Throughout 2017 and early 2018, entrepreneurs seeking to raise funding for their blockchain businesses through ICOs (Initial Coin Offerings) have largely had the field to themselves, with little in the way of vigorous or coordinated regulatory oversight.

These fundraisers, frequently armed with no more than a website and a whitepaper PDF, have raised billions of investor dollars (in BTC or ETH) based on claims that if they are provided with the necessary funding, they’ll change the world through exciting new blockchain breakthroughs.

Until recently, raising funding has been a relatively easy and simple process as entrepreneurs, as well as less savory characters, have operated under the assumption that the existing regulatory structure didn’t apply to them.

The graphic below shows the number of completed ICOs during calendar year 2017 and Q1 2018:

(Source: ICO Drops)

Here Come The Regulators

However, due to the increasing number of questionable ICOs, regulators in all major regions of the globe have begun to swing into action with the intent to curb investor abuses that they believe have occurred in the space.

As the chart above graphically shows, the number of ICOs has dropped dramatically in response to this flurry of regulatory actions among major economies.

For example, in the U.S., the SEC (Securities and Exchange Commission) has created a crypto-specific task force and recently subpoenaed at least 80 investors and entrepreneurs related to completed ICOs.

Also in the U.S., several federal agencies that have claimed direct jurisdiction over cryptoasset activity:

  • The SEC calls most cryptoassets securities and requires exchange registration
  • The CFTC calls some cryptoassets commodities
  • FinCEN requires transaction data

Regulators worldwide have issued pronouncements classifying most ICOs as ‘securities’; they’ve also issued restrictions on the types of accounts users / investors may open at exchanges, begun requiring exchanges to register and follow all record-keeping regulations including know-your-customer, anti-money laundering & terrorist financing controls, among many other regulations.

The chart below indicates the amount of ICO funding raised by country location of crypto startups in ICOs over the last five quarters:

(Source: ICOWatchList)

Although there are 29 countries represented in the above cited data, the top ten countries in aggregate accounted for 91% of the total, indicating significant concentration of entrepreneur by location.

It is likely that further regulatory guidance and consequences will come from major developed economies at the national level and I expect this to be a multi-year process before the level of regulatory uncertainty is lowered.

In response, a few blockchain startups that can’t wait for the regulatory dust to settle have apparently made the decision to leave their host country and move to what they view are more hospitable regulatory environments, such as Switzerland and Malta.

These entrepreneurs believe they will be able to survive and thrive in country-level regulatory environments that are less restrictive in their approach to crypto firms. The host countries are banking on their ability to attract a new group of entrepreneurs that will create high paying jobs and either bolster their existing financial services capabilities or create new ones.

So, entrepreneurs now have a potentially more complicated decision process on where to domicile their business. The previous view that the regulatory environment was somehow irrelevant to their behavior has become outdated.

In light of this changing environment, regulatory locales will become an increasingly important consideration for token issuers as regulators further define the limits of this new financial instrument.

Alternative Routes With The System

Instead of relocating to a different country according to what may be temporarily favorable regulatory sentiment, other entrepreneurs are choosing to remain within highly liquid markets and operate within existing frameworks to obtain their capital.

In one recent example in the U.S., a new healthcare blockchain firm, MintHealth, has decided to use the existing 506(c) solicitation framework and has created what may be a novel structure to entice investment in the firm.

According to its press release, MintHealth (Token: MHST) needs to raise $24 million to develop a comprehensive healthcare wellness system that sells a ‘Vidamints’ token to patients to incentivize them to be more diligent with their medication and behavioral modification.

Accredited investors will receive two elements for their MHST token purchase:

(i) a 10% royalty percentage of revenues generated through the sale of Vidamints by MintHealth, subject to certain adjustments and offsets

(ii) equity ownership in MintHealth

The firm is selling a security token like a ‘stapled unit’ in that it provides not only an equity interest but also a portion of the revenues from the utility token sold to and used by patients.

A ‘stapled unit’ is sometimes used by publicly held firms to combine more than one type of instrument into a single ‘unit’ that may only be transferred as a complete unit.

In this case, the entrepreneurs appear to be combining an equity offering with the potential upside of a utility token to provide investors with a more compelling upside opportunity.

A second alternative route in the U.S. that at least one blockchain team is taking is simply to avoid the general solicitation process entirely and sell interests in the firm to private investors through the tried and true 506(b) sale process.

In this process, entrepreneurs may sell to people or institutional firms that they know directly and who are accredited investors; they may not generally solicit the offering.

In a recent SEC filing, blockchain technology developer Thunder Token disclosed that it had sold $5.75 million via a SAFE, or ‘Sale and issuance to receive future equity and cryptographic tokens via Simple Agreement for Future Equity.’

Furthermore, only six investors participated in the offering, suggesting that it was institutional investors who provided the funding.

Benefits of this more standard startup approach are that Thunder wouldn’t have to spell out its approach in detail to the world via a white paper and it would gain the presumably greater expertise of institutional investors while accessing the capital needed to develop its technology. It also would not preclude selling a utility token once their system is in production.

Many Options Ahead

The above examples are two responses by entrepreneurs as they begin to more thoughtfully approach the many considerations of the evolving landscape for capital formation in the blockchain space.

Over time, as ICOs evolve or become STOs (Security Token Offerings) markets will likely take on the same regional or country-specific characteristics of current global capital formation markets; major countries with the greatest amount of available investment capital available will have an important say in the rules by which issuers will need to operate.

Just as financial markets in Asia operate differently than in the U.S. or Europe, I expect token issuer markets to have different regulatory requirements and standards.

This will likely increase costs for entrepreneur issuers and make choosing a jurisdiction based on regulatory requirements an important part of the token issuance process for startups.

In any event, the environment for token issuers is still wide open for creative entrepreneurs in search of capital.

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