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ICO Fundamentals: Empowering or Misleading Investors?

ICO Fundamentals: Empowering or Misleading Investors

The year 2018 saw the dramatic decline of the initial coin offering (ICO) market. January began with an outstanding USD one and a half billion invested into ICOs, with this figure trickling down to less than USD 200 million per month as the year closed. 

So, what killed the booming ICO industry? In large part, the US government crackdown and the relatively poor performance of the cryptocurrency market seemed enough to scare off investors last year.

Token offerings are an innovative way for startups with solid proof of concept to raise capital should the option of collateral needed to take out a business loan be lacking, or the lack of contacts or skills needed to secure capital from institutional investors.

Through the examination of recent studies from both academics and journalists, it can be observed that the biggest threat to the industry is posed by irresponsible startups that are either reluctant to keep investors fully informed, or purposefully misleading them. If the ICO market can be regulated in a way that avoids stifling innovation, it is suggested that the token model can become the most dominant form of venture capital financing.

Transparency, Truth, and What ICOs Need to Survive

One theory presented by Jiri Chod and Evgeny Lyandres suggests that investors have as much to gain as do the entrepreneurs holding the ICO – as long as there is no disparity of information available to the investors, however. And that would seem to be one of the most predominant issues cited against startups holding ICOs; offering false or exaggerated promises of returns, or whitepapers full of fraud and plagiarism.

Indeed, the Wall Street Journal investigated the details of 3,291 whitepapers pertaining to ICOs, finding that over 2,000 of them included terms “nothing to lose, guaranteed profit, return on investment, highest return, high return, funds profit, no risk, and little risk,” language that has previously led US state and Federal regulators to issue cease and desist orders or file charges. Some 16% of the whitepapers were found to show evidence of either plagiarism, identify theft or the promise of ”implausible returns.”

Many see government regulation of the sector as an appropriate way to manage the risks posed to investors and hold startups accountable to their claims. Chod and Lyandres theorize that if this is the case, ICOs have the chance to ”dominate traditional venture capital (VC) financing.” Others, however, argue that too much intervention would likely stifle innovation in the sector. US-based cryptocurrency exchange Kraken has said that the cost of handling subpoenas is becoming a ‘‘barrier to entry” for new exchanges. 

Chod and Lyandres concludes: ”An implication is that while regulating ICOs is desirable, banning them outright is not.”

The Role of Tokenomics

Another academic paper that delves into tokenomics is authored by Lin William Cong, Ye Li, and Neng Wang entitled Tokenomics: Dynamic Adoption and Valuation. It outlines a model that can be used to predict the future growth of tokens that act as a means of payment on their native blockchain platforms, with the premise of an argument centered around the notion that the expected popularity and technological progress of the project renders the token as an ”attractive store of value,” .promoting further adoption.

Again, during the ICO stage, a parity between investor and startup in terms of the project’s realistic roadmap is required in order for this model to successfully play out.

The paper also outlines some of the benefits blockchain platforms can enjoy by using a token economy: ”Tokens… can accelerate adoption, reduce user-base volatility, and improve welfare.”

The US SEC Crackdown: Warranted or Not?

While the US Securities and Exchange Commission (SEC) has received criticism for its actions against ICOs last year, examining several of the public cases individually shows that perhaps the actions of the government agency were necessary in order to keep investors fully informed on their decisions, as the research shows that it is required to promote a healthy ICO market.

In the case of AriseBank, the SEC halted the ICO after proving that the startup had falsely claimed to be FDIC-insured bank which would have allowed the decentralized bank to offer customers FDIC-insured accounts. The SEC cited that AriseBank had ”used social media, a celebrity endorsement, and other wide dissemination tactics” to raise a claimed USD 600 million of its USD 1 billion goal in two months.

One of the benefits of ICOs cited by Chod and Lyandres is the unique ability of tokens to allow entrepreneurs to shift some of the venture risks onto investors without compromising their own control rights. This could be the biggest benefit of token offerings for startups, but for it to revolutionize venture capital financing in a way it is capable of, investors need to be made aware of the risks by entrepreneurs.

2019: What to expect

The future of ICOs in 2019 depends on three major factors: US regulation, transparency from startups, and the market performance of major cryptocurrencies.

