Did the SEC just stop the music at the token party?
Yesterday the SEC made the unfortunate, but not unexpected announcement, that crypto-tokens and coins are likely securities, unless they qualify for an exemption. The most likely exemptions would relate to tokens or coin offerings that would fail the Howey test and have project utility.
The most obvious consequence of this announcement is that these crypto-securities issued to, or issued by US entities, will need to be registered at the SEC and may only be offered to accredited US investors, in most cases. Failure to do so would be a federal offense, whether you were an issuer, seller or even a buyer. Although the SEC recommended no such sanction for those involved in the specific case investigated — the Ethereum DAO from 2016 — the SEC cannot tell other arms of the law like local police or the Department of Justice what to do. Still, the less obvious and by far the more problematic issue, in my opinion, relates to the fact that crypto-exchanges would need to be registered with the SEC if they enabled the trade in tokens and coins considered securities, either because the exchange was based in the US, had US customers or enabled trading in crypto-securities issued by US corporations.
I’m not a fan of premature fintech regulation. It appears that US legislators and regulators are intent on protecting US people from the fintech monsters under their bed.
The SEC statement will likely call into question the legality of all exchanges trading in cryptocurrency tokens and coins. US buyers, sellers and issuers of cryptocurrency tokens and unmined coins may be encouraged to delist their “security” or withdraw their token and coin holdings from these exchanges. It seems unlikely that either Bitcoin or Ethereum would be considered a security by the SEC based on the announcement, so those would likely stay. The removal of the US market makers and their balances on these exchanges will reduce token liquidity, as will the removal of tokens issued by US corporations. The party could come to an end right here for many cryptocurrency exchanges.
By the end of 2017, likely more than $1 billion would have been invested globally in ICOs. Many of these projects would not have been funded through traditional channels like friends, family & fools, banks, government grants, Angels or VCs. In many cases, this is because these projects are working in new areas of technology where business models are not yet clear. In other cases, local Seed funding opportunities for these opportunities are limited. Even if you’re a willing investor, it’s very difficult for highly qualified US individuals to participate in unlisted investment opportunities, since they wouldn’t necessarily meet the high net worth or high income requirements to be classified as qualified investors. And even if you’re a qualified US investor, you’re unlikely to be able to participate as an LP in the largest Silicon Valley VC funds that get first access to some of the best opportunities — institutional money dominates.
Most of the projects raising money via ICO in 2017 will fail. That is the nature of early stage businesses, especially when they’re working with disruptive, emerging technologies. Fortunately, if history is to be believed, many of the projects will also be massive successes. Legislators and regulators need to sit on the sidelines for a while longer. It is too important for both investors and entrepreneurs and overall economic growth, that ICO markets are nurtured. Tough US regulations will lead cryptocurrency exchanges to decentralize, anonymize and move to more friendly jurisdictions.
The US is on the verge of opting out of what might well be the most significant innovation in venture finance since the Medicis — highly liquid, crowdfunded finance for early-stage projects. Let’s not screw this up.