Author: smogbar

Who determines a blockchain’s DNA? Who has the right to make decisions, and how is this right implemented in reality? More specifically, what is a blockchain’s system of governance, or “who guards the guards?”

Can blockchain technology enhance agricultural supply chains for small business farmers? A look at the issues, opportunities, and projects working to ensure the future of agricultural supply chains and small-scale farmers.

Don’t worry about the bear market. As an emerging technology, blockchain is on a typical journey to maturity and mainstream adoption.

Security Token Offerings (STOs) are the latest hype in the crypto community. Go to any conference and I guarantee you’ll hear one of the following statements.

Really?

I’m calling BS on all of it. Well, most of it, for now, anyway.

To be clear, I’m not anti STOs. I understand they could one day open up new untapped investment pools, bring more liquidity to the economy, make capital raising easier, faster and cheaper, and provide retail investors access to a new investment class.

That’s all great stuff, but people in the crypto community are running around acting like STOs are a workable, feasible and practical option today. Nothing could be further from the truth.

Hidden in plain sight are major structural challenges which put the viability of STOs and the benefits they are said to provide into serious question. Get ready because in 2019 this delusional STO hype is going to be met by a cold, hard, and highly regulated reality.

What is a Security Token Offering (STO)?

Let’s get on the same page about what we’re referring to here. A Security Token Offering (STO) is a regulated public securities offering of equity in a private company. When conducting an STO, a company issues equity tokens to investors which are legally binding investment contracts that represent the ownership of equity in a company, dividends, voting rights and more.

Rights are programmed into token smart contracts which are designed to enable the automated execution of these rights. This differs from an ICO utility token offering where contributors do not acquire any rights or equity in a company, rather future access to a product or service.

STOs do not beget liquidity

There are many people who seem to think that STOs result in the spontaneous, magic- like emergence of liquidity. In private markets, especially with small and micro-cap issuers, liquidity is very difficult to create. Not only will issuers have a tough time attracting investors but investors will also find their tokens have almost ZERO liquidity.

There are no secondary markets

No secondary markets exist to buy and sell security tokens, and this might not change for some time to come. Well, that’s not exactly true. There is a handful, but they have little to no volume which defeats the purpose of having them in the first place.

The reason for the lack of exchanges is that in most jurisdictions obtaining a license is difficult and compliance is a costly nightmare. Exchanges must adhere to rigorous and continual checks, reporting, KYC and much more. Meeting all the requirements is just too complicated, costly and risky especially when taking into account that several licenses may need to be obtained and different regulation sets adhered to in each and every jurisdiction of operations (national and international).

Traditional stock exchanges like NYSE or NASDAQ are not yet offering securities tokens because they lack the infrastructure for blockchain based digital assets. What’s more, in the US, these traditional exchanges are the only exchanges that enjoy a pre-emption of state blue sky laws. For the reasons listed above it would only make sense to set up a security token exchange on a national exchange or maybe an ATS that offers this benefit otherwise registration is required in each of the 50 states.

Adding to these complexities is the fact that other regulation sets may also apply in addition to securities regulations. For example, an exchange contemplating using security tokens denominated in cryptocurrency must abide by a whole different set of rules which apply to the transfer of cryptocurrency. In New York, this would be a Bitlicense.

With only a few exchanges that feature little to no trading volume, why would any investor want to purchase security tokens? For the possibility that maybe sometime in the future a market will exist with sufficient trading and demand?

There are no liquidity providers

Even if exchanges existed to trade security tokens that wouldn’t be enough to create adequate levels of liquidity. The creation of true liquidity also requires an infrastructure of liquidity providers. This is different to exchanges which can be thought of as trade facilitation platforms. Liquidity providers are the researchers, analysts, and salespeople who call customers to create buy orders to offset sell orders at the point in time they are required. They can be thought of as liquidity matchmakers.

“Tokenizing securities is not a magic recipe for liquidity. Tokens can be equally illiquid as their legacy digital or paper certificates. Tokens do not beget liquidity. Technology does not generate liquidity. Buyers and sellers create liquidity.” – Matthew Finestone

What’s important to understand here is that creating liquidity is a people-intensive endeavor. Doing an STO doesn’t nullify this fact which means that without liquidity providers equity tokens are highly illiquid.

