ICOs have become a huge opportunity for entrepreneurs who want to raise capital for their companies without issuing shares. Think about this: raise $50M now in Bitcoin, give away some valueless tokens to speculators, and keep 100% of your shares in the company. Do you want that deal?
Sure enough, the party needed to end. It turns out those valueless tokens had value because the investors were able to trade them on shady exchanges for more than they paid for. How much more? Think thousands of percents more. How much can you probably get if you invest in Apple this year? You get 31%. How much can you get if you invested in an ICO? Probably 1,000%. You get the picture. Recently the SEC made some very important bulletins and press releases about ICOs:
- The SEC concluded the DAO token was a security.
- They warned investors to be very careful when investing in ICOs.
- Create an new cyber enforcement unit to fight cyber crime and ICO fraud.
- They announced the first enforcement against a CEO and two companies.
In other countries such as China and South Korea, ICOs have been entirely banned. Australia, meanwhile, came out with clear guidelines.
More is coming. Probably many of tokens that were previously issued are going to be viewed as securities by the SEC. So what does this mean for the ICO market?
Well, it is actually a real good thing.
How so? Think of this: Investors will be better informed in their investment decision through the proper disclosures required by the SEC. This is the least companies can offer them. If a company decides to launch an ICO and write a whitepaper with lots of nonsense, (I have read many of those), and then go on to raise $50M, it should be required to register its offering with the SEC and let the commission qualify it. This way, the investors are reassured the offering was well-reviewed and the financial disclosures are clear. (This is nonexistent right now).
When the JOBS Act was voted into law in 2012, Congress had no idea that Bitcoin existed. Their motivation was to enact a modern securities legislation to update the 1934 securities rules. Why? Because the internet changed everything, and crowdfunding became a very important new way to raise capital, most of it through donations on Kickstarter and Indiegogo. But in reality, everyone was able to see the future: people want to invest in new ideas. The JOBS Act introduced four parts, each providing a new way for small companies to raise capital for their businesses.. Three of the parts that are most relevant to ICOs are:
- Regulation D 506(c) through which a company can raise unlimited capital from accredited investors on the internet. To comply, the company checks the accredited status of every investor. Total legal costs are around $50K.
- Regulation A+ through which companies can raise up to $50M from the general public every year. To comply, the company registers the offerings with the SEC. Total filing costs range from $100K to $300K.
- Regulation Crowdfunding through which a company can raise up to $1.07M from the general public every year. To comply, the company uses a funding portal and files a notice to the SEC. Total filing costs range from nothing to under $10K.
So what is the big deal for companies who want to raise capital with their ICO? They simply can use a Regulation A+ offering to raise $50M.
With a Regulation A+, the Bank Secrecy Act is required to review the large investments against the OFAC list to prevent money laundering and terrorism financing.
The secondary market for these tokens needs to be changed to allow for tokens that have been issued under one of the JOBS Act rules. Any exchange company that is currently operating with these shadow tokens will not want to list these new security tokens.They will be violating a whole list of laws regulating the trading of securities. These exchanges will need to become broker-dealers or only trade regular tokens. However, many of the regular tokens they are trading now are securities. Ooops! They will need to hire a good law firm and pray.
China and South Korea ordered exchanges to shut down and Japan regulated 11 of them. So there is a path forward to exchanges, but it might not be the current ones who survive.
The good news for investors in ICOs is there are companies who announced they will trade securities tokens. The first one is T0 (T-Zero), which is a division of Overstock, These new trading marketplaces are regulated as broker-dealers. T0 (T-Zero) is using the alternative trading system (ATS), which is not an exchange but a way to trade assets without being licensed as an exchange. Becoming an exchange à la NASDAQ or NYSE is hard to get the license. Becoming an ATS is easy for any broker-dealer to file with the SEC.
The new ICO market is going to further grow but this time it will happen in regulated marketplaces. Entrepreneurs will have to jump through a few hoops to get their ICOs launched with a clear legal framework.