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Why Are ICOs Important for Investors?

Can the cryptocurrency revolution accelerate the growth of Reg A+ capital raises for small businesses?

The story of cryptocurrencies and the blockchain go back just a short while with a white paper published by Satoshi Nakamoto in October 2008. By January 2009, Bitcoin was launched and in a short period has become an extraordinary asset used by some for illicit activities and most as a storage for assets. The fast growth in value for Bitcoin, which is trading today around $6,000 with a total market capitalization close to $100 billion is a testament to how important this new technology is.

In the beginning, Bitcoins were not sold but mined by people who installed a piece of software on their Internet connected computer and let it run permanently. This software produced one or more bitcoins associated with a blockchain address and protected by a private key only known to the owner. Over time, millions of bitcoins were mined and a secondary trading market was born for people who wanted to own bitcoin but not mine them. Today, the companies who mine bitcoins are large with thousands of servers because the code significantly slows down as more bitcoins are produced and the cost to mining them increased exponentially.

The Bitcoin secondary market today trades over $3 billion a day. This liquidity has created a strong demand for bitcoin and because of the limited number of available bitcoin, the price has been steadily going up. The main problem with bitcoin is the only real function it has is to store value and trade it between one person to another. Some engineers started to imagine new applications this technology could produce and decided to start bitcoin derivatives into new blockchain applications. The success bitcoin experienced has now been translated into many more cryptocurrencies and applications. The security of the blockchain and the idea it cannot be modified or hacked by nefarious parties has inspired thousands of developers to create a whole new industry around the blockchain concept.

After Bitcoin, the second most important blockchain is Ethereum. Created in 2013 by a team of engineers, this new blockchain was the answer many were hoping for. With it, anyone can create a new currencies in a couple of hours or an entire new decentralized application hosted on thousand of servers. When Ethereum was created, the developers needed capital to build it. Instead of going to the traditional route of venture capital, they chose to go directly to the owners of bitcoin and ask them to purchase ether which is the equivalent to bitcoin on the Ethereum blockchain. This process was done with an Initial Coin Offering or commonly known as ICO. This was not the first ICO but it was the most successful one. The developers created a foundation in Zug Switzerland to own the intellectual property around Ethereum. In 2014, the Ethereum foundation raised close to $18M in exchange for ether which is worth at today’s market capital over $40B. The return on investment for purchasing ether at the initial offering is over 9,000% which rivals the returns found in investments in Uber or Facebook when they were are early stages.

In 2017, the ICO frenzy has caught a whole new level of interest among cryptocurrency investors. In the last few months, over $2 billion in capital were raised by companies using ICOs. This explosive growth in capital raised has opened the eyes of the Securities Exchange Commission and many regulators across the world. It turns out, all of these companies claiming they were issuing utility tokens and not securities and therefore were not subject to the complex securities regulations designed to protect investors. Because they took this stand, investors in ICOs were not able to rely on clear and complete information about their investment in order to make an informed decision.

On July 25, the SEC issued a bulletin to warn investors about investing in ICOs. The bulletin discussed in great detail the DAO offering which raised $50 million from crypto investors and was immediately hacked with all the investors lost their money. The SEC’s position is that the DOA offering was a security and needed to be registered or be sold under one of the approved exemptions. The DOA is the first example and since then the SEC announced their first enforcement action against Maksim Zaslavskiy who issued the REcoin and according to the SEC it is a fraud. Another example is Tezos which raised $230 million in July and just recently the Tezos Foundation and the inventors are in a control dispute which is putting at risk all of the investor money.

All of these ICO issues are worrying the regulators and recently the SEC has formed a new Cyber Unit to go after ICO fraud. So how are ICOs going to work in the future with the SEC clearly watching this marketplace ? The answer is the JOBS ACT.

On April 2012, Obama signed the JOBS ACT, a new financial regulation which creates a clear framework for companies to raise capital directly from the general public and through the internet. This legislation created the Regulation D 506(c) which now permits companies to publicly solicit accredited investors, those whose income is over $250,000 a year or own over $1 million in assets outside of their primary residence. This rule requires the company to verify each investor which means some form of friction because they need to disclose their personal financial information or get an attorney or CPA to certify their investor status.

The second rule is Regulation A+, which permits companies to raise up to $50 million per year directly from the general public. This incredible new rule is groundbreaking because for the first time in 80 years, ordinary investors are able to invest in startups and risky companies. A company needs to file with the SEC an investor prospectus along with a 2 year audit (less if younger) for qualification. This process costs around $100,000 or more and can take four months. While expensive for very small businesses, this new rule has allowed hundreds of companies raise tens of millions in capital.

My own company, StartEngine, helped Elio Motors (ELIO) raise $17 million from 6,300 investors as the very first Regulation A+ in the marketplace. The third rule and the most groundbreaking is Regulation Crowdfunding which allows companies to raise up to $1,070,000 per year directly from the general public and with very little costs or delay. This rule requires no CPA audit or review up to $107,000 and after this a CPA review of the last two years. There is no SEC qualification process so a company in a matter of weeks can start a capital raise campaign on one of the funding portals (including StartEngine).

The ICO industry was created by self proclaimed crypto-anarchists who rejected the idea of a central governmental control of currency or financial regulation. These engineers had a revolutionary idea and built some very important technology that without any doubt will change the world. The reality of our society is quite different, we operate under a government and inescapable regulations. The JOBS ACT is a monumental piece of legislation which has already impacted the small business capital formation marketplace. It is now clear it will also impact the ICO marketplace and help move it out of the shadows. This process will take some time but it will help investors make informed decisions and reduce potential fraud and scams.

The ICO is the most modern form of capital raise and with the JOBS ACT it will become a formidable force in helping small businesses access the capital they need to grow and succeed.