Chairman of the US SEC Jay Clayton himself has said ”ICOs can be effective ways for entrepreneurs and others to raise capital,” so long as you adhere to the regulations set by his agency at least.

Tokenomics is a cutting-edge theory with the potential to revolutionize the structure of business development and entrepreneurship, but for it to live out these prospects, right now, startups would be advised to professionalize their whitepapers and start playing by the rules at least until the industry can prove it has matured.

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SEC Cites Cryptocurrency as Top Priority for 2019

SEC Cite Cryptocurrencies Top Priority for 2019

The US Office of Compliance Inspections and Examinations (OCIE) has suggested that 2019 will be a year of great activity on the cryptocurrency front for the Securities and Exchange Commission (SEC).

The latest report released by the OCIE says that the SEC will prioritize what it sees as risky crypto products and services, and monitor digital currency markets with more vigilance. Any product classified by the SEC as security will be prone to the usual regulatory compliance. The OCIE further stated that:

“For firms actively engaged in the digital asset market, OCIE will conduct examinations focused on, among other things, portfolio management of digital assets, trading, the safety of client funds and assets, pricing of client portfolios, compliance, and internal controls.”

The SEC has cited the protection of customer rights and the integrity of US capital markets as the main aims of the additional scrutiny being applied to cryptocurrency dealings.

Any tightening of control in the cryptocurrency space by the US regulators will not be favorably greeted by investors who are already unhappy with what most regard as SEC crypto overregulation. The regulator’s anti crypto chairman Jay Clayton has confirmed the aims of the OCIE report, suggesting that digital assets, ICOs, and distributed ledger technologies are an “area where the Commission and staff have spent a significant amount of time” and that this would continue into 2019.

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Days Could be Numbered for SEC Role in Crypto

Days Could Be Numbered for SEC Role in Crypto

A new law is under consideration that, if becomes legislation, could see the SEC’s role in cryptocurrency regulation come to an end.

The bill set to be introduced, the Token Taxonomy Act, has been formulated by pro-crypto Republican Warren Davidson and Florida Democrat Darren Soto.

The main point of conflict with the industry is the labeling of certain cryptocurrencies as securities and not as assets, particularly after SEC Chairman Jay Clayton‘s declaration earlier this year that cryptocurrencies and ICOs would be classed as securities by the US financial regulator.

Clayton’s comments were made despite SEC William Hinman commenting in June that both Bitcoin and Ethereum were not securities because their platforms don’t have a controlling body. Davidson commented on the plans to introduce the new bill; one that could potentially remove SEC from the picture, a fact that would be a great Christmas present for many cryptocurrency investors around the US:

“In the early days of the internet, Congress passed legislation that provided certainty and resisted the temptation to over-regulate the market. Our intent is to achieve a similar win for America’s economy and for American leadership in this innovative space.”

The Republican crypto trailblazer went on the point out that such as change would have the effect stabilizing the industry and adding further much-needed clarification to investors, many still hanging on decisions to be made by the SEC regarding ICOs and EFTs. He added that a law such as this would ensure that “securities laws would not apply to cryptocurrencies once they become a fully functioning network”.

Last week SEC Senior Adviser for Digital Assets and Innovation Valerie A Szczepanik indicated that in certain circumstances, ICOs may be able to avoid registration requirements.

Speaking in New York at a gathering hosted by the Wall Street Blockchain Alliance, the SEC official has suggested that in certain cases an application doesn’t fit SEC law or regulation “but that it perfectly fits the spirit accomplishing all the goals of investors protection”.

 

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SEC Chair: ICOs Effective for Capital but Must Follow Securities Law

SEC

Securities and Exchange Commission (SEC) Chairman Jay Clayton has said that although ICOs are an effective tool to raise capital, they must adhere to securities law.

The chairman’s latest ICO-related comments came during his speech on SEC rulemaking recently. He said that digital assets, ICOs and distributed ledger technologies are an “area where the Commission and staff have spent a significant amount of time” and that this would continue into 2019.

According to Clayton, ICOs are working in a manner where investors are not protected like traditional securities are, leading to higher chances of market manipulation and fraud. He and his organization have a tough stance on ICOs, saying that most of them are just like securities and, therefore, must be treated like one. This means ICOs must follow the laws set for securities under the SEC:

“I believe that ICOs can be effective ways for entrepreneurs and others to raise capital. However, the novel technological nature of an ICO does not change the fundamental point that, when a security is being offered, our securities laws must be followed.”

