In recent years, Initial coin offerings have become a popular way for many blockchain-related projects to obtain needed capital. In fact, 2017 saw ICOs bring in roughly six times as much capital as traditional venture capital funding rounds. And while some observers might have expected that fundraising success to taper off as cryptocurrencies declined in value in 2018, ICOs have continued to attract substantial investment. Unfortunately, that success has also attracted attention from regulators, and calls for greater oversight of the cryptocurrency industry and its fundraising efforts.
Recently, DCEBrief had the opportunity to speak with DNotes Global Inc co-founder and CEO Alan Yong and we asked him to share his thoughts on the current issues surrounding initial coin offerings. Below is the transcript of that conversation.
DCEBRIEF: Alan, you have been somewhat critical of initial coin offerings in the past. Could you explain why you think they’re problematic?
YONG: Of course. First, let me start by noting that initial coin offerings are an interesting and extremely effective way for startups to raise funds. There’s no disputing that fact. However, that success does not erase the ICO’s most obvious flaw, which is that government regulators are already on the record suggesting that all ICOs are, by definition, securities. SEC Chairman Jay Clayton stressed that point when he said that token sales that promise a return are securities and must be regulated to ensure that they comply with existing laws.
Many people are unfamiliar with the history of the SEC, so they don’t understand why these issues matter to that agency. It’s important for blockchain and cryptocurrency entrepreneurs to understand why we have these regulations, so we can better understand the need to work within current regulatory guidelines. That’s the best way to ensure that we are permitted to continue to innovate and create opportunities for people around the world. If we fail to meet compliance expectations, you can all but guarantee that the regulators will step in to do it for us.
DCEBRIEF: You mentioned the Securities and Exchange Commission just now. The SEC and CFTC have both been more active in the blockchain and digital currency space this year, with multiple statements and enforcement actions against perceived bad actors. What role are the regulators trying to play, and what impact do you see that having on the industry as a whole?
YONG: Well, as you know, the SEC was created in 1933 by political leaders who were desperately trying to avoid the type of unregulated, reckless exuberance that helped contribute to the 1929 stock market crash and what we now know as the Great Depression. Back then, it was not uncommon for people to sell unregulated securities that offered those enticing “once-in-a-lifetime” earnings opportunities.
Many investors were getting rich buying into those schemes, which only encouraged more of the same. That’s what I like to refer to as the “me too” phenomenon. You see someone who’s successful with their investments or their business ventures and assume that you can enjoy that same success just by doing what you think they’re doing. The problem is that casual investors back then were like many casual investors today: they rarely did their homework and were too often taken in by exaggerated claims and the promise that they could get rich overnight.
Now, what were the problems with that largely unregulated market environment? First, there was a lack of full disclosure from companies. Promises were being made, but there was little interest in requiring the promise-makers to be transparent. There was also very little accountability, and many investors were basically gambling with their investment money in hopes of an immediate and high rate of return. And make no mistake: there was a lot of money flowing into those markets, as there always is any time you have a market bubble. Finally, there was basically no one minding the store. Without proper oversight, that entire market dynamic was a giant house of cards that would collapse at the first sign of high winds.
DCEBRIEF: Which is exactly what happened with the collapse of the market and the onset of the Depression, right?
YONG: That’s correct. And few of us alive today can truly grasp just how severe the Great Depression truly was. Or how long it lasted. Unemployment reached staggering levels that most Americans today can scarcely comprehend. Within a few short years, more than 13 million American workers had seen their jobs disappear. The stock market erased about 90 percent of its value. Families lost their homes, their farms, and – in many instances – virtually everything that they’d worked for their entire lives. The human suffering was almost unimaginable by today’s standards.
The federal government intervened in a major way as it tried to get the economy back on track, and some of the programs created during that period exist today – like Social Security, for example. At the same time, however, the nation’s lawmakers moved to address the financial recklessness that had contributed to the market crash and collapsing economy. The Securities and Exchange Commission was created partly to help prevent that type of recklessness from repeating in the future.
We need to remember that the decade before the Depression was a time of great wealth – the Roaring Twenties, we now call them. Throughout that decade, capital was easily created and obtained, and that meant that almost anyone who wanted capital could get it. Unfortunately, there was no one really monitoring the investment scene, and there were a lot of bad actors, fraudulent schemes, and ill-conceived investments. When everything came crashing down, investors across the nation suffered greatly.
The SEC was tasked with preventing that type of environment from ever forming again. The agency was empowered to enforce regulations that would provide strengthened investor protections and secure and maintain fair, orderly markets. The goal was to ensure that capital could be formed in a more transparent and regulatory-compliant manner, protecting investors without stifling innovation and growth.
Since that time, we have seen bubbles come and go – like the internet bubble two decades ago. Sometimes, regulators respond quickly to new innovations and adapt their views to accommodate new technologies or ideas. At other times, like with the internet and cryptocurrency, there may be brief period of uncertainty as those regulators try to determine how to deal with new and changing dynamics. The point is, though, that regulation must be considered a given. The SEC’s mandate is clear, and concerns about compliance, fair and transparent markets, and protections for consumers and investors will always be cleared up one way or another. That’s true for our industry as well.
DCEBRIEF: Does that apply to initial coin offerings and other types of capital formation in the cryptocurrency and blockchain industry? Do you expect the SEC and other areas of government to become more active in this industry as well?
YONG: It’s inevitable. The only question is whether their intervention continues to be a more benign form of monitoring and guidance, with enforcement actions for bad actors, or a more invasive approach that involves new, onerous regulations that could potentially stifle innovation and growth.
DCEBRIEF: Obviously, you would prefer the former option.
