Article was originally published at CoinCentral.
ICO. Three little letters. A lot of implications (and not all good ones). In fact, a lot of our associations with ICOs these days are negative. Scams, hacks, interesting ideas that don’t make it to the first line of code. The blockchain is responsible for some incredible discoveries, but it’s tainted by the actions of an unscrupulous few (the kind you wouldn’t take home to Mom).
It’s time for insincere promises, downright lies, and bad actors to stop muddying the waters. In fact, it’s time for ICOs to start growing up.
It’s Not About the Failures
It’s not the possibility of failure that makes investing in ICOs so risky. Investing in any new venture is risky. While Vitalik’s statement that 90 percent of ICOs will fail shocked the cryptocurrency community, he’s actually not saying anything new.
90 percent of all startups fail, ICO funded or otherwise. That’s just a fact of the cutthroat world of business. Blockchain startups haven’t been around long enough to say whether their failures happen faster or not than financing through conventional means. Whether they bounce back from their failures and pivot their ideas also remains to be seen.
Yet the fact that ICOs are open to all subjects them to intense scrutiny, and a new type of investor expecting overnight successes. The teams are often inexperienced and simply not good at making accurate forecasts.
The Bad Actors Have to Go
All that said, it’s true that ICO scams cannot be taken lightly, nor high profile hackings minimized. At least 10 percent of all ICO funds from 2017 were lost or stolen, and even the SEC has launched their own scam to educate and warn investors.
US-based companies that held ICOs are starting to receive subpoenas. Questions are being raised, and stakeholders everywhere are getting nervous.
After all, it’s a small minority who actually plan to scam investors out of their money from the start. Far greater is the number of bonafide blockchain companies using this vehicle to raise genuine funds. They’re certainly not looking for a prison sentence for non-compliance.
Suleyman Duyar Founder & Chief Strategist at RenGen Labs says, “In the US, I think it’s pretty clear that the statements of the regulators have been cautionary enough. For me, if I were a startup, I would not do a traditional ICO in the US. I would certainly make use of Reg D or Reg CF.”
If 2017 was a year-long party. 2018 is the year of regulation. And like it or not, here’s how ICOs are growing up.
Compliant ICOs (Also Known as Regulated ICOs or STOs)
KodakCoin is one of the first companies in the US to hold a “compliant ICO.” And considering the longevity and reputation of the brand, it’s not surprising they would want to do things by the book.
But there are a few ups and downs with holding a regulated ICO, including red tape, limitations, cost, and delays. In fact, after KodakCoin announced that their ICO would be in January and then had to delay it until May 21, the rumors of a scam started to spread. What was KodakCoin trying to do anyway? Was it just one last ditch attempt from an aging camera company scrambling to stay relevant?
“The bleeding-edge pioneers (in regulation) are paying the price,” says Darren Marble CEO of CrowdfundX, the marketing firm representing KodakCoin. Doing things by the book takes time. It involves registering with the SEC and preparing for some significant back and forth–it’s a lot more complicated than a website and an ether wallet.
“Since the SEC issued its June 2017 Rule 21 report regarding TheDao that clearly established that most token sales in the United States would be regulated by existing securities laws, offering tokens in the US has become significantly more complex. Even if issuers try to comply with securities laws, a number of unresolved issues complicate issuances,” says Andrew Hinkes, Esq., General Counsel of Athena Blockchain.
Compliant ICOs are likely to be the new model blockchain companies will follow, especially with the likes of Kodak picking up the reins.
Doing Things the Right Way
There are a few options for ICO teams wanting to stay on the right side of the law.
While regulation has been up for debate especially over recent months, it’s certainly possible to be pragmatic.
At RenGen Labs, they took a proactive approach, Duyar points out, “Why fantasize about future regulation when current regulation exists now and it’s not really that different from a lot of ICOs? We just used the existing legal framework to build a platform for people to do more complaint offerings.”
Without delving too deeply into the legal framework behind, there are existing securities exemptions that an ICO team can use to kickstart their projects, and four possible paths they can take if they want to comply with the SEC.
- Register and hold an IPO. Not an option available to most startups, since holding an IPO requires disclosure of financial, accounting, tax, other business information, and significant cost and time. Startups may lack the track record to qualify, and a full IPO is likely to be cost-prohibitive for a startup.
- Reg D 506(c). This is a fast and relatively easy way of raising money, and you are not limited in the amount of the raise or the breadth of solicitation. However, this exemption allows funds to be raised from verified accredited investors only. That rather flies in the face of democratized investing and may not be attractive for many companies.
- Reg A+. With a Reg A+, you can raise as much as $50 million per 18 months, and anyone over the age of 18 globally can invest. Since it’s regulated, you can legally advertise and market your offering anywhere (including Twitter and Google). But, it’s time-consuming since you have to have your offering documents vetted and approved by the SEC. It’s also not an option for a startup team as you need at least two years of audited financials.
- Reg CF. Regulation Crowdfunding. This is the cheapest and easiest way of getting your company up and running. Anyone over 18 can invest and you can market and solicit the deal. However, you are limited to how much you raise–significantly, in fact. The cap is at $1.07 million over a 12 month period.
“Although exemptions are available,” Hinkes explains, “offerors still have the “Goldilocks Problem,” in that there’s no perfect fit. Each exemption includes significant tradeoffs as far as the amount to be raised, from whom funds can be raised, and other limitations. Issuers should seek out counsel to identify the correct offering strategy that matches their project’s needs.”
Final Thoughts
Doing the right thing isn’t always the easiest thing. There’s no doubt that issuing an ICO and receiving Ether in your public wallet is a lot less hassle than registering with the SEC. It’s also inconvenient to investors who have to go through KYC and AML when they invest.
However, regulation is not meant to stifle innovation, or complicate things for blockchain companies. It’s there to protect investors, and bonafide blockchain teams as well.
Or in the words of Hinkes, “The SEC’s policy seeks to protect investors and facilitate capital formation. Unquestionably, the SEC has already expressed its desire to allow token offerings to continue and not to use regulation to pick winners and losers among token issuers. The big questions to be resolved will include how properly issued tokens are handled in secondary trading, and the ongoing obligations of issuers after their fundraising.”
