The very first initial coin offering (ICO) took place in June of 2013 when Mastercoin raised around $5 million in Bitcoin. That was the same year that Title II of the JOBS Act launched allowing general solicitation (SEC lingo for advertising) under Regulation D(506c), an exemption that enables accredited investors to back publicly promoted private securities offerings also called accredited crowdfunding.
In 2015, updated rules for Regulation A, now referenced as Reg A+, commenced as part of Title IV of the JOBS Act. A year prior, in 2014, Ethereum raised about $18 million in its ICO.
In 2016, Title III of the JOBS Act, or Reg CF, kicked in allowing issuers to raise up to $1 million in a highly prescriptive and regulated environment on FINRA approved portals or via Broker Dealers (although few BDs used the exemption).
The same year, Waves raised 30,000 BTC in their ICO – amounting to about $16 million (at that time) an amount that seems minuscule now.
Under Reg CF, issuers have raised about $100 million since the exemption became actionable in 2016 – the bulk of the money has been funneled through a handful of funding portals.
Reg A+ has done far better in total funding successfully raised. A recent report from the law firm Stradling stated that collectively, during 2017, qualified issuers raised approximately $236.5 million.
Overall Reg D (both 506c & 506b) is a huge market estimated around a trillion dollars each year. Reg D 506c or accredited crowdfunding takes a small portion of the Reg D total but even the SEC is not quite certain how much is raised under the exemption.
In contrasting digital assets to more plebeian types of securities, during 2017 it has been estimated that over $4 billion was raised in initial coin offerings – a number that most certainly is a moving target due to the volatility of cryptocurrencies in general. January of 2018 was reportedly the biggest month ever for ICOs. Issuance of digital assets have gone from zero to billions in a blink of an eye while online capital formation that adheres to existing rules has been delegated to the slow lane.
The Wild West of Digital Currency
So what is the difference between the existing “crowdfunding exemptions” and ICOs? It’s all about regulation, of course.
ICOs have been operating in a largely unregulated realm globally – until recently. This Wild West type environment has been both good and bad.
The digital currency explosion has enabled hundreds of innovative firms to raise money in a low friction environment and at a comparatively low cost. Numerous issuing platforms have cropped up to satisfy this demand, exchanges that enable trading of these cryptocurrencies have been launched, and investors anywhere could participate without the guidance of national regulators. The markets have ruled.
An entirely new asset class has emerged with an enthusiastic legion of supporters chatting away on Telegram ready to roll the dice on the next offer. Anyone, anywhere, could participate without limitation. No percentage caps nor antiquated accredited qualifications necessary. And, for the most part, these cryptocurrencies quickly became tradable thus providing almost immediate liquidity once the coins were digitally minted.
Makings of a Crypto Bubble
On the negative side of ICOs, fraud and spammy offerings have been prevelant. A lot of good money has fallen into a bad trap never to be seen again. Even most of the non-fraudulent ICOs are expected to go to zero. Just because you mention Blockchain in your business mission does not guarantee success. This endemic fraud has created a problem for securities regulators around the globe who have never encountered a phenomenon like tokenized securities – or tradable utility tokens (if they exist). But now they are catching up.
On the other side of the aisle, for highly regulated crowdfunded offers (at least in the US), it has been a slow ride.
Policy makers terrified of fraud created rules that made it nearly impossible to occur. There has been little to no illicit acts under the US crowdfunding exemptions with the best example being Ascenergy, a company that raised money under Reg D 506c – and then settled with the SEC. We are not aware of any fraud under Reg CF. But similar to ICOs, many of these early stage companies that use the trio of crowdfunding exemptions will fail to become a success. That’s how it works: investing in early stage companies is a very risky endeavor.
Doug Ellenoff, Managing Partner of Ellenoff, Grossman & Schole, who has been engaged in the online capital formation sector from the very beginning says that while there may seem to be apparent similarities between investment crowdfunding and ICOs, from a regulatory point of view they couldn’t be more different.
