Blockchain & Money: Session 20: Primary Markets, ICOs, and Venture Capital, Part 2, by M.I.T. Sloan School of Management with Professor Gary Gensler

Session 20: Primary Markets, ICOs, and Venture Capital, Part 2

• Overview: Readings and Study Questions; Investor Protection and Howey Test; Initial Coin Offerings–Some Realities; SEC Enforcement Actions; SEC Exempt Offerings; ICOs–Pat Forward; Conclusions.
• Session 20: Study Questions
  • How ICOs mix economic attributes of both consumption and investment. How ICO tokens’ design features–their risks, expectation of profits, manner of marketing, exchange trading, limited supply and capital formation–are similar to investments schemes.
  • Why is the ICO market rife with scams and fraud?
  • What is the U.S. Securities and Exchange Commission’s current approach to ICOs? What are the options for completing a compliant ICO?
• Session 20: Readings
  • ‘Digital Asset Transactions: When Howey Met Gary (Plastic)’, Hinman.
  • ‘Initial Coin Offerings: Can Regulators Curb the Risks? How Many ICOs Are Scams?’, ValueWalk.
  • ‘ICO Quality: Development & Trading’, Satis Group.
  • ‘Hundreds of Bitcoin Wannabes Show Hallmarks of Fraud’, Wall Street Journal.
  • ‘ICOs Are Setting Capital Free. That’s Revolutionary’, CoinDesk.

• Investor Protection–Going beyond Consumer Protection
  • Investors get Full & Fair Disclosure from Issuers
  • Fraud & Deceptive Sales Practices Prohibited
  • Transparency & Anti-Manipulation Promoting Market Integrity
  • Advisors’ Conflicts of Interest Disclosed and Minimized

• U.S. Securities Law
  • The Howey Test (1946):
    • Is it an investment of money or assets?
    • Is the investment in a common enterprise?
    • Is there a reasonable expectation of profits?
    • Is it reliant on the efforts of a promoter or others?

• The Duck Test
  • “When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck.” –James Whitcomb Riley, poet

• Initial Coin Offerings (ICOs)
  • Proceeds used to build networks
  • Purchasers anticipate profits through appreciation
  • Tokens usually issued prior to being functional
  • Development, while open source, is largely centralized
  • Promoters allocate themselves ‘premined’ tokens
  • Tokens are fungible & transferable
  • Scarcity is fostered with preset ‘Monetary policy’

Telegram	$1.7 Billion	2/18	1Q2019
Filecoin	$257 Million	9/17	2Q2019
Dfinity	$102-195 Million	8/18	1Q2019
Polkadot	$144 Million	10/17	3Q2019
tZero	$134 Million	8/18	TBD

• Ernst & Young ICO Study: ‘The Class of 2017–one year later’
  • Top 141 2017 ICO Projects as of September 30, 2018
    • 86% Trading below Listing Price
    • 30% Lost Substantially all Value
    • Portfolio Down 66%
    • Only 13% have Working Products
    • Another 16% have Prototypes

Ethereum: DApps & Average Daily Volume

Exchanges	179	25875
Gambling	488	17735
Games	466	15660
Finance	228	2665
Property	62	2575
Storage	55	1745
Social	228	520
Media	111	380
Wallet	71	370
Development	142	320
Other	218	275

• SEC ICO Enforcement Actions
  • DAO Report–July 2017
  • REcoin Compliant–September 2017
  • Munchee Order–December 2017
  • AriseBank Asset Freeze–January 2018
  • Centra Tech Complaint–April 2018
  • Longfin Asset Freeze–April 2018
  • Titanium Asset Freeze–May 2018
  • Tomahawk Settlement–August 2018
  • Blockvest Emergency Court Order–October 2018
  • Airfox and Paragon Order–November 2018

• Exempt Securities Offerings
  • Regulation D–Restricted Offerings
    • 506(c)–Accredited Investors Only
    • 506(b)–Accredited Investors + 35 Sophisticated–no General Solicitations
    • 504-<$5 million
  • Regulation A–Offering Statement with Financials
    • Tier 1–$20 million–Any Investors & must file with State Securities Regulator
    • Tier 2–$50 million–Subject to ongoing reporting requirements & Limits on non-accredited investors
  • Regulation CF–Crowdfunding
    • $1.07 million through SEC Registered Platform, Information Disclosure and limits on Investors

• ICOs–Path Forward
  • Continued High Failure Rates
  • Likely Further Decline in Funding Totals
  • Increased Numbers of Enforcement Cases and Private Litigation
  • Regulators & Courts Brings Added Clarity to ICO Security Definition
  • More ICOs brought into Compliance
  • Early Tokens Tested as Some Platforms become Functional
  • Markets Better Differentiate Viability of ICO Use Cases

• Conclusions:
  • Initial Coin Offerings are a New Means of Crowdfunding
  • Benefits of Tokens Economics are still Uncertain
  • A Majority of ICOs have Failed, Many have been Scams, Many More have been Non-Compliant with Securities Laws
  • ICO Markets will only Prosper with Use Cases are Truly Viable and Issuance is Compliant with Investor Protection Frameworks

Biblio:

• Gary Gensler. 15.S12 Blockchain and Money. Fall 2018. Massachusetts Institute of Technology: MIT OpenCourseWare, https://ocw.mit.edu. License: Creative Commons BY-NC-SA.
• Video Link: Session 20: Primary Markets, ICOs, and Venture Capital, Part 2.
• Slides Link: Session 20: Primary Markets, ICOs, and Venture Capital, Part 2, Slides.