Two weeks ago, the Securities and Exchange Commission declared that the virtual tokens issued during an initial coin offering, an increasingly popular funding mechanism for blockchain startups, are considered securities and are therefore subject to a litany of regulatory strictures, including the need to register any pending offerings with the agency.
The SEC’s decree was expected to slow the pace of new ICOs, as startups scrambled to hire legal counsel and figure out how, exactly, to comply with the new rules, as we reported. However, blockchain analysts reasoned that the agency’s ruling was a good thing for the market’s long-term health, and that the increased scrutiny would help confer more legitimacy on the shady ICO market, which is fraught with hacking attacks and scams. SEC oversight benefits entrepreneurs by encouraging more risk-averse investors to buy their tokens. It helps investors by weeding out fraud.
However, it seems we underestimated the market’s willingness to simply ignore the whims of US regulators. Despite being the world’s largest economy and one of the largest markets for crypto assets, the New York Times is reporting that “the cautionary words of American regulators have done little to chill a red-hot market for new virtual currencies.”
“…even after the commission said it was looking closely at projects that may violate its rules, programmers are still embarking on new offerings at a torrid pace. Most of the offerings have little legal oversight and some appear to conflict with the commission’s basic advice.
‘The broader detail and the silences in the report should give many people pause and that doesn’t seem to have happened yet,’ said Emma Channing, the general counsel at the Argon Group, which helps projects in the industry raise funds. ‘I don’t understand why everyone isn’t as concerned as I am.’
Since the guidance was released on July 25, 46 new coin offerings have been announced and an additional 204 are moving toward fund-raising, according to data Tokendata.io.”
Despite the SEC’s ruling, the ICO market remains on track to surpass all historical VC investment in the blockchain space by year end, which stands at $1.7 billion since 2010, according to a team of analysts at Pitchbook. In the eight years since the debut of Bitcoin, only Coinbase, Circle and 21 have raised more than $100 million.
July was the best month for ICOs to date, according to NYT.
“July was the biggest month for coin offerings, with 34 projects raising $665 million, Tokendata.io data shows – or twice as much money as was raised in the first five months of the year combined.”
However, data from Goldman Sachs puts the total for July closer to $300 million, which would make July the second-best month after June. However, ICOs have surpassed angel and seed-stage funding for all internet companies since the beginning of the summer.
The decentralized nature of digital currencies allows blockchain companies to – using Pitchbook’s phrasing - “maximally leverage regulatory arbitrage.” Why should startups with a hot ICO waste money on lawyers when they can just move to Switzerland?
As the NYT explains, companies can try to avoid the SEC by blocking US investors from participating in an ICO…
“Other projects have tried to work around regulators by prohibiting American investors from buying their coins, which they have done by barring anyone who tries to buy the coins from an internet address associated with the United States.”
…but the relative ease with which US investors can circumvent these limitations still risks angering the agency, which could go after a company for non-compliance – even if it’s based in a foreign country – if US investors are found to have participated.
“Several lawyers said that the commission is unlikely to care about the steps taken to keep out American investors if Americans still end up buying the coins.
‘Just blocking IP addresses is irrelevant,’ said Patrick Murck, a partner at the law firm Cooley, referring to internet protocol. ‘There’s only one thing that is relevant, and that is whether a US investor bought in your sale.’”
While Switzerland’s regulatory climate remains accommodative for blockchain companies – it recently opened the door to the crypto-asset management industry by allowing a local private bank to begin handling digital currencies – Singapore, another crypto haven, has said it would adopt many of the same restrictions imposed by the SEC, according to the NYT.
Ultimately, the real reason so many firms have hesitated to comply with the SEC is because they view compliance as a greater business risk than non-compliance. To use a metaphor: Nobody wants to be the first person to jump into murky water - there could be sharks or other dangers lurking beneath the surface.
“Mr. Murck said that even teams that do make an effort to comply with the regulators are going to be in treacherous waters because of the lack of clear definitions and law regarding virtual currencies.”
“There are still open questions after the SEC report,” he said. “There’s uncertainty and risk in the space, even for people who are taking a professional approach to it.”
But after the waters have been tested, companies will have a clearer picture of the risks involved, and perhaps be more willing to comply.
Read the full pitchbook report on ICOs below: