The ICO World Is Heading For A Very Hard Fork

On selling securities without selling securities.
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From the earliest days of bitcoin to the current orgy of initial coin offerings, there’s been a fundamental tension at the heart of the cryptocurrency community. In broad strokes, it’s anarchists vs capitalists: Libertarian dreams of decentralized systems that protect anonymity and attack incumbents butt up against the ambitions of entrepreneurs eager to get the nod from DC and Wall Street and start minting cash.

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When it was just bitcoin, the conflict was more philosophical. But it’s a different story now with ICOs, IPO-like token sales that fund blockchain-based startups and have raised more than $3 billion this year. 

In the case of ICOs that are legit (not a given), tokens generally purport to have some future utility for end-users beyond simple speculation. But the SEC doesn’t care too much for the finer points. To regulators, there’s just people selling things to fund their companies and other people buying things to earn returns. Conclusion: Those are securities. And that reality has pushed the contradictions of crypto-world to the surface.

This tension was clear on Wednesday as crypto enthusiasts gathered in midtown Manhattan for the first-annual ICO Forward summit (tagline: “The revolution begins here”). Sponsored by a hodgepodge of crypto funds and blockchain startups, the event attracted a vast assortment of bearded guys in blazers-and-jeans proclaiming how their digital token for selling real estate or democratizing space would change the world. During one break I hear two guys loudly comparing the relative merits of ayahuasca and DMT. For some reason everyone has VR headsets.

There are two species in attendance: developers hawking their ICOs and investors eager to strike gold. The startups are diverse. There’s Trive, the app that aims to end fake news by enlisting crowds to scour news items for factual statements and rate their truth value in exchange for tokens. There’s a guy from the Startup Societies Foundation, which wants to “create a marketplace for governance” by encouraging special economic zones in regions such as hurricane-ravaged Puerto Rico, where he’s proposing an ICO to raise money for privatized redevelopment (“They’re totally destroyed areas; there’s nowhere to go but up”).

Not present, it turns out, is anyone who might actually use the tokens under discussion. That might be understandable for such a burgeoning market, whose end users hypothetically range from anyone with a computer to multinational corporations. But it highlights a thorny issue for crypto developers: If their ICOs are sales of products, and not securities, why is their principal audience speculators?

Early in the day I spoke with the 20-year-old co-founders of Gladius, a blockchain-based application that lets people lease surplus space on their computers to web companies seeking nodes for content distribution and protection from denial-of-service attacks. In exchange for renting out their gigabytes, users receive Gladius tokens to sell on an open market.

It’s a clever idea, and they’re seeking up to $12.5 million in an ICO to make it happen. But in selling their tokens to the market, the two founders told me, they’ve taken pains not attract the gaze of the SEC; they’re presenting their token not as an “investment” but as a “utility.”

Our conversation is interrupted by the first session of the day: A “Data-Driven Approach to ICO Investing” courtesy of crypto influencer Ian Balina (whom we’ve met before). By using moneyball-like data analytics, Balina explains, he’s increased his proportion of profitable ICO investments from one-in-eight to a half. These days he’s most interested in speculating on ICOs for utilities. Utilities like Gladius – which presents just after Balina.

This conundrum is general. ICO developers want to raise as much cash as possible for their projects, but to head off regulators, they need to do so without appearing to be selling securities. In part it’s about nomenclature. “If I use ‘ICO,’ it smells like ‘IPO,’” says Dan Goldman, who is developing an algorithmic trading platform called Cryptalgo. “Perhaps I should err on the side of caution.” He rehearses how he’d tell potential investors about his company, which he sees as a sort of hedge fund killer app for the crypto world. “Notice I didn’t say, ‘invest,’” he says at the end of his pitch.

That kind of logic prevails at the conference. Half the audience wants to sell a utility token and the other half wants to invest in a cryptocurrency. It’s a delicate balancing act. And it probably won’t matter in the end.

“The SEC’s not going to have a really nuanced view about whether it’s a security,” says Nick Morgan, a securities lawyer at Paul Hastings who serves as the conference’s resident regulatory scold. He compares the ICO space to private placements of public equities, or PIPEs, which proliferated in the early 2000s before the SEC dropped the hammer. Like that crackdown, Morgan expects authorities to take a “conveyor belt” approach to doling out charges once they’ve firmed up their stance on crypto coins.

“I’ve been approached by many, many people asking how I can structure my ICO so it’s not a security.” he says. “It's a misplaced priority. When you get your subpoena from the SEC I’ll come to defend you.”

There’s a contingent here that has embraced the inevitable. Dan Doney is the CEO of Securrency, “a combined RegTech/FinTech platform” that “aims to be the Amazon of Financial Services.” The former Chief Innovation Officer for the Defense Intelligence Agency, Doney welcomes the coming SEC crackdown, positioning his own venture as a bridge to a crypto-compliant future. This doesn’t necessarily make him many friends in crypto world. “I’m gonna get slaughtered on Reddit,” he says.

For the self-styled visionaries, however, the SEC question is barely worth asking. One of the presenters at the conference is Matt McKibbin, who runs a consulting firm called DecentraNet. “Decentralization will change more in our lives over the coming years than possibly any other technological shift we’ve seen,” he says, likening the crypto rush to the Reformation. He describes building anarcho-capitalist city-states on the back of the blockchain. “If you’re going to built a new city, you’re not going to have the DMV – we don’t like the DMV,” he says at one point. Later: “We can actually tokenize the moon with a startup society.”

When I ask him about the SEC’s role in the space, he waves the question off as irrelevant. “Under crypto-anarchy,” he explains, “we’ll get to determine the government that we want.”

The attitude illuminates the larger bet undergirds crypto world. Each individual ICO is a gamble on a specific application, be it a decentralized energy market or a fake news filter or whatever. But as a whole, the crypto community represents a single, giant bet on an as-yet unproven hypothetical: that the world’s problems can be solved by decentralized marketplaces run on cryptographic tokens. In a world where every Tom, Dick and Harry is clamoring for more units of exchange by which to intermediate their commercial affairs, yes, any of these ventures could indeed be successful.

But if we don’t live in that world, the entire ICO wager is lost. In their hurry to usher in the new world, crypto pioneers might end up getting lost in the current one.

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