Education Series: Regulation A+ and D


The Initial Coin Offering (ICO) was invented in 2013 with the Mastercoin (now named Omni) ICO. In 2017 during the “ICO Summer”, ICOs were reported to raise several billion dollars in funding – some estimates as low as $4 billion with others as high as $5.6 billion. Regardless of the number it is a staggering sum for a new fundraising vehicle.

The money making machine

Alluring is the siren call for instant wealth. Left and right are anecdotes of survivor bias riddled with fantastic multipliers of 100x and 1,000x gains. With 1,000x gains you could turn $1,000 into a million dollars quicker than the Fairy Godmother can transform a pumpkin into a carriage. ICOs were the seemingly money printing machine available to the everyman.

Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.

~Warren Buffett, Berkshire Hathaway 2000 Chairman’s Letter

What comes after the after party

Not all ICOs were the dazzling charmers they seduced retail investors into believing they were. Of course there were the gainers such as Ethereum and Antshares (now called Neo), but there were also blatant scammers and overly ambitious projects cooked up by predictably undeliverable teams. TokenData, an ICO tracker, details 418 (46%) of 902 ICOs have been declared failures. An additional 13%, 113 ICOs, are limping along with lackluster community engagement or vaporware as their only contribution to decentralized world.

Investors in ICOs must all be aware that regulation is coming. Rather than groan about it, let’s look at regulation as an opportunity. Much like blockchain technology, regulation is going to have to innovate to keep up.

“That makes sense because our rules weren’t designed for this technology. In fact, our rules were designed for markets that don’t exist anymore, and we need to update them.”

~J. Christopher Giancarlo, chairman of the Commodity Futures Trading Commission (CFTC)

Regulation is going to be clumsy, but eventually a good thing

Shine a light in a dark place and the shadows have fewer places to hide. Regulation could be seen as a light and the scammers are the shadows. Cynics will point out that regulation is an excuse to shrink financial gains and preserve the oligarch financial distribution. If every ICO had to register with the SEC it would expose every founder and developer to not only the retail investors, but also the authorities. Scammers would operate ICOs without the “government” stamp of approval.

Let’s play a hypothetical in that we call the SEC a trusted third party. If every ICO was qualified through this trusted third party, every ICO investor would have the concern their project of interest is a scam. All that’s left is to make a business decision. Does this project you are looking at have the potential to disrupt or innovate in a particular industry?

We’ll write another post about how to properly identify whether a project will be successful or not. For now we focus on the regulation.

I’m an ICO founder and I’m considering Regulation D or A+

Let’s start with Regulation D. It is an exemption from all registration and other requirements for a company selling equity. It assumes that all purchasers of the stock are all accredited investors. The burden of proof lies with the company since they have to prove that every purchaser is a bonafide wealthy individual. Accredited investors are individuals who earn $200K annually with a net worth of $1M (excludes real estate). Regulation D has two flavors.

Section 506(b) allows companies to fund raise without solicitation, meaning their investors are individuals they already know. If you were introduced by a third party such as a broker then the rule is broken.

Section 506(c), established recently under the JOBS Act of 2012, allows companies to solicit. This privilege is not a free lunch. The company is penalized with a higher burden of proof to verify accreditation of every single investor.

Once you’ve raised enough funds you then have to fill out some paperwork (Form D) with the SEC.

Voilà! You’re done.

Regulation A+ was also established under the JOBS Act. The ICO is perfect for Regulation A+. Basically, you are allowed to raise money from anyone, not just the whales. But once again there is no free lunch. With Reg. A there is much more scrutiny. As an ICO founder, your time and expense will be used to disclose minute details of your operations. Back and forth founders will have to provide detail and wait for feedback from the SEC. Founders can find themselves waiting at least three months before they raise one cent, one satoshi, or one Iota. On top of time, there is a real monetary expense to file with the SEC. Filing can costs tens of thousands of dollars.

Founders who raise from angels or friends and family may find Reg. A+ unsuitable given their initial financial situation. It is not uncommon for founders to then go through Regulation D. Today, very few, if any, ICOs have filed Regulation D with the SEC.

Quantalysus believes regulation is a good thing

If we were to invest in an ICO, you’d bet we would be looking for companies doing things the right way. They publish their code. They run an efficient whitelisting process. They register with the proper authorities. They have nothing to hide.

We welcome the future of ICOs. Welcome to ICO 2.0.

Other resources to find out more about Reg D and Reg A+:

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