Investor demand is probably overblown

One of the major selling points of an STO is that it enables global access to the holy grail of investors – the unaccredited retail investor. While this isn’t currently true, let’s pretend it is. Is there really a demand for security tokens on main street?

Let’s remember that there is a market today where retail investors can invest in their favorite companies like Apple, Facebook, and Nike quite easily, yet most people don’t. If most people don’t even buy stock in the brands they know and trust, what would have us believe they will buy stock in a small private company they have never heard of?

STOs don’t offer easy access to a global pool of investors

If a project registers and adheres to securities regulations in one jurisdiction it doesn’t mean they can offer their security tokens anywhere in the world or even country-wide. It certainly doesn’t mean that retail investors can be sold to either.

An STO can only be registered and sold in jurisdictions that allow the crowdfunding of equity; otherwise, it’s illegal to do so. When dealing with a security, a company cannot even begin to transact until they have the regulatory licenses and provisions in place in each jurisdiction they wish to operate or qualify for an exemption.

Herein lies the problem. Regulations differ substantially from country to country making for nightmarish and costly regulatory upheavals. For example, most jurisdictions have tough restrictions on who can purchase securities. Tough and divergent regulations make it really difficult and costly to tap into a global pool of accredited investors and, for the most part, put retail investors entirely off-limits.

A US-based example & fragmentation in Asia

If you’re a US-based company and abide by Reg S, a US securities law that allows companies to raise funds in foreign jurisdictions without breaking any US securities laws, there is nothing in this regulation that says anything about foreign securities laws in overseas jurisdictions.

So, yes, while it’s possible to offer tokens in foreign jurisdictions, US-based projects will still need to understand and abide by local securities laws. There is a considerable risk that local laws will be violated by incorrectly assuming Reg S enables securities to be sold to any investors in overseas jurisdictions carte blanche.

There are also grey areas as to what it means to be outside US jurisdiction anyway. Even if you fall outside a jurisdiction, regulations in the US can be interpreted in different ways. For example, having an offshore issuer may not alone mean a project is outside the US for securities law purposes. In a recent case, a court looked at where the validation nodes were located among other things.

In Asia, regulations around STOs are fragmented and dependent on what country you operate in. Like in the US, there are no specific regulatory exemptions tailored to STOs so companies must go through existing securities frameworks or work within exemptions. In Hong Kong, institutional investors can invest in STOs that are registered and compliant with regulations. In Singapore, a strict securities regulatory framework exists supervised by the Monetary Authority of Singapore (MAS) which has its own set of rules and exemptions while in China STO activities are illegal.

It’s a regulatory jungle out there

Claims that STOs offer easy access to a global pool of accredited investors is not true. In fact, the reality may well prove to be the exact opposite for small and mid-sized companies because complying with each jurisdiction will prove way too costly and complex. These costs and complexities lead to risks that startups and even mid-sized companies cannot handle and frankly make the entire STO endeavor not worth it. There is no access to a global pool of retail investors either because regulations in many jurisdictions explicitly prohibit this.

Nobody knows what the future holds but there is no sign of anything close to a global convergence of securities regulations. We’re in the early days, so regulators will be evolving and playing catch up for many years to come.

STOs don’t make fundraising easier and cheaper

Beyond compliance which requires an extensive amount of investor protections, financial reporting, KYC, AML procedures, and other tasks, there are several stakeholders that security token issuers will have to work with such as bankers, lawyers, accountants, exchanges, and custodians (read money sucking intermediaries). These intermediaries do things like underwrite deals and solicit investor interest in a compliant manner.

Companies with minimal funds, experience, and know-how will find it almost impossible to conduct a compliant STO on any sort of scale because the more jurisdictions an STO is offered, the more intermediaries, regulatory complexities, and costs increase.

If this were not enough, there is a lot of regulatory greyness which increases the risks of doing an STO as well. Here’s just one example. Because the tokens offered are regulated securities, does that mean every time it moves on a blockchain it counts as a securities transaction? If this is true, do blockchains need to be registered as some sort of trading venue to facilitate all the securities transactions?

