ICO’s: Will New Regulations Hinder a Growing Industry?

 In Compliance, Customer Due Diligence, ICO

Over the last six months, talk of Initial Coin Offering’s (ICO’s) and the Bitcoin-boom have shared the spotlight across the financial realm. Yet while startup cryptocurrency firms have already succeeded in raising billions of dollars rather easily via similar practices thus far, many within the United States and abroad are still in the dark on these somewhat-novel undertakings, ICO’s in particular. Initial Coin Offering’s first appeared on the scene in 2014 with little fanfare and few funds being raised overall. In little over a year this luck quickly changed as the Decentralized Autonomous Organization (DAO), a digital venture capital fund, raised over $100 million using this modified crowdfunding technique via the sale of “tokens” in less than a week’s time, catching the eye of both entrepreneurs looking to potentially fund projects of their own and investors looking to cash in on a mostly untapped field with endless potential. Sure enough this budding industry took off shortly thereafter, soaring to heights that no one could have predicted following its disappointing introduction on the global stage less than a year earlier.

The basic premise of ICO’s is to function as a large-scale fundraising platform for tech-savvy businessmen and women. In order for funds to begin rolling in, investors are presented with whitepapers or informative reports from developers, documents that run down all that a project or idea entails – i.e. what it is about, the ultimate goal of the venture, how much money will be needed to fund the project through its completion, the cut of the profits that the project’s founders intend to keep, and what forms of currency are accepted from investors, among others. During the ICO campaign, potential investors interested in a firm’s project (usually due to money-making potential) purchase “coins” created and distributed by the individual/firm themselves with legal tender or the virtual currency offerings deemed acceptable by the project managers. “These coins are referred to as tokens and are similar to shares of a company sold to investors in an Initial Public Offering (IPO) transaction”, writes Investopedia. “If the money raised does not meet the minimum funds required by the firm, the money is returned to the backers and the ICO is deemed to be unsuccessful” (Investopedia, 2018). As recent history has demonstrated. in many cases these undertakings are highly successful, translating into profits for both parties, not to mention an established product or offering from the originators of the project. One of the more successful ICO efforts seen to date ultimately culminated into the second most notable cryptocurrency found on the market today: Ethereum. After being announced in 2014, the Ethereum project’s ICO raised $18 million in Bitcoins, and after going live in 2015, its market value skyrocketed to over $1 billion.
As ICO’s have continued to grow in popularity across the globe, how these offerings fall into the scheme of financial security and improved transparency has been called into question. In 2017, the European Securities and Markets Authority (ESMA) warned of high risks associated with investment into ICO’s, stating that firms issuing these offerings basically have the freedom to conduct their activities without complying with EU legislation seen at the time. Thus investors were left susceptible to significant risk of financial crimes such as fraud and money laundering, as well losses as a result of the volatility and uncertainty surrounding cyber markets. Other jurisdictions have also begun to take notice of their own respective vulnerabilities in this regard, and have started the process of developing regulations that cover ICO’s. Earlier this week the United States followed suit, as the Financial Crimes Enforcement Network (FinCEN) – a bureau of the U.S. Treasury Department that focuses on combatting financial crime at the domestic and international levels – announced that it will begin to apply its regulations directly to ICO’s, a move that will drastically impact the industry in the near future. The article “FinCEN: Money Transmitter Rules Apply to ICO’s” cited in BSA News Now on March 7th, 2018 analyzes a letter published by FinCEN early last week regarding the current state of affairs in the regulatory realm in great detail. In the report, Drew Maloney, FinCEN’s assistant secretary for legislative affairs, explains some of the expected changes that are likely to ensue, stating that “both developers and exchanges involved in the sale of an ICO-derived token would be liable to register as a money transmitter and comply with the relevant statutes around anti-money laundering and know-your-customer (KYC) rules” (De, 2018). The letter notes that developers of ICO projects that sell convertible virtual currencies (i.e. ICO coins/tokens) are considered money transmitters, meaning that they must observe current AML/CTF legislation. This essentially means that individuals and/or groups involved in ICO campaigns that do not register with FinCEN or other regulatory bodies, nor adhere to know your customer (KYC) requirements, are subject to criminal punishment under federal law.

FinCEN is currently working alongside other finance-related bureaus of the United States government including the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to clarify what obligations entities that have been in any way shape or form involved in ICO activities will be subjected to. The application of these requirements is likely to vary, as the process appears to be dependent upon the nature of the financial activity in which these respective ICO’s are involved. The SEC has long maintained their stance that ICO’s are securities, and rumors have circulated over the past several months that this body would begin to crack down on entities not registered as money transmitters through the issuance of subpoenas. Recent reports confirmed these rumors, as it has been discovered that the SEC has already issued subpoenas to numerous ICO companies, as well as their advisors. Multiple sources have confirmed that approximately 80 firms have received these decrees from the federal regulator thus far, with more likely to follow. Among the group in receipt of subpoenas is TechCrunch founder Michael Arrington. whose ICO fund is valued at over $100 million. It is widely believed that the SEC sends out subpoenas to those who are direct targets of new investigations, or those involved with an entity or individual(s) that are currently under investigation. With the uncertainty surrounding the regulatory climate in the U.S., many of the top crypto-related projects developed by American citizens have begun to move offshore, a trend that is set to continue due in large part to the latest actions by U.S. regulators.


Global RADAR will provide future updates on developments in this ongoing saga.


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