The chairman also highlighted the commission’s openness to blockchain technology and its financial applications by talking about the creation of SEC’s Strategic Hub for Innovation and Financial Technology (FinHub). One of the major tasks of FinHub is to facilitate crypto startups to comply with current regulations when it comes to ICOs and launching of their tokens. Clayton said the “door remains open to those who seek to innovate and raise capital in accordance with the law”.

The SEC is very active when it comes to violation of regulations. Only a couple of days ago, it had issued an order to digital fund asset platform CoinAlpha Advisors to halt its ICO, fining it USD 50,000 for breach of regulations.

 

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SEC FinHub Now Monitors Blockchain Innovation and Offers Advice

The new SEC FinHub is suggesting that investors can now use a new form on their site to request meetings and other information regarding advice regarding compliance with current regulations.

FinHub is the go-to site for US Securities and Exchange Commission ICO Advisory Board inquiries regarding fintech. According to the SEC, the form will enable new companies and startups to gain access to all the necessary information required to tailor their activities to legal guidelines. The new form states, “We welcome requests for meetings and other assistance relating to FinTech issues arising under the federal securities laws.”

The SEC’s FinHub is overseen by the SEC’s Division of Corporation Finance’s Senior Advisor for Digital Assets and Innovation Associate Director, Valerie A. Szczepanik. It was designed to provide an online forum for crypto and DLT and is staffed with crypto and blockchain savvy SEC professionals. In a statement recently put out by the Finhub, the SEC claimed that:

“SEC staff across the agency have been engaged for some time in efforts to understand emerging technologies, communicate the agency’s stance on new issues, and facilitate beneficial innovations in the securities industry…”

The SEC has suggested that by launching FinHub they offered a “clear path” to investors, entrepreneurs and developers to encouraging them to engage with the regulatory body and “test ideas,” and seek advice, adding:

“The FinHub provides a central point of focus for our efforts to monitor and engage on innovations in the securities markets that hold promise, but which also require a flexible, prompt regulatory response to executing our mission.”

In another recent “educational” move, one that irritated many industry players, the SEC launched a fake website called Howeycoins which replicated an ICO, with a “buy now” link redirecting investors to an educational programme outlining in some details, the pitfalls of crypto investment. Information provided on the website looked much like that supplied during a genuine ICO, complete with white paper, statements such as “We anticipate OVER 1% daily returns, with DOUBLE 2% returns on Tier 1 investors in pre-ICO stage secured purchases.”

SEC Chairman Jay Clayton justified that particular “educative exercise” as one designed to support the uninitiated crypto investor, stating:

“We embrace new technologies, but we also want investors to see what fraud looks like, so we built this educational site with many of the classic warning signs of fraud… I encourage investors to do their diligence and ask questions,”

Visitors to the SEC FinHub’s latest form are only allowed one request, which should be regarding information related to financial technology, including ICOs and cryptocurrencies. They are also able to request a face to face meeting with a top SEC researcher to gain advice.

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Crypto Pioneers Attack SEC over Regulation in Joint Letter

A group of crypto pioneers has laid out concerns about the regulation of cryptocurrencies to the US Securities and Exchanges Commission (SEC), outlining caution that further regulations passed could be detrimental to the industry as a whole.

The news of this letter to the SEC follows another written last week by the US Congress in which they asked for more clarity on cryptocurrency security. Congress also said that they believed that cryptocurrency important for many sectors of the US economy and that the SEC’s view that all cryptos are securities, besides Bitcoin and Ethereum, is leading to an exodus of crypto and blockchain companies and talent from the United States.

This latest letter from the industry itself against intrusive regulation is sure to put added pressure on the SEC to find a solution which is suitable to all. A major warning to the SEC was about the very nature of cryptocurrency which is that it was designed to be held by a third party, rather the individual, and any future regulation would need to keep this in mind.

The letter was a crypto who’s who cosignatory document including dotcom veteran Christopher Allen, Bitcoin core developer Bryan Bishop, financial expert Angus Champion de Crespigny, blockchain attorney Gavin Fearey and Caitlin Long, most recently Morgan Stanley’s managing director.