There is also the business side to consider. Who’s going to attract the investors to this new form of investment? What’s the value proposition? STOs are no different from any other method of raising capital in this regard. Companies will have to solicit within the laws and have marketing spend to attract investors in traditional ways. They will have to push a hard sell because most investors will only come when there is true liquidity which doesn’t exist at this time.

Regulatory exemptions don’t necessarily ease the pain 

Companies conducting an STO will no doubt target an exemption to ease their regulatory burdens. Exemptions do offer benefits, but they come with challenges as well. For example, in the US, tokens can be issued under Reg D, Reg A+ or CF. Reg CF caps the amount that can be raised and the amounts each investor can contribute. Reg A brings higher disclosure burdens, and a stricter qualification process and Rule 506 of Regulation D has an accreditation threshold.

Many exemptions also have a lock-up period for up to 12 months which can cause significant challenges for investor liquidity and thus the attractiveness of the investment in the first place. Offering the tokens in multiple jurisdictions also requires qualifying for multiple exemptions which require a deep understanding and the correct navigation of foreign regulation sets.

The point is, offering security tokens come with a whole lot of follow on implications and challenges, whether a project qualifies for an exemption or not.

Technology stacks might be incompatible with regulations

Thus far, for the most part, the majority of teams in the tokenized securities industry are building on top of the Ethereum blockchain as it is the most well known smart contract platform with decent levels of functionality. They are adding layer 2 solutions with different privacy features.

This approach may backfire because these solutions need to work around the limitations of the base protocol which are already built with some kind of concept in mind. Ethereum is an open and transparent ledger which is a problem as confidentiality is often a significant requirement for regulators as well as businesses. The blockchain infrastructure used by a project must adhere to confidentiality and accountability requirements set out in securities regulations to have any chance at offering a compliant STO.

If one of the main goals of putting securities on a blockchain is to take out the intermediaries in the heavily regulated securities market without losing regulatory approval, can this be done with current platforms like Ethereum? Do newer security token platforms understand the regulations? What if they break securities laws, who gets the blame?

Some projects are working on unique blockchain infrastructures to launch regulation-compliant tokens but which regulations will they base their platform on? How will they enable global STO offerings which must comply with different securities laws? How can a blockchain platform adhere to divergent securities regulations and what happens if/when these rules change?

There are also issues about how to regulate and verify a systems-based response to the acquirement of an asset. This is not just about immediate and once off verification. It’s about ongoing compliance and showing this compliance. How will this be built into a blockchain? How will intermediaries and regulators interact with these systems?

With regards to smart contracts, regulators are going to want to know what kind of testing has been done and is this testing being done on an ongoing basis? These are just two of the most straightforward questions surrounding the application of the technology. And what about the question alluded to previously. If a token is a security, does that mean every time it moves on a blockchain it counts as a securities transaction? If this is true, do blockchains need to be registered as some sort of trading venue to facilitate all the securities transactions?

There are simply too many unanswered questions that will take time to resolve. However, it would be reasonable to conclude that projects will need to have the technology stack that facilitates their STO approved by regulators prior to an STO launch. Taking all of these complexities into consideration, do we really think 2019 will be the year of the compliant STO?

A cold, hard, and highly regulated reality awaits

Many proponents of the security token offering fail to consider a seemingly obvious fact. STOs do not exist in a vacuum. Instead, they must fit in with a highly regulated financial world built up over decades. A world that features lots of moving parts, legacy systems, intermediaries and powerful incumbents with vested interests all of which have been designed around these established sets of regulations.

It is precisely these realities, the infrastructure of entangled, technologies, regulations and supporting human elements that make changes, especially significant changes, so hard to realize. And it leads me to my sobering outlook on the viability of STOs in the near term.

“We always overestimate what we can accomplish in one year and underestimate what can be accomplished in 10 years.”

Of course, the existence of these regulatory and technological challenges won’t stop the STO hype train from ratcheting up another gear or prevent investment from flowing in. The crypto community loves a good dose of hype and will no doubt continue to underestimate the cold, hard, regulated reality that awaits.

