Initial coin offerings (ICOs) are a relatively new method of raising money by means of crowdfunding through the sale of cryptocurrencies. ICOs are highly unregulated and therefore, they are controversial in the financial world. Despite the warnings of regulators and the uncertainty of the rules concerning the fundraising method, this practice has taken off and is being widely used to raise money. Over $3 billion has been raised by startups through ICOs from investors.
Joseph Grundfest, a former commissioner at the Securities and Exchange Commission (SEC) in the 1980s and now a law and business professor at Stanford, stated that he had been asking SEC officials and staff to prohibit the primary distribution of coins as it violates all existing norms of federal securities regulation. “ICOs represent the most pervasive, open and notorious violation of federal securities laws since the Code of Hammurabi,” Grundfest said in an interview. “It’s more than the extent of the violation, it’s the almost comedic quality of the violation,” he added.
These ICOs are undertaken without the involvement of financial intermediaries such as institutional investors and financial regulators like the SEC. Due to this, the trading of these coins happens outside the traditional financial system. ICOs have recently been banned by regulators in China and South Korea due to the fact that they violate existing securities laws. Most of the startups that have raised money through such offerings have nothing to show for it. In fact, it is assumed that over 90% of these projects will fail. Yet, there is genuine interest in this business model and this way of raising money has attracted attention worldwide.
Jay Clayton, chairman of the SEC, has stated that the SEC is willing to scrutinize each ICO individually and determine which of the coin offerings are to be labeled as securities, which would require registration with the authorities. Further, he added that any ICO that violates federal securities laws would be met with strict punishment. “Where we see fraud, and where we see people engaging in offerings that are not registered, we are going to pursue them because these types of things have a destabilizing effect on the market,” Clayton explained in a meeting at the Federal Reserve Bank of New York.
Grundfest said that this a welcome step but it should not have taken so long to regulate these offerings and punish those that have acted in a fraudulent manner. The majority of the ICOs claim that they are not securities. However, the opinions on this issue are rather divided. Some companies effectively promise a return on investment and give voting rights to the coin holders. At the same time, most coins are bought in the hopes of financial gain. This has hindered the growth of this industry throughout the past few months. Whether or not the SEC will regulate ICOs and punish those who have indulged in fraudulent tactics remains to be seen.
A Former SEC Regulator’s Opinions on Initial Coin Offerings (PDF)