The letter explained that cryptocurrencies shouldn’t be type-cast due to their unique qualities and as such warned that “fitting them into existing market infrastructure introduces risks to investors that would not otherwise exist”.T he letter also warned against “applying rules to digital assets in ways which do not reflect their strengths”.

Earlier in June, SEC Chairman Jay Clayton clarified that the regulators had no intention of changing their traditional regulatory approach. He said:

“We are not going to do any violence to the traditional definition of a security that has worked for a long time. We’ve been doing this a long time. There’s no need to change the definition.”

Clayton was referencing a Supreme Court ruling from 1946 which defines a security as an investment of money in a common enterprise, in which the investor expects profits from others’ efforts. Those in the crypto industry have always maintained that cryptocurrencies, tokens, and ICOs, as assets rather than securities, need further legal definition.

 

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Congress Requests SEC Clarify Crypto Security Laws to Support Innovation

The United States Congress has sent a letter to the Securities and Exchange Commission (SEC) requesting that the agency clarify crypto security guidelines, to support innovation and to lessen the increasingly tense mood in the crypto space caused by widespread crackdowns led by the SEC.

Congress says they believe crypto is important for many sectors of the United States economy, and that the SEC’s view that all cryptos are securities, besides Bitcoin and Ethereum, is leading to an exodus of crypto and blockchain companies and talent from the United States. Congress is concerned that the United States will fall behind in the crypto and financial technology sectors due to the SEC’s behavior, explicitly stating that the SEC is inhibiting innovation by using law enforcement instead of making the rules better and easier to understand. Congress explicitly demands the SEC clarify guidelines by making them more articulate and improving them.

Currently, the SEC’s definition of a security cryptocurrency is any crypto which is purchased by investors from a centralized organization with the expectations of profits from their investments. Congress believes this classification is too broad since it basically includes all cryptos besides perhaps Bitcoin and Ethereum as security within that definition. Congress is asking the SEC to expand on its definition of crypto securities and to reference the Securities Act and Howey Test in its response. Furthermore, Congress wants the SEC to create easy to understand educational materials, like FAQs and examples, so crypto users aren’t confused.

Congress wants the SEC to create new guidelines to clarify how a crypto can transition from a security to a non-security due to decentralization, which is what happened with Ethereum. There are probably several cryptos launched with initial coin offerings (ICOs) that are sufficiently decentralized to not be considered securities that would still be called securities by the SEC due to the broad definition that is currently in place.

In the letter, Congress gives a shout out to SEC Commissioner Hester Peirce, who has stood up for crypto rights, unlike other SEC commissioners. Some people in the crypto space have labeled her ‘crypto mom’ for her nurturing attitude towards crypto.

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Philippine SEC Shares Draft ICO Regulations

The Philippine Securities and Exchange Commission (SEC) has released a report detailing the country’s proposed initial coin offering (ICO) regulatory guidelines.

The 37-page document released by the SEC reportedly comes after consultancy with several Philippine cryptocurrency companies, including Satoshi Citadel Industries and Coins.ph.

The proposed rules would require Philippines-based startups and corporations to file applications with the SEC detailing the function of the tokens and the business operations of the company. Prior to receiving the go-ahead to hold an ICO, companies would be required to submit an initial assessment request that follows the rules of the Commission within 90 days before the beginning of the token pre-sale.

The white paper, including an operations manual detailing the system’s structure, must also be submitted, alongside the evaluation of an independent legal counsel in evidence that the tokens do not meet the requirements necessary to be registered as securities with the SEC. The proposal goes so far as to request source codes and commands in attempts to expose potential scammers.

Further to receiving approval, advisers and members of the company holding the ICO are required to undergo police clearances to show they are of ”good repute“. The report offers nine instances that a team member could disqualify the ICO, including if they are found to have made any false statements regarding the project during the process, or if they have ever been convicted of offenses including embezzlement, misappropriation, or perjury.

To combat any illicit activities of investors in the ICO, know-your-customer and anti-money laundering policies would be required from all participants.

Similarly to the US, the Philippine SEC highlights the importance of registering tokens as securities should they fall within the legal definition. As stated by US SEC Chairman Jay Clayton, tokens fall under the definition of securities if there is a ”reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others“.

