The ICO3.0 a.k.a Restricted Security Tokens
For non-dilutive equity, 2017 was the golden era for the ICO 2.0 model.
Why do I say 2.0? Because the original goal of the first ICOs was not about Lambos, Moons, or MarketCap rankings. In fact, the 1.0 ICOs has very little to do with wealth – the objective was to propagate your network enough to ensure your coin was sufficiently decentralized to allow the protocol to become self sustaining. True utility, open source proliferation, and community building around a common goal. Exciting stuff.
Incredibly exciting, revolutionary, and incredibly valuable because the internet is broken. Open access, peer to peer FTP, torrenting – the internet made everything free, blockchain gave everything value.
The internet made everything free – enabling pirated music, tv, cinema, books, software, education – blockchain gave everything value.
ICO 2.0
Where value is created, enterprising minds will seek to capture it. And so began the saga of the second wave of coin and token offerings. Projects such as Ethereum did more than just establish a decentralized network – Vitalik turned the head of every hungry entrepreneur who ever tried to raise capital…and the VCs who would have or did turn him down now watched his rise to Billionaire status with envy.
Beyond proving the tremendous ability of the ICO to raise capital Ethereum became the bitcode compiler of fundraising. You no longer had to code and propagate your own blockchain but could simply build a few microservices-esque smart contracts to raise millions – and now even billions.
This was way better than “non dilutive equity” – it was a turn key money printing opportunity where you could access capital without giving any rights whatsoever to those contributing to your project. No voting, interest, dividends, equity…nada, nicht. Simply put, here’s the token – do whatever you like with it but if you HODL someone will pay you a premium when it goes to the moon…
Dolla bills, lambos, and a whole new definition for the term “whitepaper”. Little to no regard for regulation, cyber security, or a viable business model.
Most ICOs in 2017 are like 50% of weddings, no thought given to marriage or if you can even stand your partner – its all about the big day.
But hey, at least it’s decentralized.
Enter ICO 2.1 a.k.a. the STO
You know the saying about putting lipstick on a pig? This is the ICO 2.1, an offering where you slap together a Form D, shill your token at every crypto-conference you can pay to play for a speaking slot, and cha ching $59 Million dollars later you are laughing all the way to your honeymoon in the Bahamas.
What does the investor get? No rights, no dividends, interest, equity. Simply an extra step of friction between you and your one day to be released product. In many cases, these same projects — despite raising millions — have not gone through the reporting requirements and certifications to offer a financial service and do not hold a license. Many of these projects simply can’t get licenses because they can’t pass a cybersecurity audit, meet basic disclosure requirements, and anti-money laundering standards. The recent Mueller indictments demonstrate why this is so important with the use of Bitcoin for financing terrorism.
These STOs are, in many cases, more fraudulent than the ICOs they evolved from.
By masquerading as compliant, or even worse “SEC approved” (quote taken from a LinkedIn post by a New York City lawyer for a recent STO), these offerings are blatantly making claims – literally writing cheques they cannot cash. Liquidity is great, and yes, asset backed tokens will change the world but only when the issuers of these tokens start to take compliance seriously.
Here are a few examples…
- It’s not about where your offering is based. Securities regulations are intended to offer investor protection and structures around where the investor is. You know that little thing called the US Securities Act? Yeah, that’s for the USA and pretty much every country with a capital pool worth having has their own version of securites regulations – and guess what, they are not harmonized.
- Sanctions – I’m not talking about that fake Global PEP Watchlist some fly by night KYC provider is shilling you (google Japan’s recently announced bad news for all the crypto exchanges using Jumio, BigID, OnFido, or Civic) – this is about trade sanctions. That security token you issued and filed a Form D for comes with liabilities beyond the Securities Act. If you thought a max 10 years in prison for a Securities Act violation was bad look up the penalties for breaching the US PATRIOT Act. How do you breach a sanction with your 506(c) security token? Let someone from Libya, Iran, or a known terrorist buy it off of Ether Delta.
- Ignoring lock up periods. In the US a security token also needs to consider the Exchange Act. In other countries, there may be similar regulations…again, not harmonized, such as the OM in Canada. While Reg D requires a 12 month lock up period (or 6 months if you meet the criteria of the Exchange Act) the OM is typically 4 months – although two legitimate STOs (TokenFunder and Impak Finance) are explicitly not allowed to let their tokens trade.
- Remember that thing about countries outside the US having their own securities registration, exemption, and disclosure requirements? Same goes for KYC. In Switzerland you cannot legally buy equity without an old school signature (Crypto Valley has some lobbying to do before they can be part of the asset backed token era). Canada (my home and native land) is much worse, a government issued photo ID does not qualify for digital onboarding KYC in financial transactions. Instead, you must do two, yes two, credit checks from two separate agencies. Want to guess how many credit agencies in Canada have approval to ping your history? Yup…2…welcome to the Great Nothern land of legislated oligopolies. My point is, pretty much every country has their own KYC, AML, and ATF requirements and thresholds.
3.0?
All right, now that we have drudged through the FUD let’s look at the silver lining…and there is a silver lining.
First, most of these problems can be solved with technology, and many of them can be solved with blockchain as part of the solution. When blockchain is applied to an appropriate problem it can enable multiple factors of competitive advantage, integrity, and transparency over what is being done in traditional financial markets today.
Rome was not built in a day, neither was the internet, nor your local bank’s mobile app. Blockchain is quite simple but it’s power is that it touches nearly everything. This transition requires infrastructure, standards, and transparency in order for investors to gain the confidence required to move their funds from the traditional capital markets.
Matthew Unger is CEO of iComply Investor Services, the leading global compliance platform for digital finance and cryptocurrencies. iComply enables cryptocurrency exchanges, security token platforms, and ICO issuers to simplify multi-jurisdictional compliance, reporting, and record keeping on a country by country basis. You can find @iComplyICO on LinkedIn, Facebook, Twitter, and Telegram
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