YONG: Of course. While I have been on record agreeing with the SEC’s view of most ICOs – because they do meet the regulators’ definition of securities and thus should be regulated as such, that doesn’t mean that I disapprove of initial coin offerings as a concept. To the contrary, I believe that they are perhaps one of the most efficient means of capital formation we’ve ever seen. The ICO’s ability to enable virtually anyone in the world to invest in a project can conceivably provide greater access to opportunity for more people than any other form of investor fundraising.
That’s critically important for growth and innovation, since capital is the very lifeblood of entrepreneurial endeavors. To fulfill any entrepreneurial dream, startups must have ready access to capital that can enable them to properly execute their strategies at the right time and in the right way. In our hyper-connected world, the ICO provides a globally-accessible form of crowdfunding that can enable anyone with resources and internet access to participate in a funding effort. That’s truly disruptive for capital formation, and potentially world-changing.
There are, however, challenges that must be overcome – and one of the biggest problems is ensuring that this innovative new form of crowdfunding is conducted in a way that satisfies regulators around the world. That’s going to require some changes in the way startups approach the coin offering process.
DCEBRIEF: Does DNotes have a plan to help the industry make those changes?
YONG: We do indeed. DNotes Global has recently launched its own initial fundraising effort. Because we understand the issues surrounding ICOs, we opted for the regulated fundraising route and are using a Reg. D 506 (c) to raise an initial $5 million from accredited investors. Of course, that path required a lot more effort and time, as our legal team had to go through the proper channels to ensure that we were complying with all regulatory requirements. However, we believed that was the proper route to take.
Now, our long-term objective is to use our experience with regulated fundraising to advise and assist other companies in the industry as they adapt their capital acquisition strategies to meet regulatory requirements. That’s part of our NextGen VC plan – to identify companies that have true potential for success, and partner with them to help them achieve their goals.
Sadly, the lion’s share of new businesses will fail within the first five years of operation. Some estimates suggest that as many as 80 percent of startups fail within ten years. Unfortunately, many of those companies had tremendous potential, but failed to focus on the fundamentals: leadership, effective implementation of their great ideas, building the right team, and customer engagement. Many never created or executed sound strategies. And few understood the importance of applying systems thinking to their business.
Tech revolutions can be chaotic in that regard, and there is often a high level of attrition as a result. We saw it in the computer revolution and again with the internet. There were a host of new startups during each of those technological revolutions, but only a select few succeeded. Now, a couple of decades later, we have the digital age emerging before our very eyes. Everything that can be digitalized will be digitalized in this increasingly-connected world. That has prompted a great many entrepreneurs to rush in and launch their own fintech startups, and the industry now has more than a thousand cryptocurrencies, blockchain tech firms, and other related companies. Odds are that most won’t survive.
DCEBRIEF: Is that assessment based on those company failure rates you cited earlier?
YONG: Yes, but there are many factors in play here. History does offer lessons here, and what it teaches us is that tech revolutions of the kind we’re now experiencing invariably produce more failures than successes. Part of that is the newness of the technology, which often makes mass adoption a slow and frustrating process. Remember, it took time for people to grow accustomed to computers. It took time for the internet to be embraced by most people. So, that newness is an issue. But there’s another challenge as well, and it’s the “me too” nature of many new tech companies.
Many small computer and internet-based firms failed because they were launched simply to catch and ride the tech waves of their time. That’s true of many of today’s crypto-related companies and digital currencies. When you see others doing something that seems to be making them money, there is always a temptation to assume that you can do it too. After all, how difficult can it be? The reality is that it can be very difficult. And when you look around the cryptocurrency industry today, there are few projects that seem to have any real long-term strategy for success. Too many seem to exist for no reason other than to be traded on crypto exchanges. In my opinion, those projects will eventually fade and disappear. Many have already failed.
However, there are going to be many successes as well. There are some great people with great ideas in this industry, and those ideas have the potential to transform our world. Our vision for NextGen VC includes partnerships with those innovators. When we identify companies that possess vision similar to ours, we want to work with them to help them succeed.
DCEBRIEF: You mentioned helping those companies navigate the fundraising process. Would you advise them to follow the regulated path that your company chose, or do you see any role for initial coin offerings?
YONG: Some may see more success following our example. Others may be better suited to pursue the ICO option. However, part of our goal is to work with regulators to ensure that initial coin offerings comply with securities regulations. ICOs are too effective to just abandon them altogether. But they will need to be properly registered to avoid running into problems with the regulators.
Remember, the SEC mandate is not just about consumer protection; it also includes a responsibility to ensure that markets are fair. The SEC is unlikely to ever be satisfied with a situation in which some industries comply with security laws while others ignore them. So, our best option as an industry is to proactively move to come into compliance. Register where appropriate. Obtain exemptions where they apply. Just make sure that everything is done legally. We believe that the existing regulations are enough to bring order to ICOs and satisfy the regulatory authorities – but only if the industry focuses on compliance. DNotes Global is committed to leading the way in that effort.
DCEBRIEF: Any closing thoughts you would like to share with our readers?
YONG: Yes, I think it is important for all of us to recognize that the world is changing. We’re moving toward greater decentralization in many areas – empowering people around the world to take greater control over their financial destinies. Much of this process is essentially leaderless and fundamentally chaotic, and that can be challenging for regulators.
It is incumbent upon us to do our part to comply with existing regulations to ensure that those regulators treat the industry with a light touch. Where fundraising is concerned, the best outcome would be for regulators to treat ICOs in much the same way that they approach crowdfunding. Focus on consumer and investor protection but encourage innovation and capital formation. That’s important, because ICOs are a truly innovative capital formation tool that can facilitate greater job and wealth creation anywhere in the world, and that can have a transforming impact on real people’s lives.