Did you enjoy the article? Please take a quick moment to share it with your network. Also, if you have any questions or would like to connect you can find me on Twitter or email me at [email protected]  I’m always interested in meeting people working, learning, or involved with the blockchain space.

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Also published on Medium.

I’m always interested in meeting blockchain startups or talking to Developers who are creating innovative products, so please feel free to contact me on LinkedIn, or by email at [email protected]

Collin Thompson is the Co-founder, and Managing Director of Intrepid Ventures, a blockchain startup and innovation studio that invests, builds and accelerates Blockchain companies solving the world’s most difficult problems. Collin focuses on early-stage investments, innovation and business design for corporations, governments, and entrepreneurs working with blockchain technology.

Also published on Medium.

After many years of crisis, scandals, low growth rates and declining customer satisfaction, there are compelling reasons for the radical transformation of insurance services to occur. There are also powerful arguments as to why these transformations will need to begin in the emerging economies of Asia.

The case for change

For industry, nations, and consumers the transformation of insurance is more critical today than ever before.

For industry

Limited growth in mature markets and pressures to reduce costs are taking a toll on the insurance industry.

Armed with outdated IT infrastructures, insurance providers have little capacity to reduce spiraling administrative costs or develop cost-effective services for low-income developing markets. Companies remain helpless to increase their customer base or meet internal growth targets.

Restrictive IT infrastructures have led to poor customer engagement and ineffective fraud detection methods and pricing structures as well.

“So far the industry has been perceived to be fairly reactive to technology, to have issues with IT prioritisation and implementation, and ultimately to be relatively slow to innovate and change.”[1]

The time has arrived to overhaul the legacy IT systems that continue to cause significant inefficiencies and increased risks.

Seeking out transformational technologies that reduce inefficiencies and enable the delivery of innovative products and services to untapped developing markets around the world is now critical to future competitiveness.

Forget “first the west, then the rest”, it’s about “the rest, then the west”…

It’s important for companies to understand that technology adoption is no longer the exclusive domain of consumers in the West. Technology adoption today often begins in emerging economies and then flows to the west.

Out of the world’s developing economies, the emerging economies of Asia represent an unprecedented opportunity to experiment with low-cost innovation and open regulatory frameworks.

They also represent a vast customer base hungry for new services. Companies that are able to deliver micro-insurance services have the opportunity to tap into these vast markets.

A “first the rest, then the west” approach is now an imperative for future innovation, growth, and success.

For nations

For the hundreds of millions of low-income residents in the emerging economies of Asia, from Indonesia and the Philippines to Cambodia and Vietnam, access to formal financial services, especially insurance, remains extremely low.

Without the ready availability of insurance products and services to all segments of society, the economic progress made by individuals in these and other nations will remain tenuous, and future economic development will be limited.

Insurance plays a key enabling role in wealth creation, and economic growth as coverage is a prerequisite for financial institutions to offer many other types of financial services.

Governments must, therefore, begin to lay the regulatory foundations for the future proliferation of micro insurance services if they are to realize their nation’s financial inclusion targets and overall potential in the new innovation-based economy.

For Consumers

In most of the emerging economies of Asia, insurance coverage remains rare.

In fact, according to the Asian Development Bank, insurance penetration in Indonesia, Cambodia, and Myanmar is almost non-existent.

In the Philippines, insurance penetration is estimated to be around 4%, relatively high when compared to Indonesia where 1% of insurance needs are currently met.[2]

There is now widespread recognition from those in the development sector that insurance is a vital financial service to help people climb out of poverty, manage various risks and protect valuable assets.[3]

The continued absence of viable products and services means that the livelihoods of millions of individuals continue to remain uncertain.

“Insurance can protect the poor against losing their livelihoods and assets due to natural disasters or sudden illness thus preventing them from falling back into cyclical poverty.” [4]

For the small minority of these populations lucky enough to have access to insurance services, low levels of transparency, fairness in charges and claims handling and a severe lack of consumer protection is a significant problem.

