The Securities and Exchange Commission repeatedly warned founders of shady initial coin offerings that they must abide by US securities rules - but most have been too busy making money hand over fist to listen.
And now, it seems, the agency is finally ready to drop the hammer.
After announcing a handful of limited actions against suspected ICO fraudsters late last year, the Wall Street Journal reported Thursday that the agency has sent dozens of subpoenas and information requests to the companies and advisers carrying out ICOs, which have already raised nearly $1.7 billion this year. Last year, ICOs raised $6.5 billion despite crackdowns in China and elsewhere.
The subpoenas primarily include demands for information on the structure, sales and pre-sales of ICOs, WSJ reported.
U.S. regulators have repeatedly put cryptocurrency companies and their advisers on notice in recent months about what officials say are widespread violations of securities rules designed to protect investors.
"Many promoters of ICOs and cryptocurrencies are not complying with our securities laws," SEC chairman Jay Clayton said earlier this year. In another speech he said he has instructed his staff to be "on high alert for approaches to ICOs that may be contrary to the spirit" of those laws.
One former SEC commissioner said ICOs are only seeing the tip of the iceberg in terms of civil - and possibly criminal - actions.
"We’re seeing the tip of the iceberg … there is going to be a ton of enforcement activity," said Dan Gallagher, an SEC commissioner from 2011 to 2015 who now sits on the board of blockchain company Symbiont. Mr. Gallagher told an SEC conference in Washington last week that the largely unregulated token offerings are "the freaking Wild West—it is ‘Wolf of Wall Street’ on steroids."
Bitcoin's explosive gains last year helped draw a flood of money into different crypto tokens. Even the most widely hyped (and ultimately successful) offerings often sport nonsensical White Papers. Often, the product exists only on paper. As a result, the market has experienced broad-based losses as the vast majority of offerings have flopped.
Bitcoin dropped last night when the WSJ headline hit. But it has since recovered, suggesting that the pioneering cryptocurrency is growing more confident in the face of intensifying scrutiny of the ICO market...
Furthermore, the vulnerability of crypto tokens to cyber theft has led to roughly 10% of ICO tokens being stolen by hackers.
Evidence that the market is rife with fraud and abuse is beginning to surface.
A soon-to-be published Massachusetts Institute of Technology study of the ICO market estimates that $270 million to $317 million of the money raised by coin offerings has "likely gone to fraud or scams," said Christian Catalini, an MIT professor.
The SEC has so far brought only a handful of cases alleging cryptocurrency frauds, as officials have raced to keep pace with token sales in the last 18 months.
In January, for instance, the SEC halted the coin offering of Dallas-based AriseBank, accusing the company and its executives of conducting a scam and misleading investors with claims it was buying a federally insured bank. The group claimed to have raised $600 million.
At least a dozen companies have put their initial coin offerings on hold after warnings from the SEC, according to Robert Cohen, the head of the SEC's cyber-enforcement unit.
Specifically, the SEC is focusing on what are called "simple agreements for future tokens" - or SAFTs - which allow companies to hold presales before their tokens have even been created. Many investors who participated in the Tezos ICO - which raised an at-the-time-record-breaking $230 million - are now suing the company after it failed to deliver its tokens on time.
One study estimated that nearly half of ICOs launched last year have failed already.
The Cardozo Law School in Brooklyn issued a report last year claiming these simple agreements for future tokens could violate SEC rules, while also increasing the likelihood that investors are cheated out of their money.
Many of the cryptocurrency-related subpoenas were issued in recent weeks, likely paving the way for what lawyers and industry insiders expect to be a dramatic upturn in enforcement activity.
The SEC scrutiny is focused in part on “simple agreements for future tokens,” or SAFTs, which are used in some of the most prominent crypto-fundraisings, according to the people familiar with the matter.
The agreements allow big investors and relatively well-off individuals to buy rights to tokens ahead of their sale. The rights can be traded, or flipped for profits, even before the sale begins.
The SEC is concerned that such agreements are potentially being used to trade like securities without conforming to the strict rules that apply to securities.
Recently, messaging app Telegram has grabbed headlines after raising nearly $1 billion in a VIP presale for what's expected to be the largest-ever ICO (by a considerable margin).
The offering is expected to raise at least $2 billion, even though the company doesn't have a clearly defined plan for monetizing them, and it's unclear what the tokens will be used for or how their value will be determined. Certain influential individuals in the crypto space have expressed concern that a growing secondary market for presold Telegram tokens risks harming the broader crypto market.
"This feels like Wall St. It’s gross. It’s shady. It’s not what blockchain technology or ICOs were supposed to be about," Jeremy Gardner, a co-founder of hedge fund Ausum Ventures, tweeted in February.
“This feels like Wall St. It’s gross. It’s shady. It’s not what blockchain technology or ICOs were supposed to be about,” Jeremy Gardner, a co-founder of hedge fund Ausum Ventures, said in a tweet in February. https://t.co/zwxVBNA7vM— Ausum Ventures (@AusumVentures) March 1, 2018
1/ Want to know the dirty secret behind why these presales keep getting bigger and bigger?— Jeremy Gardner (@Disruptepreneur) February 23, 2018
It’s not because the projects are getting better, it’s because there’s a new secondary market business where people mark up and resell their allocations.
Indeed, there's so much money flowing into ICOs, that a company can successfully raise $50 million without having anything even approximating a viable product, Gardner said.
One of the biggest shifts in venture capital, in my short time in the business, which has arisen due to ICOs, is the increasing meaningless of capital commitments.— Jeremy Gardner (@Disruptepreneur) February 27, 2018
Previously, if an early-stage startup had $50 million committed, I’d be blown away.
Today, my eyes glaze over.
Still, it remains to be seen if the SEC stepping up enforcement would have a lasting impact on the market. After all, companies can always relocate to a more permissive jurisdiction - though the SEC can certainly make it difficult to sell those coins to investors based in the US.
Following reports of the subpoenas, Overstock.com revealed in a securities filling on Thursday that its $250 million ICO for its tZero alternative trading platform has been "under review" by the SEC, according to CoinDesk. Overstock raised $100 million during its presale, and recently began the second phase of its token offering.
The filing reads:
"The SEC is trying to determine whether there have been any violations of the federal securities laws, the investigation does not mean that the SEC has concluded that anyone has violated the law. Also, the investigation does not mean that the SEC has a negative opinion of any person, entity, or security."
In response, Overstock shares have fallen 10%
Regardless of the outcome, one thing is certain: Whatever form these actions might take, they're long overdue.