For the cryptocurrency industry, this is a turbulent day. At the beginning of December, bitcoin prices fell to $3,300, the lowest since August 2017. In the second half of 2018, the amount of funds raised through the ICO decreased, and before this, US funds flowed into the new ICO. The spectre of supervision shrouds the entire space, and with the harsh attitude of China and South Korea to this space, the United States is increasingly becoming one of the most vocal contingent. The regulator has mobilized and the public can hear the wind.
In fact, the actions of the United States have begun. Two ICOs, Airfox and Paragon, which did not have a registration token for sale, recently reached a settlement with the SEC and paid a large fine for selling unregistered securities to investors. Similarly, on November 8, EtherDelta became the first exchange to be accused of operating an unregistered exchange because most of the tokens in the transaction were securities, and the matter was headlined. In September, the New York Attorney General issued a report on these virtual markets. EtherDelta will not be the last encrypted trading company to face the legal consequences of trading. Entrepreneurs and investors are now cautious about the results of enforcement, even though they may not have done so a year ago. Therefore, the market is slowing down.
The inevitable contradiction
is that friction between the blockchain and government regulators will inevitably occur. The first is decentralization. The ability to transfer assets, peer-to-peer, no middlemen, no control. “If I think the price is fair, why can't I sell my things to anyone I want?” After all, this is how the economy works in history. In many places, the market and the open market are still easy. The goods system is widely used along with cash transactions. The second reason is protection. When we talk about the flow of small funds, no one cares about the regulatory agencies. Buy, sell, do what you want to do. No one will ask any questions. This is a secret state for many years. It is too small to have any consequences.
However, as the amount involved has increased to millions, hundreds of millions, or even billions of dollars, this shift has followed. To some extent, everyone cares. If it is your money, you want to know if it is protected, whether it is in a safe investment or safe storage. If it is someone else's money, and the scale is big enough, somewhere, the government or the regulator will start asking questions. As of November 28, the encryption company had a market capitalization of $141 billion and a 24-hour trading volume of $20 billion. By removing Bitcoin from the conversation, you will get $65 billion in market capitalization and $13 billion in transactions, about half of the market. This is a lot of money, but there are very few monitors and restrictions. Once you look at the money more closely, a disturbing problem arises, and the problem arises at the ICO.
It turns out that an entrepreneur with little business experience may not be able to raise tens of millions of dollars through ICO. The ICO's failure rate is well documented, especially worse than the failure rate of traditional startups. Funds are disappearing or being wasted on a large scale, and too little money is spent on actual business development. A certain percentage of this failure rate can be attributed to fraud and hacking to trick people into buying their tokens, but in another aspect of the equation: honest, enterprising entrepreneurs. These people can be said to be naive entrepreneurs, they raise funds through ICO, but they raise more funds than they know. For example, a dreaming software engineer, a white paper, didn't have a viable business plan and raised $25 million from ICO. What do they do with so much money? They just skipped the seed fund and the A series and went directly to the B series, but did they have an effective product or user base? We don't know the answer. These entrepreneurs are caught in a situation where they may consume cash at a lower than prudent pace and let themselves fall into failure.
The flaw of the traditional fund is another point of view, of course, I think it needs improvement. However, I have something to say in the fundraising round. There is a reason why the company did not raise so much money at a time, especially when the company is small. It’s no secret that most startups have failed. So why give $25 million to an unproven concept? In fact, savvy investors will not. Regulators care about encryption because retail investors are participating in and speculating on these markets. Here, speculation is the key, because consumer behavior shows that these crypto tokens, coins, currency, no matter how you classify them are securities, not utilities or anything else.
The legislation authorizes the Securities and Exchange Commission to protect retail investors, to make the market fair and investors protected. Since the Great Depression (the Great Depression was caused by retail investors involved in speculative investments), this task has been in place. There is no protection in the encryption market, there are few popular terms like KYC and AML, and there is little disclosure of the investment itself. It is no wonder that regulators are coming to crack down on this group.
The way forward
Once the law enforcement is completed and the market matures around the regulated institutions, the situation will be very different. Of course there will be omissions, in which case those who carry out the ICO (if they have the ability) will return the money to the investor. Maybe they will provide ICO again within the scope of the securities law, maybe not. For those who do not act, there may be litigation, fines and possible time of imprisonment. However, within the scope of supervision, tokens also have a way forward. Just because the blockchain supports decentralized networks does not mean that everything should be decentralized. Blockchain also creates benefits in a centralized network. Decentralization does not solve all problems. I don't think this is the solution to the securities problem.
Tokenized securities have many benefits, including reduced costs, easier transfer, and faster settlement times. In addition, through the Promoting Emerging Companies Act, security tokens can be sold to the public in the same way as ICO. They only need to disclose more information to investors, so the cost will be greatly increased. This is not surprising, but these costs are controllable. However, in the secondary market, the situation has become more interesting. Establishing a fair market is already difficult enough. How can a decentralized exchange prevent investors from buying and selling, thereby manipulating prices or cleaning transactions? This mutual trading between individuals or small groups can create a false wave of investment to attract unsuspecting investors.
Even though smart contracts can provide solutions to these problems (which is a big assumption), regulation around securities trading means that the secondary markets for these securities are far more complex than decentralized exchanges can handle. They need a standard, some centralized source of knowledge, know everything in the market: who, what, where, when, and why. A closer look at several of these regulatory requirements reveals clearly why decentralized peer-to-peer transactions are not an option for securities trading:
Rule 144 – this rule states that 20% or more equity is owned Company executives or shareholders, within a three-month period, cannot trade more than 1% of all issued shares, which is the average weekly trading volume for the previous four weeks. Decentralized exchanges are unlikely to know this unless they are identifying customers and monitoring transactions, so a certain degree of concentration is required. Therefore, decentralized transactions do not align transactions.
12g - This rule states that if a company has more than 2,000 registered investors or more than 500 non-accredited investors, it must become a fully public reporting company. The cost of doing so is very high and is impossible for small companies. This is a problem for ICO because the purpose of the token sale is to create a large number of token holders for liquidity.
However, there is good news: If a company uses regulatory crowdfunding or regulation A to enforce ICO (which is how you publicly sell security tokens), then the company is not subject to 12G restrictions. Thousands of investors can hold shares in a company and the company does not have to go public. However, there is a warning to the regulations crowdfunding and Regulation A. Both regulations require companies to use the Registered Transfer Agent (RTA) for secondary transactions, which must be registered with the Securities and Exchange Commission. This means that the token cannot be traded on a decentralized exchange at all, because every transaction must go through the RTA. The blockchain can reflect the outcome of the transaction, but RTA, not a smart contract, must execute the trade.
That's why we developed the ERC-1450 on StartEngine, a new security token standard that eliminates the peer-to-peer transport of ERC-20 tokens. Unlike most tokens, ERC-1450 tokens cannot be directly peered. Instead, ERC-1450 communicates with regional trade agreements before completing any transaction to comply with Rule Crowdfunding and Regulation A.
People first think of blockchain as a means of fundamentally changing the market. Blockchain has the potential to increase the efficiency, transparency and liquidity of existing markets. Just because something can be decentralized doesn't mean it should be decentralized. If the ideal behind the decentralization system is the concept of fair market and equal access, then there should be some kind of regulatory body to ensure fairness and equality in the market. This is the original intention of the securities law.
