Initial coin offerings (ICOs) have exploded in 2017 as blockchain startups have managed raised over $2 billion in funds since the start of the year using this innovative new form of financing. Not only have initial coin offering enabled startups to raise millions in funding, the increase in value of many of the newly issued digital tokens have generated high returns for their investors.
Initial coin offerings (ICOs), also known as initial token offerings, token sales or crowdsales, are a form of startup financing that involves the sale of a new cryptocurrency to early backers of a project. This new cryptocurrency or digital token then act as a quasi-share in the company. In that sense, ICOs are not that dissimilar from IPOs (initial public offerings) in the stock market.
However, ICOs have been entirely unregulated until very recently and have, therefore, stirred up some controversy in the startup world. In the wave of initial coin offerings that have been hitting the market in the past nine months there have been numerous cases of scams as well as a wide range of low-quality projects that have attempted to capitalize on the boom in this new funding trend to raise money for their founders without actually delivering a functional product or service.
Unsurprisingly, this trend has not gone unnoticed by financial regulators around the world. Until July, startups have been able to raise funds without the interference or scrutiny of regulatory authorities. However, this has changed.
ICO Regulations Are Here
On July 25, the U.S. was the first country to announce regulations covering initial coin offerings. In a statement by the U.S. Securities and Exchange Commission (SEC), the regulator highlighted the risks associated with investing in token sales and announced that new digital tokens, which effectively act as securities related to the issuing company will fall under the scope of U.S. federal securities laws. In other words, if a startup is issuing a new token for the purpose of fundraising that acts as a tokenized share in the company, its initial coin offering falls under the S.E.C.’s jurisdiction and requires regulatory approval.
Singapore followed suit on August 1, when its financial regulator, the Monetary Authority of Singapore (MAS), issued a statement that said: “[…] the offer or issue of digital tokens in Singapore will be regulated by MAS if the digital tokens constitute products regulated under the Securities and Futures Act (Cap. 289) (SFA).” Therefore, the sale of digital tokens will be regulated if they can be considered tokenized securities. This is effectively the same regulatory stance that the U.S. has taken.
On September 4, China shocked the cryptocurrency market by going a step further and announcing at outright ban of token sales linking the issuance of new digital tokens to suspected fraudulent activities.
Seven government administrations including the China Securities Regulatory Commission, the People’s Bank of China, and the China Banking Regulatory Commission issued a joint statement declaring that ICOs are a form of unauthorized illegal funding and that all companies and individuals within Chinese borders are prohibited from raising funds through a digital token sale.
South Korea followed China in a surprise announcement that it will also ban all future token sales within its borders. The Financial Services Commission announced on September 29, that all type of initial coin offerings (ICO) will be banned as it believes that the trading of digital currencies needs to be tightly controlled and monitored.
The financial regulator in the U.K., on the other hand, has taken a more liberal stance towards ICOs and issued a statement that highlights the potential risks of investing in newly issued cryptocurrencies and recommends conducting thorough research on a project before investing.
“You should be conscious of the risks involved […] and fully research the specific project if you are thinking about buying digital tokens. You should only invest in an ICO project if you are an experienced investor, [are] confident in the quality of the ICO project itself (e.g. business plan, technology, people involved) and prepared to lose your entire stake,” the Financial Conduct Authority (FCA) says in the statement.
Furthermore, Switzerland’s financial regulator FINMA announced that it will crack down on fraudulent ICOs that may have taken place within its borders while the Canadian financial regulator, the Canadian Securities Administrators (CSA), announced that securities law requirements could now apply to initial coin offerings when the newly issued cryptocurrencies can be categorized as securities.
Regulations Could Boost Innovation
While regulations are widely considered to stunt the growth of new markets and technologies, the reality is that the right type of regulation could actually lead to more innovation in the tech sector.
Currently, there is a wave of low-quality blockchain projects with underperforming digital tokens that are still entering the market. Moreover, non-blockchain startup projects have also jumped onto the ICO bandwagon in the hope of easy money, which has diluted the ICO market even further. Promising new startups who have put in the work to launch a successful ICO are therefore struggling now to hit their token sale targets as the market have been flooded due to a lack of barriers to entry and a lack of regulations.
If regulators manage to find the balance between preventing scammers and low-quality projects from conducting ICOs, while still giving enough breathing space for well-run, high-quality projects to fund themselves through token sales, then startups could actually benefit from increased regulations in this space.
Step one needs to be to increase the barriers to entry to a level where scammers are not able to meet the regulatory requirements to launch an ICO and, thereby, hindering their fraudulent activities.
Step two needs to be the issuance of regulatory requirements that prevent unprofessionally run projects from launching ICOs by requiring them to have a legal team, a minimum amount of capital pre-ICO and being able to transparently demonstrate what their raised funds are being used for, for example.
If regulators can manage to create an ICO framework that takes the above-mentioned two steps, then the ICO market could flush out the low-quality projects that are diluting the market and, instead, empower truly innovative and professionally run projects that opt for an initial coin offering as their source of funding. This would help to protect the consumer as underperforming tokens would be flushed out of the market and would boost innovation as promising new companies could gain access to vital funding.