“Investment Crowdfunding [Reg CF] not only must be done through a regulated and FINRA approved funding portal, there is mandatory disclosure and caps on the amount of capital that an issuer can raise and how much an investor may invest. While ICOs are quite innovative, they have been marketed and sold outside of regulatory conventions and the guardrails have been unfortunately disabled. Unlike ICOs, Reg A+ requires the submission of a full and complete offering document with the SEC for its review and comments. There is also a $50 million cap but may be sold directly by the issuer directly to both accredited and unaccredited US investors. A 506(c) offering is different from ICOs in that ONLY accredited investors may invest and only if they have been verified as accredited by a third party.”
Over the past several years, we have heard time and again the lamentations regarding “traditional” investment crowdfunding and the slow pace of uptake. This is in stark contrast to the exhuberant excitement engendered by the newly minted crypto-rich and the ICO market that is ripe with speculation.
Today, we are seeing the security token world combining with securities crowdfunding as issuers in the US start to file either a Reg A+ or Reg D exemption. New platforms that are embracing regulation are being launched and existing regulated marketplaces are offering an option to sell these digital assets. There have even been a couple Reg CF offerings on StartEngine and Republic.
Georgia Quinn, General Counsel of ICO platform CoinList (part of the AngelList family of platforms) and a Crowdfund Insider Contributor said there is a merging of sectors occurring right now. In the end, it is all about online capital formation its just some of these offerings may be crypto based.
“ICOs will likely create more demand for more traditional crowdfunding as the market starts to realize that the majority of these offerings are securities and require registration or exemption from the securities laws. The crowdfunding exemptions [Reg D 506c, Reg A+, Reg CF] seem like the natural exemptions to use.”
Jor Law, a securities attorney that advises many ICOs and a co-founder of VerifyInvestor, perhaps explained the clash between ICOs and more traditional crowdfunding the best;
“ICOs, or at least the properly conducted ones, are an example of the power of crowdfunding. We have seen a significant increase in crowdfunding volume from ICOs. I think everyone in crowdfunding is thinking that this is how it should’ve been a few years ago when securities crowdfunding first became legalized.”
Asked if he believes that ICOs are impacting traditional equity crowdfunding, Law spoke from experience;
“Yes. While many investors are sticking to what they know and are comfortable with, there’s no question that crypto has diverted attention away from regular crowdfunding. Nevertheless, it’s a net positive for crowdfunding. The new investors who are getting comfortable with crowdfunding through crypto are likely to continue to crowdfund non-crypto in the future, especially after the crypto hype settles down.”
“ICOs are really a subset of crowdfunding. In some ways, they’re an enthusiastic way for the JOBS Act rules to be used (although, we are seeing a trend of presales only, with no crowdsales). In some ways, ICOs are different because they often deal with open-source, decentralized projects and a new asset class that often straddles both value and function. On the other, they’re very much the same, except that there is a lot of money and hype in the space.”
Tokenized Securities will Become Professionalized & Regulated
So the consensus seems to be that tokenized securities will soon become professionalized and clearly regulated and potentially driving more capital to innovative firms. But should new rules be put in place recognizing digital assets as a new type of investment? Are there aspects of Reg D/A/CF that could be improved?
[clickToTweet tweet=”#ICOs are really a subset of #crowdfunding. In some ways, they’re an enthusiastic way for the #JOBSAct rules to be used ” quote=”#ICOs are really a subset of #crowdfunding. In some ways, they’re an enthusiastic way for the #JOBSAct rules to be used “]
Most all industry participants admit either publicly, or privately, that policymakers must fix certain elements of US investment crowdfunding exemptions. They just need to do it. Perhaps regulators can look to the UK and review their rules as Great Britain has the most robust and effective investment crowdfunding market in the world. Or maybe public officials could look closer to home and follow the advice of US Treasury Department report from 2017 that outlined needed improvements.
So where to next?
The SEC and its Cyber Unit is in hammer mode for issuers that did not file for an appropriate exemption. Dozens of subpoenas have been delivered to issuers and other “gatekeepers.” But this moment shall inevitably pass.
Once the enforcement dust settles, there will be an opportunity for a more robust online capital formation market that includes, debt, equity and digital assets – and hopefully with updated regulations. While perfect should never get in the way of good, we now have enough information and perspective to improve upon existing crowdfunding rules while empowering tokenized securities.
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