Startups’ Cryptocurrency Fundraising Loophole Gets a Regulatory … – WIRED

The Securities and Exchange Commission (SEC) headquarters building stands in Washington, D.C.

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Cryptocurrency was invented by people who didnt much like regulators, but red tape can still bind the technology that enables it, blockchains. Fresh proof comes from a pronouncement from the Securities and Exchange Commission late Tuesday. It said that regulations applying to investments such as stocks also apply to some initial coin offerings, a novel approach to fundraising that startups have used to draw in more than $1 billion this year.

Described simply, an ICO sounds like a childish money making scheme. A person, project, or company in need of capital creates a new kind of digital coin and sells a tranche of them for real money. Magic! The coins are created using the same kind of technology behind cryptocurrencies such as Bitcoin or Ethereum, and usually paid for using digital currency, not dollars.

ICO boosters describe them as a democratizing financial force that provides capital to projects unlikely to get it from established sources such as banks or venture capitalists. The SECs announcement means that some projects will now have to pay up for the lawyers, disclosures, and paperwork required to register with the SEC before they can solicit money from Americans.

That news was widely expected, but could cool a fever that even proponents of ICOs say risks leading people to stake money on poorly planned, or even outright fraudulent projects. You had a mix of serious teams with good developers and track records and then a bunch of entrants looking for a get rich quick scheme, says Christian Catalini, an MIT professor who has been studying ICOs, and considers them a valuable financial innovation. I think the SEC is worried that many people dont realize its like gambling; many or most of ICOs will go to zero.

So why would you buy into one of these schemes? Often because the brand new coin, or token, youre offered today is supposed to have some kind of utility or value tomorrow.

In May, browser company Brave raised $35 million in less than 30 seconds by selling one billion units of what it calls Basic Attention Tokens, for example. The tokens are intended to be used inside a new market for monetizing online publishing and advertising. Buying in early might give you a chance to shape that market and get better deals on ads than you could by joining up once it takes off. Another reason ICOs have proved popular is that you can usually trade the tokens you just bought right away with other people, offering liquidity you dont usually get when backing early stage startups.

If youre thinking all that sounds similar to how companies already sell shares or other tradeable things to investors, youre thinking like the SEC. An Investor Bulletin issued late Tuesday warned that while ICOs may provide fair and lawful investment opportunities, they can also be used improperly to entice investors with the promise of high returns in a new investment space. To avoid that downside, the SEC says that from now on some ICOs will have to meet the same standards applied to non-crypto securities such as stock offerings. That means registering with the SEC and disclosing information about the investment vehicle and its risks. The policy announcement was prompted by an investigation of Ethereum-based investment scheme The Dao, which attracted $150 million-worth of funding and then saw a third of it stolen by a hacker who exploited sloppy coding.

The new guidance was expected. But its arrival, and the fact that the SEC didnt lay out exact criteria for what would make an ICO a security (or not), makes the business of launching a new ICO in the U.S. more complicated. Wannabe token issuers now face the task of figuring out if their scheme falls under existing securities laws. If it does, theyll have to go to the trouble of registering it with the SEC. Bruce Fenton, founder of blockchain-focused investment advisors Atlantic Financial, says that the legal and administrative fees to do that can cost anywhere from $20,000 to the millions of dollars for more complex operations.

The extra friction will probably slow the pace of new ICOs. Startups raised more than $1.2 billion with ICOs in the first half of 2017, according to financial research company Autonomous. Catalini of MIT thinks a deceleration would not be a bad thing, because recent excitement about ICOs has created a situation where teams with not much of a product, plan, or technology can rapidly raise millions.

Even the valuations of the credible ones are astronomical for an early stage startup, Catalini says. The SEC doesnt want people to put their savings into this who cannot afford to lose them. He believes the frenzy has been stoked by millions flowing into ICOs from people who lucked out and got into Bitcoin and Ethereum early, giving them a lot of unexpected capital to play with.

What next for ICOs? They arent going away, but they may become more select. Catalini guesses that the evolution will be similar to that seen with equity crowdfunding, where startups solicit money in small chunks from many people. The SEC moved to allow that in 2015, triggering excitement about a radical new grassroots funding model for companies. In reality, Catalini says his research indicates crowdfunding that targets accredited investorsa status that requires a net worth of $1 million or a hefty incomehas been much more significant. Targeting only accredited investors can help you avoid having to register your security with the SEC.

Many people in the cryptocurrency world see yesterdays news from the SEC as legitimizing, not constraining. After all, recognition by the SEC might draw in more investors previously unsure about ICOs. Coin Center, a Washington, DC, nonprofit that advocates for cryptocurrencies, says the decision matches up with a regulatory framework it proposed two years ago. It also notes that what the SEC has said leaves plenty of latitude for ICOs to avoid it being categorized as a security. Restricting who can invest is one way; non-profit projects can get also exemptions.

Fenton says any dip in ICO activity caused by the SECs announcement wont much alter the overall trajectory of ICOs. The number of ICOs is likely to grow almost regardless of what roadblocks may slightly slow it down, he says. Overall the space will grow fast, including the market of tokens that are registered securities. Evidence cryptocurrencies will radically disrupt the financial system as some have hoped is still lacking, but they are managing to survive within it.

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Startups' Cryptocurrency Fundraising Loophole Gets a Regulatory ... - WIRED