Regulation and Value of Token Generating Events aka ICOs
ICO (initial coin offering) mania has gripped many a crypto investor. A typical ICO will have as many as 5,000 - 10,000 participants.
At the recent True Global Ventures Disruption in Financial Services San Francisco event, a group of blockchain entrepreneurs and legal experts discussed the value and regulatory environment for ICOs, or token generating events. Since Chatham Rules apply, no attribution to particular speakers is allowed, however many interesting topics and trends were discussed.
China is being heavy handed and it's a sensitive time now. There is a big conference going on, which is deciding power for the next 5 years, so announcements are more of a political thing. They are not necessarily banning everything, but want to maintain control.
The event occurred after China banned ICOs but before they cracked down on exchanges. Some say the move will strengthen the Hong Kong market, and there is already some evidence of action moving to Japan (https://cointelegraph.com/news/china-drama-causes-big-migration-of-bitcoin-traders-businesses ). Given the recent news out of China and Jamie Dimon's remarks, crypto prices retreated last week. However many traders in the market - including yours truly - bought on the dip. Bitcoin prices have since recovered to $3890, which is still down from the peak level of about $5000.
Australia has an extraordinarily supportive fintech environment. There is no framework for ICOs currently (no SEC type test), and regulatory bodies have been deliberately hands off to try to attract startups and encourage innovation. Australia is seeing a massive influx after China news, and many are trying to run ICOs in Australia. Malaysia and Vietnam are other examples of friendly places in the Asia Pacific region. Singapore is friendly from the startup side, but harder on capital raising.
Are ICOs Securities?
Some thought that tokens wouldn’t be regulated in the US, but now the SEC is catching up. These coins are not currencies like Bitcoin or Ether since they are sponsored by a company and there are products attached, so they might be considered securities offerings. Regulators will look at current statutes and precedent to determine if they are securities.
Some questions to help evaluate: Does it fall into an investment contract? How have we applied regulation to art collections, gold, silver, etc? They can look at various assets that people don’t typically think of as securities to determine.
While some experts take a more liberal approach, others believe ICOs will definitely be considered securities and one would be taking a lot of risk offering them to non-accredited investors (definition of accredited is income of at least $200,000 per annum or at least $1 million in non-real estate assets). The SEC could bring action against you and you’d have to spend all your money fighting in court. A potential solution to avoid trouble would be to code tokens to invest (for accredited) versus to use (for retail). This type of approach has not been seen as of yet.
Some Important Releases and Precedents
- The US came out with a DAO Report (https://www.sec.gov/news/press-release/2017-131). There was no enforcement against the DAO because they paid everyone back.
- The Howey Test could be important and relevant in this discussion (https://medium.com/bittrust/passing-the-howey-test-how-to-regulate-blockchain-tokens-d218da93a8b6)
- If you are an issuer and you are participating in a pump and dump scheme, you will be in deep trouble. It is inadvisable to promise returns or mention “exchanges”, “appreciation”, or other similar words.
- In the past, if unaccredited investors were buying, the SEC was much more likely to count it as a security. The SEC is extremely unlikely to go after those selling to accredited investors only since they are expected to look after themselves.
- If selling a security, one needs to be a licensed broker/dealer and all the regulatory boxes need to be checked.
Value of Token Sales
Identifying "Good" Token Sales
When it comes to finding the "good" token sales, many experts agree that it's important to look at the fundamentals - such as team, track record, and a detailed use of proceeds. Some like to see proof of traction such as developer support in the form of hackathons, APIs, and functioning prototypes. Half-jokingly, some people think the more money spent on marketing, the worse the ICO will be.
Vitalik Buterin, the founder of Ethereum, has been said to have a sniff test:
If the token could be replaced by Ether itself, then it's not a good token.
Role of Liquidity - Speculators vs Utility
Is immediate liquidity after an ICO a good or bad thing? Liquidity could encourage speculation, which could put a damper on the utility of the tokens. Some people think there shouldn't be liquidity until you can use the tokens.
On the other hand, it can be very important to engage developers from the very initial stages. Offering things like simulators and availability will allow developers to start building products around the technology. It is also possible to design the sales so that ownership is more distributed and not just concentrated in the hands of a few whales.
A few cited admired projects and interesting areas of development: