Challenges Facing Startup ICOs in the U.S.
This blog was written by CEO Dr. Emad Mousavi and originally published for LinkedIn. You can follow him by following this link, or visiting https://www.linkedin.com/in/miremadmousavi/ .
The cryptocurrency space has seen astronomical growth in the last few years, starting with the Bitcoin craze and culminating in the current market comprising hundreds of individual coin offerings worldwide.
According to Coindesk.com, in 2015, the initial coin offering (ICO) market was worth $9 million. By 2016 it had grown to $256 million. That figure shot up to $5.5 billion in 2017 and now, halfway through 2018, we’re looking at a market still in its infancy but already worth nearly $14 billion.
The rapidly growing cryptocurrency market offers tremendous opportunity for startups to utilize tokenization and blockchain to create new coins and new paths to funding their business ideas. You can think of it like a crowdfunding model, but rather than simply contributing toward a goal, people who buy tokens are looking for a real profit from small or large investments.
The opportunity to fund a startup with an ICO rather than through traditional venture capital firms is clearly significant; Coindesk puts the median ICO size in 2018 at $13 million. However, taking advantage of this opportunity is not as easy as it sounds, especially if you are based in the United States of America.
Most token buyers are blockchain enthusiasts and have experience in the cryptomarket, and they’re happy to use this channel to invest. Still, the vast majority of these investors are also outside the United States, where they are not beholden to the stringent trading and investment regulations of the US Securities and Exchange Commission (SEC.)
U.S. investors are barred from buying into many ICOs based on these restrictions, which even the SEC admits are evolving. In fact, some non-U.S. token marketplaces won’t even allow a U.S. IP address to access their website and a very common information to look in every ICO rating report is specifically if US investors are banned from buying tokens. Of course it will be primarily the seller, in this case the startup company who is running the ICO, who would face legal action by SEC should they violate US federal regulations.
Essentially, SEC rules dictate that when a cryptocurrency becomes decentralized beyond a certain threshold, it is no longer considered a security by the agency, but it is a commodity. Bitcoin and Ether, the two most popular coins on the market, have met that standard and are considered commodities, but the smaller ICOs almost always are securities.
What that means is that the smaller ICOs, being classified as securities, are subject to the same restriction as regular stocks. This makes it easy for investors anywhere in the world to buy Bitcoin or Ethereum, but harder for them to invest in emerging coins such as those launched by startups for funding, if they want to be in compliance with the regulations of the government of the United States.
Hence, for any US startup who is seeking to launch an ICO, it is a complicated months-long process involving attorneys and compliance experts, mountains of paperwork, and of course a major cost that most entrepreneurs can’t afford; otherwise they would not be seeking funding in the first place. With increased SEC scrutiny and even a few criminal charges filed against non-compliant and fraudulent offerings, the path to a compliant ICO is longer—you might publish a whitepaper and a roadmap outlining your revenue model, growth plan and other technical considerations; you need to develop a token and a token structure, create code on a blockchain, secure proof-of-stake to increase token valuation, and other steps that can be well overwhelming for a startup. The to-do list is endless and can cost hundreds of thousands, and that’s before you start marketing and staffing and paying for all of the other logistical details involved in an ICO launch.
As you can see, for a U.S. based entrepreneur looking to fund through an ICO, the barriers to entry are enormous and complex, meaning most won’t succeed without already having access to a lot of capital. And in a capitalist economy fueled by entrepreneurship, that’s a real problem. Shouldn’t we be encouraging new business ventures instead of stifling them? Not to mention, we’ll be trailing behind many other countries in Europe and Asia when it comes to defining and gaining profit share in the crypto market. The current setup simply banns international investors from funding US-based startups but possibly allows US individuals fund international startups as long as they can hide their country, which is easily possible for cryptocurrency owners.
Of course, no one is advocating for complete relaxing of federal regulation that are designed to protect US citizens. The potential for fraud in ICOs exist, just as it is with any normal business investment, which is why the SEC exists in the first place. What’s really needed is for the SEC and the other federal governing bodies of finance to implement a more efficient and practical framework for U.S. based entrepreneurs to launch an ICO, while keeping the necessary fraud protections in place.
The U.S. should look to models utilized in other countries in Europe and Asia and develop a framework that offers entrepreneurs the flexibility for funding their ideas with ICOs. By opening up new financing models to U.S. investors and entrepreneurs, we can take advantage of the vast profit potential of the cryptocurrency markets, but also encourage innovation and entrepreneurship in our own country, using both local and international capital. Such framework should still have some regulation in place to protect investors, like tying the allowable cap of the ICO funding to some startup information or requiring the entrepreneurs to clearly educate the investors of the risks of their investment. However, they should eventually be very practical and affordable for an ordinary American. It is probably safe to say most US entrepreneurs only need to raise a few hundreds of thousands or less to turn their idea into a profitable business, so any compliance preconditions and requirements for ICO should cost much less than hundreds of thousands to provide US entrepreneurs a similar level of opportunities as available for those of other countries.
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