Despite its bad reputation, ICOs can offer a myriad of opportunities for retail investors to help incubate startups. But its potential relies on how we approach its regulation.
Since 2013, approximately $19 billion has been raised through initial coin offerings (ICOs), according to market research platform CB insights. If we were to shutter the door on ICOs, a whole generation of startups may be at stake.
In the midst of FTX’s collapse, US Senate Banking Committee Chairman Sherrod Brown (D-OH) announced that he wants to bring legislation that can protect retail investors from cryptocurrency fraud. While the consideration is made with good intentions, it may make important innovations like ICOs obsolete.
Over the years, ICOs enabled entrepreneurs and retail investors to raise money to fund new startups and projects as a convenient alternative to following Sarbanes-Oxley regulations.
The SOX Act of 2002
The Sarbanes-Oxley Act, a US law that was passed in 2002, aims to protect investors from fraud by creating higher standards for financial reporting and auditing. Otherwise known as the SOX Act of 2002, it also imposes newer, tougher penalties for those who break the rules.
Created in response to high-profile financial scandals in the early 2000s involving publicly traded companies like Enron Corporation, Tyco International plc, and WorldCom, the US Congress was desperate to gain back confidence and trust from investors – and generated rules that were to be enforced by the US Securities and Exchange Commission (US SEC).
The SOX Act has made it provenly difficult for budding entrepreneurs to access public capital markets, with most startups choosing to stay private. Why? It’s because the SOX Act makes it harder for new businesses to access money from the public markets, as auditing processes get more complicated. Combined with the SEC’s watch, it’s no wonder most startups turn to ICOs.
Those following crypto news all know that the SEC has a rather harsh stance on crypto – imposing regulations by law enforcement. As the SEC seems to be getting more regulatory oversight over crypto in the states, we may lose ICOs – and something needs to be done about it.
The SEC has been giving ICOs a bad rep as they believe that it poses risks of fraud. However, ICOs can be also thought of as another method of equity crowdfunding.
Equity crowdfunding vs. ICOs
Equity crowdfunding was introduced as US Congress brought in the Jumpstart Our Business Startups Act (JOBS Act of 2012), with Congress wanting to grant more opportunities to raise money, letting smaller businesses, early-stage startups, and individuals be able to raise money from a wider range of people – not just the public markets.
As the JOBS act lowers auditing, reporting, and disclosure requirements for companies with less than $1 billion in revenue, it also creates greater opportunities for companies to offer stock without going through registration through the SEC as a publicly traded company.
But ICOs have been proven to be more popular than just normal crowdfunding. Since 2013, only $969 million has been raised through equity crowdfunding from platforms like Kickstarter – but ICOs have raised more than $19 billion, according to data compiled from CB insights.
But why did this happen? Equity crowdfunding happens in centralised platforms, and are limited in how much they can fundraise.
ICOs are the crypto industry’s answer to equity crowdfunding: offering a similar easy process for crowdfunding that may also represent a stake in a crypto company or a crypto project, usually with the intent for long-term development.
While many crypto companies opt to use other terms like “initial decentralised offering” (IDO) or “token generation event” (TGE) to represent similar fundraising activities to ICOs, the SEC shouldn’t take away ICOs as an investment option, as a whole generation of new companies and startups may be at stake.
How should we rethink ICOs?
Some people think of ICOs as “mini-IPOs”, where companies providing ICOs are given a greater chance of raising money.
IPOs, or Initial Public Offerings, is a process where a private company offers shares of its stock to the public for the first time, and allows the company to raise equity capital from public investors.
If we think of ICOs as “mini-IPOs”, where in this case, more investors beyond public investors can invest in a given private company, we’d also have to devise similar laws and regulations that can protect investors in this case, rather than having a blanket securities law imposed on ICOs, or just outright banning them due to fear of risk.
A lot of bad press has been generated around crypto, with many retail investors believing that the crypto industry is mostly scams, and won’t benefit from much regulation. However, if not enough measures are taken, tech and Web3 entrepreneurs may find it harder to raise capital to grow their businesses.
When someone mentions ICOs, you’d probably hear that ICOs have a poor chance of survival – with most shutting down within four months.
However, are these shutdowns due to fraud or failure? While regulatory forces want to understandably protect smaller investors, businesses just failing out of bad luck from an ICO shouldn’t be punished. Instead, measures to protect failed projects and unlucky investors should also be considered, rather than treating the entire fundraising method as a dubious way to raise money.
If regulation on ICOs steers in another direction, the US can potentially lose its spot in being a leader in the tech industry, with billions of dollars at stake.`
