Dear SEC: ICOs & ‘Tokens’ are killing innovation

Initial Coin Offerings have raised $200 million dollars in 2017. Here is a short list of recent ICOs, and their fundraising results:

• Basic Attention Token — $35 million USD
• Storj — $30 million USD
• Waves — $16 million USD
• Qtum — $15.7 million USD
• Gnosis $12.5 million USD
• Iconomi — $10.5 million USD
• Golem — $8.6 million USD

So what is an ICO? ICO’s are an old phenomenon in the blockchain space with a new brand name. The word ICO is merely a synonym for an ‘unlicensed security’. ICOs are released to investors under a pretense of venture equity, but with the specific purpose of circumventing SEC authority and control.

ICO fundraisers leverage the confusion around ‘blockchain technology’ to swindle uninformed consumers with false promises, dubious claims, and dishonest terms related to their ‘high yield’ investment opportunities.

Here’s the state of the ICO/Token industry today:

• Token-based fundraising and company valuations are 5x-10x higher than incumbent fundraising mechanisms, with no investor protection
• Retail Investors are left holding these worthless securities in lieu of real world assets, unable to comprehend what risk they’ve agreed to
• Previously fined offenders are operating these schemes unscathed, and without even so much as reputational damage to their name in exchange for dumping these securities onto victims
• Elaborate schemes are undertaken to project scarcity, where no scarcity exists, for the promotion of ‘tokens’
• Inventory of these so-called ‘decentralized’ ICO tokens sit on exchanges where they are actively traded, and rarely (if ever) withdrawn for use
• To date, there has never been a ‘consumption’ of a token that offers an efficiency over incumbent online solutions.
• In many cases, it is unclear how these tokens are anything more than unsecured and poorly structured liabilities issued by the ICO team.
• It is unclear why ‘blockchain’ is needed for any of these projects, other than as a mere label, in which to dodge regulatory enforcement.

‘Tokens’ have preexisted blockchain by decades, and are in widespread use in incumbent data systems. The only new ‘development’ that is causing the rise in these platforms, is the lack of SEC action in response to increasingly aggressive fundraiser claims.

How did we get here?

Clearly Bitcoin was the precursor. Bitcoin’s success was an unplanned experiment which culminated in a massive bubble during 2013. But as Bitcoin’s market cap growth stalled in 2014, Venture capitalists began early attempts at recreating the manic euphoria of the Bitcoin movement in the years prior. David Johnston (Factom) and Ethereum promoters led much of that discussion, with many of today’s fundraising buzzwords coined in various papers and guides that they promoted. Over time, more established, and vocal Venture Capitalists began to chime in.

Fast forward to today, and these ICOs are effectively pitching the security as the common man’s ticket to Silicon Valley success.

If the ICO term sounds eerily similar to “IPO” well, that’s no coincidence. In the minds of impressionable and inexperienced, an ICO is an IPO. ICO proponents will of course state otherwise, but the difference between these terms is increasingly cosmetic.

Here’s what IPOs and ICOs have in common

• Both are sold at the onset of a venture, to fund a team of corporate officers for deployment of a venture
• Both are marketed by teams of promoters for sale on exchanges (though ICO promoters are far more aggressive boiler rooms operations)
• Both ICO and security exchanges are nearly identical (or strive to be) in their design, and trade features

Here’s what’s different

• ICO has ‘blockchain’ in it. Though what that means? Well, no one really knows, or cares.
• There are no regulations, constraints, or pretense of investor guarantees on ICO offerings
• There is very little due diligence being performed on these offerings, and it is routine practice for convicted offenders to launch these offerings without restraint
• The ‘rights’ offered to shareholders are shockingly limited. There is generally no pretense of signing legally valid documentation for profit sharing, voting, auditing, or corporate rights of any kind - despite the fact that promoters often promise that their schemes will permit these things
• Members of the ICO promoters and marketers are generally given inventory, alongside insider information in the venture, and use this position to exit their risk onto investors immediately after ‘going public’ (and before building a product)

What’s the Problem?

• When ICO’s deliver 100% of the company’s expected receivables at launch, founders are incentivized to leave their project immediately thereafter
• As such, these projects are increasingly resembling classical ponzis, with the losses
• No pretense of accuracy or responsibility for claims have led to ornate perpetual motion schemes receiving funding, at expense to humbler better-grounded offerings.
• Incumbent and regulated VC models are no longer sustainable fundraising options, as the returns from ICO ponzis are starving out capital and perverting investor expectations

The common narrative amongst investors is surprisingly simple: Great fortunes were made in Bitcoin, this is your chance to get in on Bitcoin riches. And this narrative is so ingrained in the minds of investors that websites exist to strengthen and quantify the claim.

For the ICOs that have already run their course, victims will not speak out. They believe that either they themselves are fully responsible for their loss, or that they would not be able to exit their meager positions by doing so.

There is no ICO success story. Like all ponzis, ICOs are nearly guaranteed to be profitable until the time at which capital inflow has ceased. The success stories merely exist amongst the lucky, or those with insider information on when to pull out of the schemes.

Where’s it going?

• Left unabated, ICOs will completely displace any pretense or recognition of security regulation law
• Boiler rooms will continue to grow more aggressive in finding ignorant and unaware Americans to prey on
• Facebook, Youtube, and other social media ads will grow more brazen with their claims, and less scrupulous with their demographic targeting
• Self-help coach, Youtube, and Celebrity endorsement schemes will continue to grow into organized affinity fraud
• Unrepentant and serial offenders will continue to run subsequent and larger rounds of ICO schemes
• Companies completely outside the blockchain space will use the moniker “ICO/Token/blockchain”, to raise capital without the cost or liability associated with traditional securities regulation
• ICO claims will grow increasingly detached from the limits of science and meaningful progress
• Industry representatives will sponsor bills and advocate legislation designed to indemnify operators, and promote these practices

So what’s next from here?

The ICO industry will get as big as the SEC decides it should be. Though I’m sure that recent high profile actions were a fine use of its resources, such scandals have now been dwarfed by the growth of the ICO market. My assumption is that reputational damage to the SEC will grow commensurate with this market.

Ridicule of the SEC’s authority is already common amongst investors, and will spread to fundraisers themselves. Such disdain is already at so great a level that this Texas company would appear to be recreating the original Howey Test, but with the word ‘blockchain’ in their prospectus.

So-called ‘Blockchain’ securities have become a return of the South Seas Bubble, the fallout for which will eventually become a burden to American citizens and taxpayers. An ‘ICO’ is merely a label that’s been assigned to the current state of a securities regulation vacuum. There’s nothing ‘blockchain’ about tokens.

Dear SEC: ICO’s and Tokens are killing innovation.

Special thanks to the silent contributors to this letter. For supplemental audio version of these concerns take a listen to this interview with Izabellla Kaminska of the Financial Times (and Junseth) summarizing the state of the ICO industry well.

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