 

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ICOs Only Account for Less Than 2% of Securities Lawsuits

A report released by litigation consultancy firm Cornerstone Research indicates that initial coin offerings (ICOs) account for under 2% of securities class action lawsuits – just 12 of 750 cases.

ICOs are not the main offenders… are they even securities?

With the total number of securities lawsuits at levels unmatched since 1995, the report found cases involving ICOs hit just five in the latter part of 2017, and have reached seven in 2018 so far. There have been 111 suits filed in total since the start of the year. While cases filed against American companies are reported to be on the decline, there is a growing number opened against European and Asian companies, nearly double that seen in the last decade.

Whether ICOs even classify as securities is currently up for debate. Securities can be defined as financial assets that represent a proof of ownership in the stake of a company that has intrinsic monetary value, but some argue tokens and cryptocurrencies purchased during ICOs do not qualify under this definition. This disagreement has led many to question whether the US Securities and Exchange Commission (SEC) is even the correct entity to be investigating cases involving ICOs.

Despite much bad press regarding ICOs, several of these few cases opened against crypto-related companies found fault in their reluctance to file their tokens as securities, which is a legal requirement in the US.

In one instance, Ripple (XRP) is facing three separate lawsuits from investors who lost money when they sold the tokens on. The plaintiff in one of these cases argues the XRP classifies as a security because i) they must be purchased with money, ii) investors reasonably expect to profit from them due to Ripple’s own promotional efforts, and iii) the profits collected are determined by the company’s management decisions.

The Massachusetts branch of the SEC suspended five cryptocurrency companies offering ICOs in March this year because they had all failed to register their tokens as securities.

In February, SEC Chairman Jay Clayton declared that ICOs must meet securities regulations, ”end of story”, although in June the SEC voted that Ethereum did not meet the definition of a security. Ethereum and Ripple have fundamentally different structures and use-cases for them, but it indicates a more reasoned, practical approach may be taken by the SEC in the future.

 

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Educational Hoax ICO Site Launched by US Government

The US Securities and Exchange Commission (SEC) has produced a website advertising a scam initial coin offering (ICO), in an effort to educate the populace on how to identify such fraudulent websites.

In a Wednesday press release, SEC Chairman Jay Clayton discussed the intent behind the initiative. While acknowledging the rapid growth in the number of ICOs, he explained a need to help give investors the tools they require to recognize fraudulent sites.

”We embrace new technologies, but we also want investors to see what fraud looks like, so we built this educational site with many of the classic warning signs of fraud… I encourage investors to do their diligence and ask questions,”
Clayton detailed.

Howeycoin ‘ICO’

The mock ICO website advertises the fictitious Howeycoin token, reading: ”Howeycoin is the newest and only coin offering that captures the magic of coin trading profits AND the excitement and guaranteed returns of the travel industry. Howeycoins will partner with all segments of the travel industry (air, hotel, car rental, and luxury segments), earning coins you can trade for profit instead of points.”

Information provided on the website looks much like that supplied during a genuine ICO, with statements such as “We anticipate OVER 1% daily returns, with DOUBLE 2% returns on Tier 1 investors in pre-ICO stage secured purchases.”

SEC Chief Council Owen Donley noted the ease at which scammers can utilize convoluted jargon to lure individuals into false investments, but pointed out significant red flags that can indicate fraud.

By clicking on the internal website links, visitors are directed to an SEC site that notifies them of the truthful nature of the website.

The SEC notice explains: ”Our bogus site is a mash-up of a number of different things we’ve seen – any particular fraud may be harder to spot than the red flags here. Here are some of the signs of fraud that are on the Howeycoins site – we hope reviewing these may help you recognize a real fraud in the future!”

Targetting of ICOs

There is certainly an emphasis currently placed on targetting ICOs and cryptocurrency related scams, when in fact around less than 1% of Bitcoin-related transactions have been linked to illicit activities. Although, it is true that several high-profile ICOs have been shut down due to suspected, or convicted fraudulent activity.

While it is certainly necessary to regulate ICOs to ensure they are providing the services and tokens that they are advertising, the current enforcement of numerous subpoenas by the SEC does indicate an arguably overzealous approach towards cryptocurrency start-ups when compared to how mainstream financial scams are currently handled.

 

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