The Philippine Securities and Exchange Commission (SEC) has recently said that it will soon promulgate its rules on Initial Coin Offerings (ICO). SEC Commissioner Ephyro Luis Amatong was quoted in a news report that regulating ICOs will allow smaller companies to raise funds safely.
I am very much in favor of regulation. The step taken by the SEC should be lauded as it eliminated the regulatory impasse surrounding ICOs. In the draft, the SEC has not banned ICOs but will require substantial documentation from the issuer – the company raising funds via an ICO. However, it is apparent that startup companies and small, medium-sized enterprises (SMEs) may find it more challenging to raise funds through an ICO and quickly grow their businesses.
The draft rules require the proponent (issuer) to undergo an initial assessment to determine whether the cryptocurrency or token that will be issued is a security. The definition provided in the draft basically defines all types cryptocurrency or token issuance as security. After the initial assessment, the prospective issuer will have to register the ICO with the SEC.
The documents to be submitted for review include a comprehensive prospectus, a whitepaper, an operations manual, certificate of incorporation, curriculum vitae of the team members and advisors, legal opinion on the legality of the security tokens, applicable permits and licenses from other government agencies, legal opinion on the tax implications of the proposed ICO, escrow agreement with an independent escrow agent, copies of material contracts entered by the issuer, evidence of financial capabilities of the issuer and team members, bank account certification of team members, code audit report, comparative annual audited financial statements, corporate income tax returns, board resolutions related to the ICO, manual of corporate governance, and payment of applicable fees. After registration, the issuer should also comply with subsequent periodic reporting requirements. All of these requirements apply to both foreign and domestic ICOs.
As you may deem from the above requirements, an ICO has been considered to be similar to the traditional fundraising methods employed by large companies raising billions of pesos. For most startups and SMEs, the requirements for assessment and registration can be very tedious considering that the amounts raised by these companies are relatively less substantial. The requirements, aside from time-consuming to fulfill, can be costly.
Most startups have chosen ICO as their preferred means to raise funds just because it is a lot easier and faster. Simply put, ICOs are a lot better option than a lengthy and expensive Initial Public Offering (IPO). Startups want their fundraising to be done quickly to test, validate, and scale their business model so that many more people can use their technology as soon as possible. They don’t need so much cash but they do need a small capital push to become massively successful.
It seems that all ICOs, regardless of size, reputation, potential, and novelty of the ICO project, will be treated the same under the new rules, which is a very dangerous assumption. A ₱1 million ICO is not the same as a $20 million one.
The draft rules, when promulgated, can significantly limit the number of innovative companies who would want to tap into the benefits of an ICO. I fear that excessive regulation can reduce the interest on ICOs as a highly-efficient funding mechanism, increase the proliferation of ICO black markets, encourage “loopholing” or the use of legal gray areas to avoid compliance, discourage capable small and medium-sized entrepreneurs from considering blockchain technologies in their businesses, encourage non-registration of ICOs and/or lead to companies leaving the country to look for jurisdictions with ‘friendlier’ regulatory environments; instead of promoting innovation, investor protection and ease of capital flow.
An Alternative Perspective
I believe the key to reducing the number of scams and irresponsible ICO issuers in the market is to make it easy for the regulator to monitor these ICOs. Thus, I offer my humble suggestion on how to regulate ICOs.
Risk-based Approach. Registration and compliance of startups or blockchain-enabled companies should not only be primarily based on historical documents but also on the risk that it poses to the investing public. Historical documents often do not indicate or lead to the success of the ICO or guarantee investor protection. I suggest that there should be different registration requirements and levels of compliance required depending on the size and scope of the token sales.
Multi-sectoral Approach. I suggest a multi-sectoral recommendation committee composed of various government agency representatives (SEC, BSP, DTI, DOST, DICT, etc.), industry representatives, and knowledgeable academicians who will assess the legality, technological viability, and economic potential of an ICO project with just a whitepaper and other information materials. This will encourage entrepreneurs to submit whitepapers to the committee and seek counsel from this committee without fear of being rejected.
If the committee finds the ICO project viable, they would recommend to the regulator the special registration of the token sales depending on the size of the company, scope of the token sale, and funding requirements. This would also encourage a risk-based approach to regulating ICOs instead of having one common standard for compliance.
This process can significantly reduce the workload of the regulator by allowing a team of experts to review not only the legal aspects but also the technological viability and potential of an ICO project. This also streamlines the processes of the various government agencies towards regulating token sales. It is better to encourage compliance rather than to cause industry participant to resent regulation.
Principles-based Approach. The regulation should also follow a principles-based approach which can make it more robust and flexible. A principles-based regulation provides guidance that can be applied to the infinite variations in circumstances that arise in practice. Such an approach can prevent the development of a mechanistic, “box-ticking” approach to decision-making and the use of legalistic loopholes to avoid compliance. It is essential that the ICO regulation can cope with rapid changes in the blockchain/cryptocurrency ecosystem which continues to evolve at a pace faster than other emerging technologies.
Regulation plays a crucial role in the healthy functioning of an economy. It just needs to cope up with the changes brought about by technology and be flexible enough to allow fundraising companies to grow and the emerging market to mature. Imposing excessive requirements on technology-driven fundraising can stifle the growth of industries and can cause a serious adverse effect on the country’s economic competitiveness.