The SEC’s First Bite into a Growing Pie

Something significant happened this summer, funding from ICO’s officially passed funding from traditional VC’s for the first time in history. As of June 9th, ICO’s had raised a total of $327M vs $295M from VC’s. Since then, ICO’s have pulled even further ahead with several companies completing their historically large rounds of funding, such as Tezos (raised $232M) and Bancor (raised $150M). At the beginning of August, there were around 80 active ICO’s and an additional 150 upcoming ICO’s. Today, there are over 250 active ICO’s and well over 300 slated for some time in the future.  With that level of money pouring in, it is no surprise to anyone following this space that the SEC was going to get involved. Earlier this summer they did just that by issuing an investigative report on The DAO tokens. This kicked off a number of other countries to begin putting varying degrees of regulation in place as it relates to the world of cryptocurrency.

On July 25th the US Securities and Exchange commission put out a statement on how they are viewing ICO’s in general and specifically, what their disposition toward The DAO incident is. This is something that the blockchain community was long anticipating and their ruling on The DAO came as no surprise. Their ruling stated that the DAO tokens were deemed securities and are “subject to the federal securities law”.

The SEC will be regulating ICO’s or Token Sales where the tokens are being used as securities rather than currencies. Currencies are a medium of exchange and have a store of value. A good example of this is Bitcoin, where you can exchange bitcoin for various goods & services. Securities on the other hand are investment contracts. The Howey test is commonly used to determine if something is a security. It passes the test if it checks off the following buckets:

  • It is an investment of money
  • There is an expectation of profits from the investment
  • The investment of money is in a common enterprise
  • Any profit comes from the efforts of a promoter or third party

The DAO tokens clearly met the requirements of the Howey test. The entire organization was based on the idea that investors would buy tokens, have a direct say in the governance of the organization and be rewarded once it was profitable. That being said, the SEC decided not to press charges but rather outlined a set of guidelines and cautions for people considering participating in an ICO.

As mentioned earlier, the number of companies popping up in this space has been outrageous. As a result, any Joe Schmoe has been able to disguise a poor idea for a company with the vail of a token / virtual currency and raise massive amounts of money. A perfect example of this was a company that recently had an ICO and is literally called “Useless Ethereum Token”. They describe themselves as “The world’s first 100% honest Ethereum ICO. No value, no security, and no product. Just me, spending your money” and yet they were able to raise $93,528 (or, in their words, enough to buy 77 televisions)!

At the end of the day, the SEC ruling is a good thing for the market and for investors. Investors will have greater confidence investing in companies that have been registered with the SEC, as they will be able to make decisions that are more fully informed. The number of Joe Schmoe’s building shams of companies in the space will hopefully see a decline in the future. The time and resources put into bringing these “useless” tokens to life will hopefully be put back into building out the blockchain infrastructure, as there is still a ways to go before the hundreds of companies being built would be able to operate on-chain.

Written by: Matt Hibberd

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