are a rapid way to bring blockchain technology and other nascent products to market rapidly. Indeed, one of the NewtonX interviews that informed this article was with the CEO of a company that recently had a successful ICO for a blockchain-based product. As we’ve previously written, blockchain does have potential, but is still in its infancy. ICOs are a way forward for infrastructure building.

That said, the lack of regulation has made investors wary of the technology. As regulation improves, however, ICOs may become a democratized source of investment for an emerging technology. Filecoin, for instance, raised over $250M in its ICO to create a blockchain-based file storage network, and was backed by VC giants including Y Combinator. While the product is still in development, if it is successful it will be a pioneer for the potential of ICOs.

Companies considering an ICO would be wise to think of their tokens as securities, and investors considering backing an ICO would be equally wise to do heavy due diligence. As regulations improve and trust in blockchain as a technology grows, ICOs may very well prove a viable means of investment and fund raising.

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About Author

Germain Chastel is the CEO and Founder of NewtonX.

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