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.
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, the protocol was meant to boost investor confidence and protect retail investors. However, Sarbanes-Oxley has only 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.
Kickstarters Need a Kickstart
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.
While online crowdfunding was innovative for its time, Kickstarter and AngelList are centralized platforms and 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. According to CB Insights, $19 billion has been raised since 2013 through ICOs, while only $969 million has been raised through equity crowdfunding. Clearly, ICOs have won out.
The SEC 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.
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. 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.
– Don Phan, Web3 business development manager at Amazon Web Services
