What are the Crucial Requirements for an ICO in 2018

ICO 2018

2017 was very generous to all sorts of ICOs (initial coin offerings). No matter how ridiculous the offering was, everyone got their slice of the pie; a total of $6.2 billion was raised in 2017 by 875 successful projects.

Since then, the number of ICOs grew to 1,160 projects, and the amount of money raised by them in 2018 was bigger than in the previous year – $7.2 billion. However, most of this money went to a few large projects, like Telegram ICO, while many small projects failed to reach their planned funding goal. What caused this decline? Many ICOs from 2017, 80% of all crowdfunded projects, didn’t deliver a working product one year later. Some of them spent nearly all of their investment in the development process, so the development was significantly slowed down and only a few actually delivered something. Actually, 64 out of the top 100 projects with the biggest market capitalization still don’t have any working product. This is why regulators stepped up to do something; they were attracted by the multitude of financial scams happening in this sphere.

Source: https://research.bloomberg.com/pub/res/d28giW28tf6G7T_Wr77aU0gDgFQ

The founders of ICOs, conducted in 2017, seemingly believed that crypto is terra incognita for governments and regulators which will forever stay that way, because they obviously can’t extend their power to decentralized markets, right? That’s the only explanation as to why several founders violated all the rules and ignored the necessary compliance procedures for accepting money from non-professional investors. Recently, the US SEC subpoenaed 80 crypto companies and the head of the SEC, Jay Clayton, claimed that every ICO he saw was a security. This means that these ICOs must comply with regulations, but a lot of these ICO startups didn’t do it. So why is it that regulators don’t like unregistered offerings?

We aren’t living in a decentralized world

Regulators have an amazing ability to track almost anything and anyone, and a system can only be decentralized if it doesn’t require interaction with the real world. If you raise money through an ICO, you have to pay salaries, you have to pay for an office, and for all of these expenses you need fiat money, which is probably stored in the bank. And here is the point where regulators show up and ask you, “Where did you get all that money?”

Regulators didn’t bother with ICOs when the whole industry was small and it didn’t look like a craze worth regulator attention. Regulators are large entities that don’t react to small things; they only react to violations of investors’ rights. When the blockchain all started, it was just a few computer geeks selling magic Internet money to each other, so it wasn’t a big deal at first. However, when crypto started raising billions from retail investors, that was when people (especially the regulators) started to pay attention. There are only a few things that regulators care about:

  • It shouldn’t be a money laundering.
  • The token sale should be officially registered.

Money laundering is a very sensitive topic for regulators. The term was first introduced in the 1930s to explain what happened to the money behind illegal alcohol sales, but it was really only involved with the laws against tax evasion. A few decades later, the epidemic of drugs in the US in the 1980s and terrorism in the 2000s led to creation of the modern AML (anti-money laundering) laws. Usually, a person is considered innocent until proven otherwise. That’s called the presumption of innocence. But according to AML laws, suspicious money can be confiscated first and its owner must prove that it comes from a legitimate source later. Banks have obligations to know their clients, verify them, monitor all transactions, and freeze any suspicious accounts that might contain dirty money.

Source: https://www.washingtonpost.com/posteverything/wp/2016/04/08/why-i-refuse-to-send-people-to-jail-for-failure-to-pay-fines/

In crypto, as every address is just an anonymous sequence of numbers, the origin of funds is undisclosed by default. So, if somebody conducts an ICO without verifying their investors, they may be assisting in money laundering; that’s the logic of regulators anyways. Also, let’s not forget that the law prohibits selling risky assets to non-accredited investors. That’s why many of the projects that organized crowdfunding in 2017 are now subject to investigations, as the statute of limitations has not passed yet. Many ICOs were shut down – such as Munchee, AriseCoin, Centra – they were forced to refund investors, and in the case of Centra two founders were arrested for organizing a fraudulent ICO, appropriating investors’ funds, and selling unregistered securities. If you weren’t clear about the law earlier, it’s obvious now – regulators won’t allow anyone to violate the law. The only way to conduct an ICO is to comply with the law.

The new reality for crowdfunding

The stance of regulators around the world on ICOs is pretty transparentICOs are allowed in some jurisdictions only if it’s officially registered and all investors are verified using KYC/AML procedures. Some ICOs are already adapting to this new reality, selling their tokens only to accredited investors and funds, thus evading any legal problems. For example, TON made its $1.7 billion sale private as well as Terra, a stablecoin, which raised $32 million from private investors.

