Case-By-Case or Cease-and-Desist? In Search Of a New Approach to ICOs

That rumble you hear is the sound of regulators around the world mobilizing resources to tackle the pressing matter of token sales.

Yet, in spite of the spectacular growth of blockchain token-based funding, no one seems to have a clear idea of what type of rules to introduce. The resulting uncertainty (not to mention ridicule) is left hindering progress as money flows to unviable projects and investors are left vulnerable to foul play – exactly what regulation is supposed to prevent.

Perhaps a new approach is needed.

But to see where this could go, it's worth stepping back and asking what we expect the regulation to do.

Safety belt

First, why do we need regulation, not just of finance, but of anything at all?

To protect us. At its roots, that is the main role of government – to protect its citizens from avoidable harm and extreme loss brought about by others or from our own lack of common sense. When it comes to securities, that usually means stopping us from making poor decisions.

After all, the word "security" means "safety," from the latin securus, or "free from care." Obviously, with time, the original intent of financial securities got buried in market myth, and the promise of high returns changed the connotation, implying risk.

As markets got more complex, instruments emerged that creatively skirted around the rules, which fostered innovation but also fragility, as we saw in 2008. Many argue that stronger oversight and tighter limitations could have prevented the crash – but at the time, innovation seemed like the better option.

This is especially relevant now that digital token sales have entered the picture.

Second, given the risk inherent in ideas with no working model, barely any documentation and doubtful liquidity, should the state intervene to "protect" us from token sales? The concern is that heavy-handed control would quash the fascinating progress going on in the space.

However, a wait-and-see approach is perhaps not doing enough to prevent extreme loss.

In applying a blanket rule with few specifics, the SEC seems to be taking a hybrid approach. In addition to its previous admonitory statements, this past week it announced not one but two new task forces to strengthen its footprint in token activity and investor protection.

While this is no doubt designed to both reassure and warn the market, it is still lacking in concrete guidance, requires case-by-case analysis and relies on post-hoc measures.

Checklist

A more solid and less resource-intensive solution could be to focus more on prevention than penalties.

This could be done by making it harder to sell newly issued tokens, regardless of structure, through disclosure and due diligence conditions.

Similar to the filing requirements for an IPO, tighter pre-sale rules could confirm that participants see the relevant documentation, while analysts have greater access to pertinent information and regulated alternative exchanges – such as the one revealed by tØ earlier this week – have time to ensure a minimum level of liquidity.

Establishing disclosure requirements would also streamline the regulators' workflow, and set clear guidelines for new ideas without eliminating either risk or creativity. What's more, it would impose a discipline on issuers, while leaving the ultimate decision on whether or not to participate to better-informed investors.

While passing through hurdles to get authorization does not necessarily mean that an issue is a good value or even honorable, it could serve to filter the flow and mitigate some of the risk.

And, obviously, not everyone thinks that regulation in financial instruments is a good idea – or even that it's possible.

But for buyers that want protection and issuers that want respectability, official support can open up new areas of opportunity and growth.

Changing lanes

The SEC has already shown its willingness to forgo full-IPO levels of disclosure, with its Regulation A+ exemptions. A different category could be introduced for blockchain tokens that harness some of the advantages of this new distribution mechanism while ensuring a certain level of probity.

It would mean higher issuance costs than the current situation, which will push some contenders out of the market. However, projects with solid prospects and decent fundamentals should be able to cover those costs, either through existing revenues or through the intervention of angel and venture capital investors.

This type of collaboration could perhaps put a welcome end to the talk of ICOs "replacing" traditional financing methods, and encourage more stable, hybrid approaches.

It would also help bypass the prickly need to determine, on a case-by-case basis, whether a token is a security or a "utility coin." It wouldn't matter – ideally, they would all be a bit of both.

As well as simplifying the regulation of the sector – giving it a solid base from which to innovate while offering a certain level of comfort and upside to buyers – this approach would help shift us from the set mindset that new concepts can be defined by old categories. That alone could be enough to unleash another wave of creativity, giving rise to new functions, ecosystem and terminologies.

Who knows, perhaps we could come up with a better word to describe this new paradigm-changing concept, more in line with its potential. And "security" could go back to meaning something secure.

And "security" could go back to meaning something secure.

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