Individuals with limited education and familiarity with complex insurance products remain at risk of exploitation unless insurance providers can simplify their offerings and realign their incentives.

Several problems, one corrosive root cause

Over the last decade, a dramatic shift in trade power has taken place away from the advanced economies in North America and Europe to the emerging markets of Asia. [5]

From nations like China that have developed at a rapid pace to countries that are at the beginning of their economic development journey like Myanmar, the emerging economies of Asia are now a vital part of the world economy.

But offering services to these low-income markets in Asia has remained entirely out of reach for most insurance companies. This despite the massive growth opportunities and a general awareness of the importance of these markets among industry executives.

Why?

The answer is surprisingly simple and can be traced to a single, yet highly corrosive root cause.

Fragmented, old-world IT systems and siloed record keeping infrastructures that lack basic levels of interoperability.

It is the outdated systems utilized by most insurance providers that are creating the spiraling costs and crippling inefficiencies which have in turn prevented insurance companies from developing cost-effective micro-insurance services for low-income customers in the emerging economies of Asia.

Simply put, without the transformation of these systems, insurance companies will become increasingly inefficient and remain unable to access vital growth opportunities.

A devastating flow on effect

Sky high administrative costs & backend inefficiencies

Administrative expenses and backend inefficiencies are crippling the insurance industry. With complex contracts between multiple stakeholders that need a significant amount of human processing, the administration of insurance has not only become expensive but highly inefficient as well.

Underwriting and claims settlement, two critical processes conducted by all insurance companies today involves the time-consuming and often inaccurate evaluation of information.

After a claim is registered, an astonishing variety of tasks must be completed. These include but are not limited to, the retrieval of supporting documentation, performing fraud detection checks, determining which party is liable for the damage, determining the amount of the claim, and communicating back and forth with the customer and other parties involved.

Processes are slow, manual, paper-based, repetitive, expensive and also prone to errors and duplication.

Inefficient client onboarding and compliance processes

Insurance companies must complete several compliance related steps which create significant time and cost delays as part of the onboarding process for new clients.[6] These include the collection, validation, and verification of key documents such as proof of identity, proof of address and proof of birth.[7]

Compliance officers must also manually check and share enormous amounts of data with third parties and internal due diligence teams which can take a considerable amount of time to complete. [8]

Vast resources are spent by companies to fix needless errors during the compliance process and reconciling data sets across departments and external intermediaries is a massive headache.

Ineffective fraud detection

It is estimated that $45 billion is lost annually to insurance fraud with approximately 65% of fraudulent claims going undetected.[9]

Fragmented and siloed record keeping practices together with record systems that lack basic levels of interoperability have led to a severe lack of advanced data available for risk analysis for fraud detection.

Legacy systems prevent risk and compliance teams from gaining a systemic view of transactions and a complete historical record of a customer, limiting their ability to identify duplicate transactions or those involving suspicious parties.[10]

With a limited ability to detect fraudulent activities, insurance companies must deal with greater risks and expenses and charge higher premiums to their customers.

Blockchain replaces fragmented and siloed record keeping infrastructures with a unified platform

If you’re like many insurance executives, you may be wondering what all the blockchain fuss is about. The technology continues to garner endless attention yet there remains a lack of understanding among decision makers within the industry.

Putting the hype and bluster aside, the promise of blockchain lies in its capacity to eliminate the root cause of the inefficiencies that impact the delivery and management of insurance services.

“This technology has the potential to impact the entire insurance value chain end-to-end, including information collection, underwriting, rating, actuarial analysis, quoting, binding, billing, contract management, claims processing, distribution, policy administration and also regulation.”[11]

Blockchain technology offers to rid the insurance industry of the high administrative costs and backend efficiencies that have plagued the insurance value chain.

Labour-intensive, repetitive and error-prone underwriting and claims settlement processes are transformed through the use of a unified platform to store and share all documentation.

