In the annals of crypto history, initial coin offerings (ICOs) were the latest innovation until they weren’t.
After briefly eclipsing traditional forms of venture financing, ICOs have largely been relegated to the sidelines of the fundraising ecosystem after an SEC crackdown. A glance at the moribund market for coin offerings during the first quarter of 2019 revealed distressing news. Coin offerings, which had raised $6.9 billion in the first quarter of 2018, were down to $118 million during the same period in 2019.
SEC Commissioner Hester Peirce, also known as “Crypto Mom” to enthusiasts, thinks she might have a solution to the problem. Last week, she circulated a Safe Harbor proposal for coin offerings. Briefly, the proposal grants coin offerings a three-year reprieve from the stringent disclosures and compliance-related activities of securities laws that accompany public offerings. The idea behind the reprieve is to “allow for transition from conception to distribution within a decentralized network or a functioning network,” explained Peirce in an interview with Laura Shin. That transition might not necessarily involve another coin offering, she said. It could mean raising further funds through other avenues, such as a Reg. A+ offering or a Reg. D offering.
According to Peirce, the federal agency has conflated coin offering tokens as investment contracts as they were defined in the Howey test, commonly used to classify securities. “Plots in the orange grove were not securities. Nor were the people managing the contracts. It was that whole investment contract wrapped together that was the security,” she said. A similar analogue within the coin offering context would be the terms and disclosures that coin issuers provide to investors.
To that extent, Peirce’s safe harbor requires disclosures and commitments from issuers to work. While they could previous get by with a single page detail of their plans, issuers will have to disclose information about the project and development team and commit to decentralization or a functioning network within three years under Peirce’s proposal. It also “preserves” the SEC’s antifraud authority, she says.
Will the Proposal Work?
For the most part, Peirce’s proposal has received a guarded welcome from the crypto community. There are some exceptions, however. Journalist David Gerard wrote that the proposal would only encourage more scams within the ICO ecosystem because it exempted coin offerings from securities laws. Lawyer Preston J. Byrne was even more upfront about the proposal and wrote that it was “hilarious, if it weren’t so serious.”
Both of them might have a point. The problem with Peirce’s proposal is that it does not cover new ground. It relies on past precedents, of which there aren’t many in the crypto ecosystem, to formulate an approach to offerings. For example, it does not offer a proper definition of decentralization that can be used to assess a network’s maturity. Another SEC commissioner, William Hinman, had said that Ethereum was “sufficiently decentralized” for its offering to be exempt from securities laws. But he did not elaborate on or set a baseline for the “sufficiently decentralized” test. Besides, relying on the SEC to determine decentralization would be akin to reverting back to the same set of circumstances that led to the current situation for ICOs.
And what if developers do not reach a decentralized or functional network within the specified timeframe?
In an article for Coindesk, Commissioner Peirce stated that developers should take a “clear-eyed look at the viability of the project” at the end of the time period. The underlying premise here is that all developers and coin issuers are honest and sincere in their intentions. Available facts, however, lead to a different sort of conclusion. Crypto forensics firm Chainalysis estimates that $3.99 billion was lost to crypto-related scams in 2019 alone.
What’s more, three years might be a more than comfortable cushion for fraudsters in an industry where ICOs fail within the first four months. (Among the notable failures was photo company Eastman Kodak’s ICO). Then there’s the matter of non-delivery or delay of products. Previous research has shown that approximately 71% of ICOs conducted in 2017, a year during which such offerings thrived, failed to deliver a product. An example is that of Filecoin, a high profile offering that raised $257 million, often missed deadlines outlined in its offering document and delayed its product launch multiple times.
The lure of ICOs was that they circumvented the SEC’s expensive and time-consuming processes and expedited fundraising. Peirce’s proposal compresses that regulatory holiday to three years. But it does not solve the underlying problem of weeding out bad actors and ensuring SEC oversight without enforcing strict compliance at the same time. Perhaps, the crypto community realizes its shortcomings. Some even say it may not be worth the effort.