This morning in the gym, I noticed the first of (likely) many “warnings” on CNBC about Crypto-assets emanating from Davos. This should surprise no one, as that confab, which includes the most powerful financiers in the world, is primarily about consolidating and maintaining the power they hold as modern-day aristocrats.
While I am not a zealot for the world-changing potential for BitCoin, Ethereum, or other crypto-assets, I do understand their potential, particularly in the context of investing. Crypto, you see, threatens to undermine the stranglehold on innovation and early stage investing that elite crony capitalists have established. Look no farther than blaring headlines “Blockchain Startups Absorbed 5X More Capital Via ICOs Than Equity Financings In 2017” to clarify the threat. The largest difference between ICOs and the equity financing described in the article is that ICOs raise money primarily from individuals, while most early stage equity investing is done by large pools of money controlled by venture capital and private equity firms.
The simple fact is that ICOs, like the IPOs last century that were used by technology companies, are a PUBLIC financing method, not reserved to the elite. This century, however, early stage IPOs have been displaced by private equity, meaning that the large pools of private capital controlled by people, such as the participants in Davos, have become the gatekeepers to early stage investing. The implication, therefore, is that enormous investment returns formerly available to anyone smart (or lucky) enough to have invested early in companies such as Amazon, Cisco, and Microsoft, are now much harder to achieve via the public equity markets. Thus, it is easy to connect the dots to understand that crypto, according to those in control, must be contained. The fact that they wish to tie up entrepreneurs in red tape in order to ”protect” investors, reminds me of a famous speech by Issac Asimov, who explained how resistance to disruptive tech is always framed as “protection”:
“If anyone wonders why … Well, when I read all of these references I discovered, to my amazement, that all through history there had been resistance…and bitter, exaggerated, last-stitch resistance…to every significant technological change that had taken place on earth. Usually the resistance came from those groups who stood to lose influence, status, money…as a result of the change. Although they never advanced this as their reason for resisting it. It was always the good of humanity that rested upon their hearts.
For instance, when the stagecoaches came into England, the canal owners objected. Not that they would lose money, although they would, but they feared for humanity. Because as the stagecoaches tore along at fifteen miles an hour, the air whipping past the nostrils of the people on board, would by Bernoulli’s Principle, suck all the air out of the lungs.”
In the case of ICOs (and crypto in general), there are multiple threats. As I noted, there is a threat of losing control over the financing of early stage technology investments, but there are others as well Many in the financial old guard understand the power of networks to disrupt business models, and fear the potential for distributed ledger technology to facilitate their growth. Still others are concerned about the potential for crypto currencies to become a viable alternative to the system of government controlled “fiat” money, which has enriched the financial sector.
Now, before people jump to conclusions, I am NOT suggesting that the “Wild West” of ICOs continue unabated. I am concerned, as are many in the crypto industry, how scammers and charlatans are capitalizing on the public fascination with the new technology. Rather, I believe that regulators should bring enforcement actions against clear cases of fraud and design well-written exemptions and changes to rules such as Reg A+ and broker dealer registrations to accommodate network tokens and other crypto-assets.
First, a word about fraud. If ICO promoters or founders say or publish misleading things, which create the impression that investors have more rights or participation in their project, or if they misrepresent the state of the technology itself, such statements could be prosecuted today. As far as I know, making fraudulent statements about products or investments does not require additional rules to enable prosecution. In addition, it is certainly open to civil litigation, fine print disclosures in the whitepaper non-withstanding.
As far as securities rules are concerned, I think that rules such as Reg A+ should have specific provisions for network governance disclosures as opposed to pure corporate statements. Crypto-Industry groups have drafted such disclosures, which go beyond what Reg A+ requires in some dimensions, but ignores some disclosures that are irrelevant. In addition, proper disclosures of ICOs should describe all tokens distributed in the ICO as well as post ICO lock ups agreed to in the process, as well as providing for subsequent enforcement of those provisions. In addition to modification of current rules, there is also the issue of establishing a Self Regulatory Organization (SRO) structure that is appropriate. It would be reasonable to allow the industry to establish their own SRO(s), as opposed to making the assumption that FINRA is the only option. It is not that it would be impossible for FINRA, but they would need a lot of help from the industry to develop understanding of the nuances of these assets.
Whatever is decided, it is also important to manage the resulting transition from unregulated entities to SEC approved ones. One important and likely transition is for the current “exchanges” trading Ethereum, its alternatives, and the tokens based upon them to be required to become Alternative Trading Systems. This transition should be arranged in such a way to avoid disrupting the billions of dollars already invested in such coins by the public. If the SECs mission is to protect investors, they will heed these words, rather than acting precipitously in the interests of the self-interested parties calling for such action. On the other hand, it is important to start the process soon. Founders of networks with good intentions are now stuck in an impossible situation.
At CoinRoutes, for example, we intend to ICO a coin that will enable a self-regulating network for aggregating liquidity. While it is clearly a network token and not equity in our corporation, it does depend (using Jay Clayton’s words), at least somewhat, “on the entrepreneurial and managerial efforts of the founders.” As a result, I can see how our soon-to-be-created token could easily be judged a security in the future. On the other hand, competing models in liquidity aggregation have either ICO’d already (such as AirSwap) or are planning to follow the existing processes and have their “coins” listed on existing exchanges. This means that adopting a very conservative approach would put us at a serious competitive disadvantage. Thus, in addition to wanting rules that recognize the important differences between network tokens and equities, my hope is that clear guidance will soon be forthcoming in order to re-establish a level playing field for entrepreneurs.