Government Regulation of ICO: what makes it complicated?
“I’m gonna make a $hit t$n of money on August 2nd on the Stox.com ICO” — said a world box star Floyd Mayweather on his Instagram in July. He pretty much became the first celebrity to draw attention to the so-called Initial Coin Offering (ICO) — a crowdfunding system for generating cryptocurrencies and tokens, which constitutes virtual shares that companies sell to investors for their projects to draw funding. And he was right to do so: Stox — an online market for ICO forecasts — indeed grew by over $30 mn. back then. Since then, other celebrities took their interest in it. However, it seems they won’t be as fortunate: As of November 1, the United States Securities and Exchange Commission (SEC) has been on the offensive to take control over ICO.
How it all began
Just a few years ago, no one was aware of the so-called “initial coin offering”. And now, ICO has even gained more attention than the Initial Public Offering (IPO). According to Coinschedule, over the last twelve months, more than 200 of placed tokens invited investments amounting to $3.3 bn. To compare with, this very indicator amounted to $70 mn. last year. This leap became one of the reasons Bitcoin got hyped and reached its historic peak on November 2 — $7.5 thousand.
It is this crypto boom that drew the attention of regulators, who fully realized their loss of control over a huge slice of financial transactions. China and South Korea have already banned the ICO. The Western countries are thinking of that as well. Even though they only consider imposing restrictions in this area for now. The United States Securities and Exchange Commission has moved ahead and introduced the idea of registering tokens. But even then, the main challenges of government regulation remain in place.
Which ones exactly?
According to Peter van Valkenburgh, an expert from Coin Centre, the difficulty extends to the very interpretation of the term “tokens”. Technically, tokens are some sort of an entry in the Ethereum, blockchain or distributed registry, the copies of which are stored in computers worldwide — the same principle lying at the heart of bitcoins. The Ethereum registry, however, not only keeps track of the currency stored inside (“ether”), but also contains the so-called “smart contracts” — algorithms for the conclusion and maintenance of commercial contracts in the blockchain technology. Investors redirect the ether to the smart contract ICO that generates tokens directly for the trade. The issuer of ICO can store ether for some time and use it to develop his/her project.
But in legal terms, it is much more complicated according to a Kevin Verbeck, an analyst at Wharton a business school at the University. SEC, notably, argues that the technology principle is irrelevant in this case: if tokens are used to invite funding, they become securities automatically. ICO experts respond that tokens are not used solely to invite funding, but also perform certain functions in the projects funded through them. For example, some companies offer discounts or extra services to investors in exchange for the purchase of tokens.
The problem for regulators is also the so-called utility token. These coins are used as a tool for internal transactions. Basically, they are monetary units, not shares, and therefore can no longer be considered as securities.
Finally, it is not clear what jurisdiction do the tokens exactly fall within. They are a sort of program code, which you can categorize as a financial product. At the same time, they can combine all classes of assets, which causes legal tension in turn, especially in the USA, where various classes of assets are regulated by various governmental authorities.