“Every personal insurer’s core computer system is, at heart, a big, centralised transaction ledger. At the very least, blockchains deserve to be evaluated technologically by insurers, as a potential replacement for today’s central database model.”[18]

There are significant benefits for compliance as well. Regulators can gain access to full sets of unchangeable data in real time without requiring companies to conduct reconciliation and the collection of detailed information for reports.[12]

With the same data available to all parties, insurance platforms powered by blockchain can experience unprecedented data sharing capabilities and back-end analytics for pricing and risk.[13]

“We believe that blockchain will play a major and disruptive role right across the insurance value chain. From customer onboarding and ‘Know Your Customer’ (KYC) requirements through to claims processing and adjudication, the potential use cases for blockchain in the insurance sector grow each day.”[14]

Detailed audit trails of all past insurance claims can be maintained for risk analysis and fraud detection. Risk teams gain a system-wide view of all their customer’s records to enable not only the identification of duplicate transactions but also those involving suspicious parties.

As a result, long and tedious onboarding and verification processes experienced by legitimate customers can be dramatically reduced.

Smart contracts could change the game

Equally as fundamental to the future of insurance are smart contracts. When run on a blockchain, smart contracts become self-executing contracts where contractual enforcement, rights, obligations, performance, and payment are automatically executed.

By enforcing the rules for insurance claims through code instead of human decision making, event-triggered smart contracts make it possible to automate some types of claims.[15]

“Alongside big data, mobile and digital technologies, blockchain is essential to establishing an efficient, transparent and customer-focused claims model based on higher degrees of trust. Within claims prevention, new data streams can enhance the risk selection process by combining location, external risk and analytics. A distributed ledger can enable the insurer and various third parties to easily and instantly access and update relevant information (e.g., claim forms, evidence, police reports and third-party review reports).”[16]

InsurETH, for example, a company developing blockchain solutions for the insurance industry, built a flight insurance product that runs smart contracts on the Ethereum platform to automate insurance claims and automatically refund users in case of flight delays or cancellations.

By eliminating the manual processes involved in claims management, smart contracts can reduce the costs and time associated with the handling of claims and also disintermediate the claims process.

The use of data from a mobile phone or sensors could streamline claims submission as well.

A report from EY explains,

“The use of data from a mobile phone or sensors can streamline claims submission, reduce loss adjuster costs and increase customer satisfaction, with blockchain systems facilitating communications and coordination among all parties. Consider how sensors can trigger alerts to insurers that a crash has occurred (thereby initiating a new claim), and then route secure and relevant data to preapproved and conveniently located medical teams, towing services and/or repair garages.”[17]

By making the processes associated with the delivery and management of insurance services more accurate, efficient and secure, companies can save money on their service offerings in mature markets and also gain the capacity to offer cost-effective micro-insurance services to low-income markets in the emerging economies of Asia.

The future of insurance starts today in the emerging economies of Asia

The insurance sector has traditionally been slower than most other industries to adapt to change. Decades of neglect driven by conservative and risk-averse cultures have brought the industry to a tipping point.

Outdated systems and IT infrastructures have left insurance companies with gross inefficiencies, high administrative costs and ineffective fraud detection methods.

Insurance companies are failing their current customers and continue to have a limited capacity to develop cost-effective products and services for underserved low-income markets.

With limited growth in mature markets there are now acute pressures to innovate and find new sources of growth.

Insurance executives must come to the realization that band-aid solutions cannot fix the root problems afflicting the industry or meet the challenges of tomorrow.

There is also a need to internalize new realities that have come with globalization and the new digitally based world economy. Economic power shifts in recent years away from the West to the emerging economies of Asia mean that significant growth is no longer found in New York, London or Paris.

Ho Chi Minh skyline – a symbol of economic growth and increasing prosperity in Vietnam.

Rather it is the economies of China, Vietnam, Indonesia, the Philippines and many others that hold unprecedented growth opportunities.

For hundreds of millions of low-income people living in these markets, access to formal financial services, especially insurance has will mean the continuation of real economic growth and formal inclusion into the global economy.

Nations and industry have important roles to play to ensure both financial inclusion and competitiveness.

Governments must lead by example and begin to lay the regulatory foundations for the future proliferation of insurance services. They must also initiate collaboration with the insurance industry to seek out and test new technologies for mutual benefit.

