How a sensible ICO regulation could boost the next wave of DLT innovation
In this article, we aim to explain what are the main issues regarding the ICO and how credible regulations could affect it in a positive way.
Initial coin offering, or as some might well define it — ‘the quickest way to lose your money’ is a long-gone form of crowdfunding. Despite the hype created by the booming Bitcoin price and massive amounts raised by numerous projects, not many of them are still operating and providing value for the token holders today. It is a shame that all of this creativity built around the unlimited opportunities provided by the decentralized ledger technologies went away. In this and a few more articles to come, we will touch on the core legal issues around ICOs and how they might be solved with a suitable regulatory framework. Our theory is that a favourable regulation that protects token holders and introduces transparency and clarity in the process can be a game-changer with the potential to boost the EU’s economy or any other jurisdiction that implements it. It will help the whole industry to base itself not just ‘on thin air’ but rather on value-generating mechanisms.
The heart of the issue
There are two core issues in this space:
1. very few token issuers did what they promised to the public; and
2. nobody created the direct link between the increased demand for the issued tokens and the market.
Regarding the first one, a sensible regulation must follow through the whole process — from the (pre-)sale of tokens — to the execution of the anticipated project. Usually, all promises are outlined in the whitepaper describing the problems that shall be solved and the envisaged solution, team, road map, token price increase factors and legal nature of the token. However, you will read (at least in the well-written ones) that this document is not binding and can be changed at any time, also can’t be the one that token purchasers can base their decision to buy tokens on. Yet, this document creates your vision of the project and the opportunity as the Offering Memorandum does in the traditional financial world. The unfortunate result here is that we often have a public offering of digital units with the expectations (but no promises) of return and definitely no guarantees of project implementation. Thus, the whitepaper may not be binding but becomes blinding to the buyers. So how does a sensible regulation address these issues?
The first and most crucial issue to be solved is that Whitepapers must be compulsory for their issuers. Any changes in these documents need to be made upon preliminary approval by the community and the competent authority. To achieve that, with the necessary degree of flexibility, we need to go through the core pillars of the ICO crowdfunding concept, which are the following:
- It always starts with the idea — the value-generating structure of the project. In other words — the founders have to explain to the public the nature of the opportunity and the envisaged solution. It is further necessary to outline how it will generate value for the users of their service/product and the economic reasoning for prospective token buyers. At this step, any regulatory interference shall be limited to assessing of the legality of the scheduled activities and the potential licensing regime that they might be subject to. Any feasibility of the successful outcome needs to be left to the market to decide.
- The community pressure for the project execution to follow the proposed road map is actual, and all founders can feel it. It is essential because ideation without execution is just a delusion, and it can be seen that many ICO funded undertakings didn’t happen at all. The main reason for this is the complete lack of transparency around funds and no mechanisms to ensure that they are spent according to the plan. In this regard, the founders shall present to the authorities their road map with milestones to be achieved on a time and material basis. Further, the continuing execution might be supervised, and funds may be released upon reaching the milestones. This would drastically improve the success rate of all projects.
- Another vital issue is the detachment of the tokens from the project’s development and progress. One can quickly see how the tokens of accomplished projects went down while other undertakings with less market validation achieved a higher price. ICOs did a tremendously bad job in improving the political and marketing fraudulent pricing established in traditional markets. Instead of linking the price of the tokens to the value generated by their businesses, many teams decided to leave it to the mercy of the market — pure speculation and PR tricks. This creates the “thin air” problem around this industry, which otherwise claims to be changing the world in a better direction. If a product is as good as it needs to be, it will create high demand for tokens purchases — therefore, this demand combined with the scarcity of tokens shall lead to higher prices. Currently, this work is done by promising tweets of CEOs, but the effect is not favourable in the long run. The solution here is to set a clear milestone that will trigger the direct link of the token purchases for platform utilization directly to the market and not to private smart contracts of the projects. And second, the token allocation and market manipulation shall be under strict supervision by the competent authorities. In this way, the token will inevitably become a valid indicator for the value provided by the tokenomics model and the related products/services.
Obviously, this article would be too long if we are to cover all aspects that a credible regulation may affect in a positive way in the ICO world. The reality is that this type of crowdfunding proved to be quite viable in terms of boosting entrepreneurship and providing the freedom to innovate. While it is true that the economic impact can be highly optimistic, we need to get this regulatory framework right so that it does not kill the innovation but rather introduces clarity, transparency and security around the tremendous opportunities relating to the decentralized ledger technologies. The ICOs deserve a second chance. We will dedicate a few more articles to boost a more comprehensive understanding of the concept of a sensible regulation governing the next generation of decentralized project financing.