The ICO Conundrum: A Challenge Beyond the SEC Mandate

Executive Brief

Initial coin offerings have been in the news quite a bit in recent months, as blockchain and digital currency startups have become increasingly reliant on them for their capital formation needs. By some estimates, more than 4 billion dollars in capital have been raised using this funding mechanism. The fact is that ICOs have become an increasingly popular option for raising capital. However, that popularity has been accompanied by increased government scrutiny.

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Yes, ICOs are a controversial funding option. And that leaves the cryptocurrency industry with a conundrum that must be addressed – and soon. With regulators turning a watchful eye to these initial coin offerings, wisdom behooves each of us to ask that most basic of questions: are ICOs a good or bad thing for our businesses?

The World’s Reaction to ICOs

Though the world’s governments were slow to react to this sudden explosion in the use of ICOs, they have started to take notice – and that has meant new challenges for crypto-related firms in various countries around the world. China made headlines last year when it banned ICOs altogether, and South Korea soon followed suit. Even Japan is reportedly considering a similar harsh response. Meanwhile, officials in Europe, Russia, Singapore, and elsewhere are considering steps to enact new regulations to govern the sale of these coins.

The net impact of these decisions has yet to be determined, but there is a definite trend that the industry should try to understand. Regulators are concerned, and they typically react to concerns by doing what they do best: enacting new regulations. It would be folly for entrepreneurs in our industry to ignore the questions surrounding ICOs and simply hope that our respective governments will leave the status quo intact. After all, hope is not a strategy.

In the United States, similar questions are being asked by government authorities. Already, regulators in the U.S. have started to speak out on these token sales, and the SEC has taken action against certain offerings. CFTC commissioners have decided to view digital tokens as commodities, which could make them subject to laws governing those types of assets.

However, much of the ICO controversy in the U.S. revolves around the SEC’s view on the matter. For entrepreneurs considering an ICO in the United States, it is vital to understand what the SEC does and why, since that understanding may provide insight about whether an ICO is really the best option for any given company.

The SEC’s Role

The SEC could be considered a child of the 1929 stock market crash and the dismal economic period that followed. That crash set off a chain reaction of economic disasters that would devastate the U.S. economy for more than a decade. By the early 1930s, historians tell us that about half of the nation’s banks had closed operations. Unemployment skyrocketed, leaving nearly a third of the working population without a job. And those are just the highlights of what we now call the Great Depression.

Securities played a role in the massive loss of wealth that occurred during that time. Some $50 billion in securities had been sold in the previous 9 years. Yes, the Roaring Twenties was a decade in which capital formation was easy, with few regulatory controls impeding growth. As a result, the U.S. economy grew by more than 40% during the Twenties. The modern age was dawning, with mass production on the march and a host of new rising industries. Everything was golden – until it wasn’t.

In the aftermath of the Crash of 1929 – a crash that saw nearly half of all securities sold in the prior decade rendered completely worthless, Congress moved to create new regulatory controls. In 1934, the Securities Exchange Act was passed, which created the Securities and Exchange Commission (SEC). The SEC’s mission was a direct response to the disaster that befell many investors during the stock market crash, as the commission was charged with the responsibility of protecting investors and maintaining the type of fair and orderly markets needed for reliable capital formation.

As most Americans know, the SEC fulfills that mission in a variety of ways. One of its roles involves the creation of rules to govern securities. Under those rules, securities can only be sold if they have been properly registered with the SEC, or specifically exempted from registration. That registration process is designed to ensure that the commission can provide investors with the information they need to make sound investment decisions.

The SEC’s Reaction to ICOs

For U.S. companies that might be considering an ICO, the SEC’s position on the sale of digital tokens cannot be ignored. In recent months, the commission has been fairly vocal about its thoughts on the topic. The SEC Chairman has reminded investors that there has yet to be an initial coin offering properly registered with the commission. At the same time, he suggested that the SEC considers the sale of these digital tokens to be comparable to securities.

Here’s where things get complicated. Since the SEC clearly views most digital token offerings as securities, where does that leave companies that want to use ICOs to raise necessary capital? Obviously, that depends on the type of company we’re talking about. Some entrepreneurs will shrug at the SEC’s assessment and rush to launch their ICOs – and hope that the commission remains slow to react to the controversial sales. Others will take a different approach, and shy away from ICOs altogether.

Make no mistake: I wish that ICOs could be structured and conducted in ways that meet existing security laws, either through registration or exemption. Unfortunately, without significant changes to existing laws, it is simply not possible. To date, the issuers of ICO tokens are exclusively decentralized entities without any central authority. Moreover, the money collected goes to individuals, partnerships or incorporated companies that claim to be working on some great ideas presented in a white paper. Meanwhile, the investors have no ownership or voting rights in the private entity that received the investment.

The conundrum is real – though it should come as no surprise to anyone. Technology almost always outpaces regulations, and ICOs are a clear case in which the law has some catching-up to do. So far, more than $4 billion has been raised through ICOs around the world. Unfortunately, none of those token sales have properly registered with the SEC – and that has the commission concerned about the offerings.

A Different Approach

To deal with this conundrum, DNotes Global Inc. will approach capital formation in a different way. The good news is that ICOs are not the only way to raise the funds needed to advance project goals. For DNotes, we believe that Reg. A+ Mini-IPO Title IV Tier 2 is a superior option, and one that won’t run afoul of current laws or SEC regulations. That’s why this capital formation option has been a part of our planning process for more than two years.

Perhaps there will come a time when ICOs will no longer be the subject of such intense controversy. Eventually, the SEC and other regulatory bodies will almost certainly develop the right framework to ensure that those funding mechanisms are in full compliance with existing rules and regulations. Until that time, though, DNotes will continue to follow the road less traveled.

Author: Alan Yong

DNotes co-founder Alan Yong is a well-regarded author, tech visionary, and entrepreneur who established Dauphin Technology in 1988.

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