ICO: The danger of over-regulation

16 April 2019 at 10:06 pm | Posted in Economy

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There are different views among economists towards governmental intervention in economic activities. Two sources of this disagreement that can be applied to ICO regulations are (i) individual “taste” and (ii) the “transferability” of conventions. In this second article of a 4-article series, I first address these two sources; then, I share my opinions on some sensible regulation and some unreasonable ones.

First, regulations always assume a certain “taste” or preference for those affected. Sometimes, this assumption is overwhelmingly valid: for example, we can safely assume few people, if any, prefer high amounts of pesticide residues in their grocery or brakes that can fall off randomly from their cars. To businesses, such regulations provide the certainty that makes it eaiser for them to operate. Sometimes, however, this assumption may not be valid and obvious to all: for example, many countries require employers to favor local residents and would only allow foreigners to be hired in absence of qualified local applicants. This process, while protecting local labor force in the short-run, harms the competitiveness of the labor market and can undermine the development of the workforce in the long-run. Here, the government assumes that the public wants protection against competition in the labor market; not everyone shares this view.

Worse still, sometimes the government believes that it knows the interests of the public better than they themselves: In the crypto market, particularly in regards to ICO, some regulators have taken the stance that the public should be “protected from it”. In other words, those in the public that want to invest in ICOs are acting against their own interests. This is the only possible conclusion because no one is forced to participate in ICOs.

While it is obvious that the prevalence of fraudulent ICO is astounding, surely the sensible solution is to prevent and punish these financial crimes rather than to get rid of ICOs altogether? Will air travel be around today if the regulators a century ago thought that planes were too dangerous and banned them all? Can’t we trust that some among the public have enough knowledge of the industry and have adequate skills in identifying obvious scams? For this group, wouldn’t ICO be a viable option to diversify their portfolio, seeing that it has a different risk profile than most alternatives?

Second, while it is normal to refer to old conventions, we need to be mindful of the diversity and distinctiveness of ICO tokens compared to traditional assets. In center of this is the identity of “security”. We see three general approaches:

One, led by the US SEC, holds that only “significantly” distributed assets are not “securities”. In this view, currencies such as Bitcoin and Dogecoin are kosher; almost all ICO tokens are securities. While they do not literally ban this new fundraising format, this course of action undermines the raison d’être of ICO: Projects seek ICO financing because they are short of funds. They issue an ICO token that provides value that will be delivered to investors once their project becomes operational, and the investors benefit from growing usage of the token that potentially drives up its price. For projects to register a public security offering, the costs would often be comparable to developing the project, at least through some degree of production.

One must ask these questions: (A) If the project can be profitable, why is it not profitable now that it is already operational? Why is ICO needed? (B) If the project is already profitable, why give away values in the form of ICO tokens? Are these tokens overvalued from the start? See, following the path led by US SEC, only unviable and/or overvalued ICOs would ever take place. They fail to realize that ICO tokens, even if you refer to them as “securities”, are neither shares, nor obligations, nor derivatives — they are different, and regulations of them should reflect this difference.

Two, an intermediary approach, led by Switzerland, acknowledges the existence of “utility” tokens. However, in the same breath, this view holds that before all features of the utility token is functional the ICO is considered a security offering. In the process, legal opinions are required to be constructed to support the view that the token satisfies the standards of utility tokens at the time of ICO. It is less costly and can be reasoned with, though it does put the burden of development and legal affairs on the project.

Three, the more open view not only acknowledges the difference between utility and security tokens but also treats ICO as it is to most projects that consider it — a format of crowdfunding not dissimilar to Kickstarter or Indiegogo. The projects still have the responsibility to deliver the product, and the management of funds needs to comply with established rules.

Having examined these two sources of disagreement, I share several other points that are part of my opinion:

  1. KYC is a good thing for ICO. While I personally share the view that ICO tokens are not securities, we must acknowledge that they can be transacted easily and often without intermediary. Money laundering is therefore a risk. Project can protect their reputation and financial interests by following good KYC practices. This applies often to the operations of the projects beyond ICO.
  • Whitelisting by local regulators is also a good thing. This provides a certificate of trust that makes it easier for potential investors to protect themselves. However, sensible regulation that makes the process of whitelisting clear and low-cost is crucial.
  • The enforcement against financial crimes should be stricter, and not only in ICO space. As I have alluded to in the last article, scams are illegal through and through. However, so far many known scammers have got away with their crimes. It is up to law enforcement and regulators together with the community to rid the environment of criminals and to form a credible deterrence.
  • Most importantly and in conjunction with the previous points, let’s not make it harder for legitimate projects than it already is. A huge motivation for ICO is when we have a good project but not enough funds to develop it and bring it to profitability. Requiring millions spent just to organize ICO only ensures that it becomes another way for big corporations to boost their bottom line while paying less tax.

This article is written by the CEO of IdeaFeX, Dr Jiulin Teng. You can follow him on Twitter or LinkedIn.