Please note that the following piece represents the author’s opinion and not the opinion of the Ivey Business School, the Scotiabank Digital Banking Lab, or Scotiabank.
by Mauricio Di Bartolomeo
August 1, 2017
If you have been exposed to capital markets and/or the Initial Coin Offering (ICO) phenomenon, you probably agree that there needs to be some basic degree of regulation or “ground rules” to protect retail investors from fraud. The Securities and Exchange Commission (SEC) published a bulletin on ICOs on July 25th, 2017, suggesting that some may be deemed securities. The price of Ether has been down since the announcement, but as the fast money runs for cover, regulation paves the way for bigger and better participants.
Year to date, there have been hundreds of ICOs with over 1 billion USD raised.1 Many of them raised funds with no cap or target amount, and no immediate use for the excess. We should note that the vast majority of these offerings did not even have a product – they were based on whitepapers.
Have you ever asked yourself where this $1 billion came from? Have you heard of a Fortune 500 company or a Tier 1 retail bank taking a position on any one of these digital assets? Would their governance structure allow them to invest in these assets without scrutiny from their shareholders? The short answer is, no. While there may be some recent hedge funds and specialty investment vehicles catered to accredited investors, the great majority of these funds come from retail investors worldwide, many trying to “get rich quick” without a proper understanding of the technology. This is the perfect environment for a scam.
Fast forward to today (August 1st, 2017) and a lot of these hot ICOs have crash-landed, with many shirts lost in the process:
With so much money raised and lost in such a short time-frame, it was only natural to expect a reaction from regulators. The questions we should be focusing on are: how accepting will they be, and what will the ICO process look like under the new legislation?
The bulletin issued by the SEC on July 25th should be seen as an encouraging sign. Below is a short excerpt from the publication:
“Developers, businesses, and individuals increasingly are using initial coin offerings, also called ICOs or token sales, to raise capital. These activities may provide fair and lawful investment opportunities. However, new technologies and financial products, such as those associated with ICOs, can be used improperly to entice investors with the promise of high returns in a new investment space.”2
The bulletin also calls on investors to be wary of ICOs with “no net worth or income requirements.” It further advises that “many registration exemptions require that investors are accredited investors; some others have investment limits.” This as an effort to protect the most vulnerable investors and make ICOs safer for everyone.
Another great public service announcement that it includes is telling investors to be aware of unlicensed exchanges. This is a serious risk that most people take very lightly. Many have more money in their unregistered exchange trading accounts than they do in their bank – unaware that there is no legal recourse to go after those funds should anything happen.
In short, I see the SEC bulletin as a first step to encourage voluntary registration from ICOs and a word of advice to investors that want to participate in the sector. It is a necessary step in Ethereum’s coming of age and its acceptance by larger companies as a stable platform to build their applications.
The reaction from regulators has caused a short-term scare in the price of Ether, as many investing in the sector were doing it for the laissez-faire aspect of it. There is a large portion of funds invested in Ethers and ICOs whose legitimate origins may prove difficult to confirm. Those people are now looking for the door in anticipation of potential further crackdowns.
While the price of Ether may be depressed in the short-run, recent developments from regulators are steps in the right direction. The more compliant the platform becomes, the better suited it will be for larger partners and even greater adoption. That all bodes well for this new digital asset, whose value is directly related to its reach and network effects of its participants.
Mauricio Di Bartolomeo, MBA