Hard Regulatory Choices (ICOs, crypto)
“Most punters were not alive during the Dutch tulip craze. Thankfully, they can now experience the Initial Coin Offering (ICO) craze.” Unknown Techno-Optimist.
If you follow Stephen Palley on twitter, you will have read his views on the silliness and bubble-like moment we are witnessing in ICO land – most of them guppy centric:
If you have not, then you most assuredly heard about the recent SEC comments on ICOs – see here – or the SEC’s recent enforcement action – see here – or the even more recent declaration from the People’s Bank of China (PBOC) – see here for a full english translation – banning ICOs altogether. Basically, winter is here for ICOs, ranging from a benign and restrained SEC winter, to a full blown “Night King riding a dragon” PBOC winter.
If you have not, then you must have just come back from a year long trip to Mars and need to read below attentively.
We are blessed with several “crypto” experiments: a) bitcoin (the reserve asset), b) blockchain technology (in its pure bitcoin forms), c) ethereum (both the asset and the blockchain), d) distributed ledger technology. Any number of projects under each of these main experiments will yield meaningful economic breakthroughs (think what +20 years of internet experimentation brought us). This time around, these crypto experiments are able to propagate at the speed of light thanks to the maturity of the internet as well as the early successes of bitcoin and ethereum – not to mention a little “thing” called globalization. Further, these crypto experiments have to deal with money (whether fiat or non-fiat). All these factors raise the stakes substantially when it comes to either legislation or governance for the greater good.
It is impossible to deny that we are living in a crypto bubble where most, if not all, assets are being bid up based on the triplet effects of the promise of real opportunities (good), FOMO (not so good) and nefarious activities (outright bad). The ICO craze can be filed under the “nefarious activities” bucket at this stage given the overwhelming majority of such schemes are neither legal nor grounded in any sound business reality.
The lack of sound business reality is usually dealt with by the swift and cold application of market forces. Illegality on the other hand has a tendency of being treated with a lag – the long arm of the law, whether legislative, judicial or regulatory, tends to move at a slow pace. This slow pace is usually not an issue, except when the rate of change enabled by a set of technologies reaches such a frenetic pace that unintended consequences become more negative than positive in real time.
I think we can safely state the ICO craze has happened swiftly, over a short period of time, and been very “successful” based on one kpi, the amount of capital raised. We can also safely state the overt activity has been illegal (speculation) and that inevitable failures will occur thereby threatening sound and needed experimentation. Left unchecked such activity may produce even more negative consequences – think of widows, orphans and their precious savings. Thusly, I welcome the PBOC’s definitive action as it will provide a welcome breather to the crypto space and allow, hopefully, sounder thoughts to prevail. Yet, outright bans come with negative consequences too, namely in the form of a chill over experimentation and innovation.
Be that as it may, I also think regulators need to rethink their approach to new technologies and business models in light of the instantaneous, distributed and decentralized properties exhibited by ICOs. Outright bans as well as permissiveness or lack of clarity should be avoided. Clear guidelines and strong enforcement when illegality is patently proven should be prompt and decisive. Yet, this is not enough and I believe regulators also need to upgrade their technology expertise, engage earlier with the startup world and provide continuous guidance along the way.
I do not necessarily believe regulators need to undertake a complete overhaul of their rule books – I will defer to the specialists amongst us as to the applicability of current rules with regards to ICOs. I do believe regulatory process and discovery need to be rethought in an age where the propagation of a specific technology and/or its use unfolds at a different pace than in a purely analog world. As such, unintended negative consequences will impact a given ecosystem faster. Today, ICOs were able to raise hundreds of millions relatively fast, and other than investors – whose activities are circumscribed to the crypto space – losing money, there is not much of a risk of contagion with the “outside” world. Yet, think of what tomorrow will bring, with a next wave of fund raising around a new crypto-techno scheme. It is not unreasonable to think that one logical outcome could be see tens of billions being raised, even a few hundred billion and that such a raise in the aggregate could have more than an endogenous impact. A “digital ready” regulator engaged and active rather than passive and reactive would be able to foster safe and useful innovation.
Finally, jurisdictional cooperation and collaboration is essential. Clear SEC guidelines and enforcement only impact the US and are undermined by permissiveness in different jurisdictions, given the very nature of the crypto ecosystem. Outright bans can also be undermined by permissiveness in different jurisdictions. In other words, regulatory competition, and its ensuing arbitrage, may not helpful for optimal innovation in crypto. (Incidentally, the same could be said of other technologies such as AI – for different reasons maybe.)
Alas, the world of bottoms-up regulatory cooperation will take a long time to emerge and we are now faced with a PBOC ban and its immediate consequences which I believe will be:
- a relative and welcomed cooling down of the price of BTC and ETH
- an absolute curtailing of dubious ICO activity both in China and the US (assuming we do not witness a PBOC reversal)
- the bulk of upcoming US based ICOs to be fully legal and compliant, more business minded and less focused on the absolute search for empty enrichment.
I remain unsure whether smaller jurisdictions will swiftly follow or play regulatory arbitrage. For the health of the crypto space, I hope all jurisdictions will fall short of the PBOC’s stance and be more insightful and engaged than what the SEC delivered to date.
ps: thank you to Stephen Palley for his invaluable feedback.