What is required in order to obtain a license from a regulator? An applicant must provide a package of documents (which may differ from one jurisdiction to another):

  • The terms and conditions
  • The dispute settlement policy
  • KYC policy
  • AML policy
  • Project purpose
  • A detailed business plan
  • How much organizers invested by themselves
  • How much is planned to raise
  • The economic-legal basis of the token

All of these policies must comply with the chosen jurisdiction’s laws. For example, all ICO tokens must be run through a Howey test to see whether it is a security or not. If it’s a security then these tokens can be sold to non-professional investors only by virtue of regulated offering. Also, there’s a lot of AML policies and they are basically the same in all jurisdictions, because there is an established standard.

howey test
Source: https://blockonomi.com/howey-test/

In the jurisdictions where the Howey standard is accepted, the regulator analyzes the project, checks all documents for their legitimacy, compares it with similar projects, and then decides if the project is approved for a license or not. That’s the only way how ICO projects can become compliant with the law in some regions. All other crowdfunding projects will be punished, sooner or later.

Regulatory-compliant ICOs

Some ICOs are already trying to receive approval from regulators and a good example of this is the PAX token. It’s a property-backed stablecoin that raised $15 million and is currently waiting for approval from the SEC. With this proposed platform, all funds received from investors go to buying real estate, giving a return for using it to ICO investors. That’s like a Real Estate Investment Trust (REIT) on the blockchain.

If we want to talk about the projects that have already been given a green light from regulators, we can mention Impak Coin, which received approval from the Canadian regulator, the Autorite des marches financiers (AMF). The project was relieved of some of the requirements that are necessary for companies that sell securities, because it was considered a test. For example, it wasn’t necessary to register as a securities dealer, given that all AML requirements and KYC screenings were met. Impak Coin managed to raise over $1 million.

There will be more and more regulated ICOs over time. But getting an approval for selling tokens is one thing. Another thing is to get a license to provide regulated financial and banking services.

What to do after selling tokens?

A project can sell its tokens, but after that it must deliver an actual working product. If it’s a fintech startup, it needs a license if they aim to provide banking services, which is pretty hard to get. And if it doesn’t have it, the project can stall for a long time. TenX, a crypto card startup, was forced to cancel the issuance of its card because Visa dropped the partnership with its provider WaveCrest, and TenX didn’t have the license to do it on their own.

Let’s take an example from the UK. The Financial Conduct Authority gives the license after a thorough analysis of the applicant. Here is a part of their strict set of rules:

  • They must provide information about the financial stability of the company,
  • About the benevolence of the company, because all actions of the financial provider must be done in the best interests of its clients,
  • And it must follow the rules of holding clients’ money.

Not every company can comply with these rules, and even fewer ICO startups can handle it.

Among those crypto projects who did manage to obtain the license for financial activities, we can name a few. One of them is Platio. They are developing a banking application of many purposes: storing and spending fiat and crypto and trading crypto and stocks. It allows users to utilize Smart Escrows protecting both the buyer and the seller, and pay invoices, all from one app. It also has a unique instrument called Asset Guard to solve the problem of access key loss and avoid volatility risks. An important remark: Platio had the FCA license right from the beginning. That allows the company to legally offer financial services since day one, like any other financial company.

Another licensed project of this kind is World Bit Bank – a crypto bank, that has a license from European Union financial regulators. After completing its ICO it plans to start acquiring various banks with licenses for carrying out financial services in many regions of the world like the USA, the UK, Switzerland, or Japan, rebranding them to operate under its brand.

And the last one worth mentioning here is Baanx. It’s a project that aims to build a crypto bank as a white-label service, integrating other brands into their network and sharing their license with them, because in the case of using a white-label product it would be Baanx providing these licensed services, and brands only using them. The company owns a licensed credit broker Optimal Search Limited, authorized by the FCA.

What’s next?

Crypto startups turn to legal procedures because nobody wants to end up in jail. So far, legally compliant ICOs raised $350 million this year, and if we count Telegram this number increases to $2 billion. Regulators and governments won’t ease their grip, so all projects trying to raise money without registration are doomed to fail as they will be considered illegal and be persecuted to the fullest extent of the law. The Wild West days of raising easy money is over, but the kingdom of scams has fallen as well.

security token
Source: https://dilbert.com/

Considering that most previously conducted ICOs didn’t deliver any product, these new regulations may force new projects to be more responsible and possibly eliminate a lot of fraud from the market. This won’t guarantee the success for any one project, but it will allow legal projects, such as those that we’ve previously mentioned, to be developed in a more healthy atmosphere.

Thanks to the Howtotoken Agency experts for the information and comments provided for this topic.

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