In the fallout over FTX, U.S. Senate Banking Committee Chairman Sherrod Brown (D-Ohio) recently announced he is considering legislation aimed at protecting retail investors from cryptocurrency fraud. Legislators and regulators should proceed with caution. Casual observers may be skeptical of the innovation of cryptocurrencies, but the clearest innovation has been initial coin offerings (ICO).
ICOs have allowed entrepreneurs to raise money, circumventing the thicket of decades-old Sarbanes-Oxley regulations. Members of Congress serious about economic growth should be encouraging initial coin offerings and rein in the U.S. Security and Exchange Commission’s regulatory overreach.
Don Phan manages the cryptocurrency business at Amazon Web Services and was previously a congressional staffer.
Initial coin offerings are a technological innovation that disrupts the current fundraising apparatus calcified after passage of Sarbanes-Oxley. Sarbanes-Oxley should serve as a cautionary tale. Passed in the aftermath of the Enron-Arthur Anderson accounting scandal, Sarbanes-Oxley was meant to boost investor confidence and protect retail investors.
Instead, Sarbanes-Oxley has made it more difficult for entrepreneurs to access public capital markets. Startups are now staying private longer precisely because accessing money from the public markets has become so burdensome.
The U.S. Congress took a step in the right direction with the Jumpstart Our Business Startups Act (JOBS Act of 2013), which promoted equity crowdfunding, the kind most associated with platforms such as Kickstarter and AngelList. The intent of Congress was to allow more investors to take part in the growth of early-stage startups and for startup founders to be able to raise money from a much wider range of people.
Congress pushed in the right direction by promoting equity crowdfunding, but Congress could not foresee how much bigger the ICO market would be. According to data compiled from CB Insights, $19 billion has been raised since 2013 through initial coin offerings, while only $969 million has been raised through equity crowdfunding. Clearly, ICOs have won out.
While AngelsList and Kickstarter were innovative for their time and paved the way for our understanding of equity crowdfunding, they are centralized platforms that were ultimately limited in their scale. The intent of Congress was to make fundraising easier for founders to raise from small investors, exactly what ICOs do so well.
The Securities and Exchange Commission bears the most responsibility for giving ICOs a bad name and has vastly overstepped its authority as an executive regulatory agency. The SEC does not have final say over cryptocurrency regulation – Congress does. While the JOBS Act intended to make fundraising easier, the SEC is pushing for an overregulated regime that replicates the worst features of Sarbanes-Oxley.
If the SEC gets its way, fewer retail investors will be able to take part in the growth of early-stage startups and startup founders will only be able to raise from a limited range of sources. The chilling effects of possible SEC enforcement can be seen in how cryptocurrency entrepreneurs must contort themselves to avoid the “ICO” term for fear of an SEC crackdown.
Founders now use incomprehensible terms such as “initial decentralized offering” (IDO) and “token generation event” (TGE) to disguise what would otherwise be a simple fundraising exercise. Congress should use the provisions of the JOBS Act to provide ICO entrepreneurs with a “safe haven” of legal protection from SEC enforcement.
Furthermore, SEC regulation of ICOs should be viewed as protectionism over initial public offerings, or IPOs, in which an agency led by a former Goldman Sachs partner protects the IPO ecosystem of investment bankers, auditors, corporate lawyers and regulators who bear the most risk of ICO disruption.
Fraud or Failure?
A regularly quoted statistic is that most ICO-backed ventures shut down within four months. Legislators and regulators need to convincingly distinguish between fraud and failure. Business failure is not a crime and should be encouraged by lawmakers attempting to encourage economic growth.
Regulation is often a zero-sum game because rules aimed at protecting retail investors – the proverbial grandmother who has lost her life savings in the latest crypto fad – come at a real cost to entrepreneurs, who must contend with more rules while being starved of the capital needed to grow their businesses.
Chairmen Brown and Gensler may be sincere in their desires to support growth and tech entrepreneurship, but they risk strangling the clearest source of funding for future innovation.
Most potential retail investors have heard that cryptocurrencies are largely scams they should avoid, so the benefit of regulation will likely be minimal. On the downside, another layer of regulation will make it more difficult for entrepreneurs to raise the money needed to grow their businesses.
If more regulations pass, it is foreseeable the innovative startups of the future will be built in foreign countries, far away from Silicon Valley, far from American shores.