SEC: Initial Coin Offerings Must Be Regulated

If you thought a lot of ICOs were limiting US participation due to zealous regulators already, wait until you read the following: SEC has concluded that DAO tokens are a “security,” which should be regulated. The report spends a lot of time establishing that the DAO was in fact a centralized organization, describing actions that run parallel to those of any struggling start-up which has actual control over its resources.

The issue of whether the DAO had sole discretion or full control is important because it then implies responsibility for investor losses as a result of security malfunctions. Legally, it opened up a can of worms, which is why the SEC commissioned the report in the first place. The authors appear to be intimately familiar with blockchain technology, which is refreshing and scary at the same time.

Curators of The DAO had ultimate discretion as to whether or not to submit a proposal for voting by DAO Token holders. Curators also determined the order and frequency of proposals, and could impose subjective criteria for whether the proposal should be whitelisted. One member of the group chosen by Slock.it to serve collectively as the Curator stated publicly that the Curator had “complete control over the whitelist … the order in which things get whitelisted, the duration for which [proposals] get whitelisted, when things get unwhitelisted … [and] clear ability to control the order and frequency of proposals,” noting that “curators have tremendous power.” Another Curator publicly announced his subjective criteria for determining whether to whitelist a proposal, which included his personal ethics.

The ultimate conclusion of the report is that “virtual organizations” and those interested in investing in them should exercise a healthy amount of caution, because some of these newfound securities may find themselves in trouble with the agency down the road.

Whether or not a particular transaction involves the offer and sale of a security—regardless of the terminology used—will depend on the facts and circumstances, including the economic realities of the transaction. Those who offer and sell securities in the United States must comply with the federal securities laws, including the requirement to register with the Commission or to qualify for an exemption from the registration requirements of the federal securities laws. The registration requirements are designed to provide investors with procedural protections and material information necessary to make informed investment decisions.

A perfectly rational argument goes along the lines that since the government is still very new to regulating cryptocurrencies, a reverse innovation effect becomes possible when over-regulation sets in, wherein innovation only happens within the bounds of government mandate. This will retard progress of systems which are intended to improve life and make opaque organizations more accountable. The DAO hack was only the first major hack in a long string of ICO hacks that have happened since Ethereum entered the stage.

The way for this industry to handle the coming horde of luddite regulatory bodies is to make them obsolete before they truly have sunk their claws in. This is to say, the DAO and its “curators” should exercise some of their uncommon power to enforce standards which make these hacks literally impossible. Perhaps not an upgrade to the standard itself, but a new standard altogether by which ERC20 and other smart contract tokens can be tested before deployment.