The Future of Initial Coin Offerings

By Russ Banham

Perspectives

Until recently, Initial Coin Offerings, or ICOs, were perceived as a great way for startups to raise capital, in large part because of the unregulated nature. Experts pegged the amount of capital raised through ICOs from $4 billion to $6 billion in 2017, and nearly $3 billion to date this year.

Now this spigot is slowing due to growing legal and regulatory scrutiny around ICOs. The U.S. Securities and Exchange Commission (SEC) maintains that the sale of tokens that gives investors ownership in startups falls within its jurisdiction. But several other regulators, including the Federal Trade Commission (FTC), the Commodities Futures Trading Commission (CFTC), and the Comptroller of the Currency (OCC), have weighed in that they, too, should regulate ICOs and the sale of tokens.

This alphabet soup of oversight is making investors pause before plunking down on cryptocurrency. The caution is to be expected, said Joel Telpner, a partner at New York-based law firm Sullivan & Worcester, where he heads up its blockchain practice.

“ICOs, cryptocurrencies, and the blockchain technology that underpins them are such radically different concepts that they’re completely beyond current regulatory regimes,” Telpner explained. “Regulators are struggling to understand what these are, whether they should be regulated, and how that might happen.”

When a Rose is Not a Rose

As investors hesitate, ICOs are taking a breather. Funds raised in May are nearly one-third the amount raised this past December, according to ICO research firm Autonomous Next, which blamed the sluggish conditions in large part on “continued regulatory uncertainty.”

At its simplest, and ICO entails investors seeking a share in the startup venture to purchase virtual tokens, assuming enough capital is raised to launch the company. While the primary use case for ICOs is nothing new—“just another capital raising concept,” Telpner called it—the atypical nature of ICOs has caught the attention of myriad regulators, baffled if the tokens are a form of currency, a security, a utility or something else.

If deemed a security, then the SEC wants to regulate ICOs. “Some players have marketed the tokens at a discount to investors that get in early, giving them the opportunity to sell the tokens at the time of the ICO to make a quick return,” said Telpner. “To the SEC, that sounds a lot like a security.”

However, the blockchain platform that serves as the foundation of the ICO has the appearance of a utility, since the tokens also provide a way to access the blockchain’s products and services. Complicating the picture is that tokens also can be used to verify the data on a blockchain platform. Businesses or consumers wanting to access this data pay for that opportunity with tokens.

“In these situations, tokens are used as commodities or to buy or sell goods, making them different than a security,” Telpner said. “You’re now dealing with a form of commerce in which the tokens are equivalent to a real currency. You don’t take a share of Starbucks’ stock and buy a cup of coffee.”

These various scenarios emphasize why various regulators are giving closer scrutiny to ICOs, blockchain platforms, and cryptocurrencies. In May, for example, the FTC issued a temporary restraining order against four cryptocurrency investment ventures.

Under the Microscope

Although it may be too soon to predict the future regulatory landscape, companies dealing in blockchain and AI solutions are nonetheless optimistic that the current pause in ICOs is temporary. Still, Telpner said he would not be surprised if ICOs are regulated by several government entities at different stages.

“There is some talk now that a token would be regulated as a security the first year after the ICO, and then morph into a utility token afterwards,” he said. “Another idea floating around is to create different types of token categories—some securities, some commodities, and some utilities. Depending on the circumstances, different regulators would be involved.”

As the ICO market matures, at least some regulation is likely. “These are such radical technologies in their earliest stages of development; regulators are just trying to get a bead on what this all is and how it may change going forward,” said Telpner. “That’s a good thing, as it allows for more thoughtful treatment.”

The ongoing work of the Congressional Blockchain Caucus is to study blockchain technology for use by the government and industry, and to examine the actions of states like Arizona, that is writing its own legal definitions. “In Arizona, the legislation would allow an ICO to raise a certain amount of funds without risking violation of securities laws,” Ron Wince, founder and CEO of Myndshft, a healthcare AI and blockchain solution, said.

This regulatory action, most believe, is a good start. “The more clarity, the better for all concerned,” Wince stressed. “If regulators try to regulate this new animal using old regulations, we’ll just end up with a patchwork quilt. We need regulations, but we also need them to be as innovative as the technologies they regulate. Shortcuts are not to anyone’s advantage.”

Russ Banham is a Pulitzer-nominated business journalist and author who writes frequently about the intersection of technology and business.