Last year was tough for all ICOs in terms of both price and regulation. The prolonged one-year bear market affected the value of the most issued tokens, which lost nearly 95% from their all-time-highs. Currently, most of the projects have some financial troubles and, making the situation even worse, they got the Securities and Exchanges Commission (SEC) on their tail. Some of them will have to return all the collected funds to investors, and it’s unknown as to what fate awaits the remaining ones.
In their recent annual report, the US SEC claimed that it shifted its focus towards the protection of retail investors. This report includes a long list of cases brought against some of the ICOs. Also, let’s not forget that Jay Clayton, the chairman of the SEC, said that all ICOs are securities and those that are not compliant will be brought to justice sooner or later. Is this the end of ICOs as we know them and what options do they have now?
- 1 The demise and failure of ICOs
- 2 Legal options
- 3 Security Token Offering
- 4 Conclusion
The demise and failure of ICOs
Currently, there is a multitude of problems surrounding initial coin offerings:
- The lack of registration in any jurisdiction for almost all ICOs. ICOs were marking their tokens as “utility tokens,” and selling them with a deep belief that it wouldn’t have any consequences.
- The lack of an actual product in many cases. Blockchain technology is almost 10 years old, but it has only seen active development in the recent years. One year later, after the ICO craze, we can hardly name any blockchain product that we can really use in our everyday life.
- The bear market that had a devastating influence on both the price of ICO tokens and their collected funds. Most ICOs were raising funds through ETH in exchange for their tokens in order to finance their operational costs and developments. Now as the ETH price fell to 90%, the funds of those projects that didn’t cash out diminished as well and, in most cases, they can’t finish their products.
All this combined created the problems we’re witnessing now. When it all started everybody believed that this kind of fundraising was the new financial paradigm for startups, and that it was how crowdfunding should look like.
One year later, investors saw that there’s another side to this freedom – no one is responsible for taking the investor’s money. Such a degree of freedom attracted many fraudsters. Millions of dollars were given to unknown fundraisers with shady intentions. During the bull market, it was still okay because the price of the tokens was increasing and the quality of the actual project didn’t really matter all that much. Nowadays, facing a bear market, investors sobered up and saw that they paid for literally nothing – no product, hence no value for the tokens they had initially bought. That’s when they remembered the officials.
The SEC and many other financial regulators from other countries – China, Japan, South Korea – were not happy about the unregistered companies selling securities. China banned ICOs right from the start – in September 2017. It cooled down all crypto activity inside the country – nobody wants to be considered a criminal in China because they have a death penalty. South Korea followed its example and banned them as well.
The US SEC didn’t take such radical measures, but anyway, continued to oversee the situation. The more complaints they were receiving, the more reason they had to intervene. Since then, the SEC began to actively pursue ICOs which were conducted without any proper registration. It published cease-and-desist orders on two ICOs; Paragon, which raised $12 million, and Airfox, which raised $15 million. It seems that the SEC created a template for ICO projects, as the two orders seemed similar. The reasons for the charges were:
- Each company’s token is a security.
- Each broke US securities laws because they a) failed to register with the SEC and b) did not qualify for an exemption.
The charges were settled when both companies agreed to register their tokens as securities, pay $250,000 in penalties, and refund investor money. The price of both tokens surged instantly because the buyback means that both companies would pay the initial ICO price for their tokens. As we remember, the price of many tokens fell 90%, and those investors can count themselves lucky that they can exit the market without any loss in this case.
One question remains: what should be done to evade dealing with the regulators? It seems that it won’t stop from now on, and hundreds of ICOs are under probation by the SEC. William Hinman, the SEC’s director of corporation finance, said in June, “Calling the transaction an initial coin offering, or ‘ICO,’ or a sale of a ‘token,’ will not take it out of the purview of the U.S. securities laws.” The example of the SEC can be followed by others jurisdictions, too – the European Union, Canada, Britain.
So, there is no way to evade punishment from now on. The regulators are relentless if they find something that can be considered a violation of law. The options that ICOs have are:
- to register officially as security dealers, according to the local law of their jurisdiction
- offer all investors a full refund
- finish their products, giving value to the sold tokens; however, this doesn’t guarantee that it will help to evade problems with unauthorized fundraising.
Refunds are the tricky part – after all, a lot of money was already spent in 2017-2018, and returning the whole amount may seem impossible. But it’s the only way to evade jail if regulators would consider the ICO illegal. The only exception is that the situation when the tokens were sold only to accredited investors or only to the citizens of countries that are “crypto friendly” or don’t care about pursuing financial criminals around the world. In all other cases, the judgment of financial regulators can reach the startups that violated these procedures, and there’s no way to prevent it. What’s done is done.
Meanwhile, what happens to all the future startups planning to raise money? They can take a valuable lesson: always consider regulators (especially the SEC) if you plan a global token sale. But there is a new trend in legal fundraising emerging: STOs.
Security Token Offering
An STO (security token offering) is similar to an ICO; it’s still a method for fundraising, but it’s compliant with regulations. All tokens are issued in a legal framework and can be traded freely on a special kind of regulated exchange. Unlike ICOs, the circulation of STO tokens can be limited to certain addresses on the blockchain that can be the addresses of registered accredited investors.
Issuing STO tokens is harder than the usual ICO process, because it involves gathering a ton of paperwork on the financial stability of the company, passing all the required audits, and obtaining the documents from investors in KYC/AML procedures.
Currently, there are two ways to conduct an STO:
- The first way is to gather all the necessary documentation, get the approval from the regulators of the chosen jurisdiction, and maybe even develop a private blockchain for issuing tokens. That, however, is the long and ineffective method.
- The second one is to use an established platform for STO issuance. For example, in Malta (a very crypto-friendly jurisdiction) is the platform ICO Launch Malta, who was voted as the “Startup of the Year” at Malta’s Blockchain Summit 2018. Using their complete STO platform, any company can simplify the process by outsourcing some of the necessary steps: submission of STO applications to a regulator, drafting the prospectus for their potential investors and technical requirements, and issuing the actual tokens.
Using a special platform to conduct an STO becomes more and more popular – why should you do it by yourself if you can outsource the work for a much cheaper price. And the most important nuance here: it’s 100% regulatory-compliant, so no one would come and knock on your door two years later. That, of course, would be a really valuable trait for many startups.
Will STOs overtake ICOs in the next few years? What will happen to the existing ICOs? These are the interesting questions, and nobody knows the answer. However, it can be said with confidence that the ICO model that existed in 2016-2018 is going to enter oblivion very soon. It’s not transparent and it has shown its inefficiency, making it safe to say that the STO model will soon prevail. STOs are more regulated and it demands responsibility from the companies that issue them, which will be great for future investors.
Thanks to the Howtotoken Agency experts for the information and comments provided for this topic.
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