“Like the first generation of the internet, this second generation promises to disrupt business models and transform industries. Blockchain (also called distributed ledger), the technology enabling cryptocurrencies like bitcoin and Ethereum, is pulling us into a new era of openness, decentralization and global inclusion.”[19]

Industry will need overhaul legacy systems and embrace transformational technologies like blockchain that can enable the delivery of cost-efficient micro-insurance services to new developing markets to ensure competitiveness.

A supercharged insurance industry powered by blockchain technology in combination with a modernized regulatory framework will not only lead to critical growth opportunities for companies but also help trigger the proliferation of financial services and drive economic development in the emerging economies of Asia.

Discover how blockchain technology could transform, global supply chains and national healthcare systems.

Anthony is the head of content and research at Intrepid Ventures. He has spent the past several years researching and analyzing technologies and working with a diverse mix of blockchain companies to help them gain insight and develop authoritative content.

Realizing the revolutionary nature of blockchain technology and the existence of a significant knowledge gap among entrepreneurs, industry, and government, Anthony now concentrates his time on creating educational content, researching potential use cases and analyzing the impact of the technology on global industries.

Also published on Medium.

Note: This post should not be considered professional investment advice. If you want to invest in digital assets like cryptocurrency, assess your own personal and financial situation, risk tolerance and consult a financial professional.

Cryptocurrencies have become a significant topic of interest for investors. As with any overly hyped topic, there are polarising opinions and lots of noise, making it difficult for investors to get a clear picture of the risks involved. The truth is, cryptocurrencies are in their infancy and have several significant risks that demand an investor’s attention. Over time, these risks will increase and decrease, and new risks will emerge. If you’re considering whether to add cryptocurrency to your traditional portfolio, here are a few critical risks to examine.

Price volatility & manipulation

Cryptocurrencies have been on a wild ride. Epic booms, busts, wild swings, and scams have amazed and baffled investors who have witnessed unexplainable and unprecedented gains and losses over the last decade.

For example, here’s a coinmetrics chart on the volatility of daily returns (14-day average) comparing BTC (Red) to S&P 500 (Teal). Volatility swings in Bitcoin (BTC) and other crypto assets makes it hard for investors (especially retail investors) to build confidence and secure gains.

Volatility in crypto prices is common and generally stems from three main sources; sentiment, speculation and market manipulation. It’s the unregulated and anonymous nature of digital asset markets combined with the susceptibility of cryptocurrencies and other crypto assets to sentiment, emotion, and publicity that make prices volatile.

Crypto exchanges, media owners, and powerful investors can manipulate prices. This manipulation seems to be widespread – albeit not widely proven yet. The most used manipulation strategies include wash trading, dark pool trading, pump and dumps, and shilling.

Lack of regulations

A lack of regulatory frameworks means there is a high degree of uncertainty like price volatility and manipulation. Investors and entrepreneurs are also concerned about the possibility of future restrictions which may have a significant impact on the value of cryptocurrencies or completely ban them altogether.

For the large part, crypto regulations are complex, disorganised and haphazard. One area of particular concern for investors is tax treatment. A lack of regulation or what some term as regulatory greyness means some investors are scared off investing because they don’t have a clear understanding of what tax obligations need consideration or what actions must be taken and what records need to be kept.

The good news is that regulators are catching up. Authorities in many jurisdictions are taking steps, producing research papers, standards and introducing new regulations. One of the first countries to begin building a robust regulatory framework is Switzerland. The country has proposed an idea for minimising rules while still keeping companies in line with legislation through ‘sandboxes’ allowing startups to experiment and innovate within controlled conditions. Britain and Singapore have been exploring their blockchain and crypto regulatory environment as well, providing platforms which enable companies to experiment under relaxed regulation and licensing requirements. In the US, the New York Attorney General’s Office recently launched the most comprehensive study on exchanges.

Market adoption

Thanks to a market downturn, the entire digital asset market is worth less than McDonald’s. But even before the 2018 slump, the crypto market relative to other markets like currency, gold, stock markets was vastly smaller.

Market adoption remains low for a host of reasons from regulatory concerns and technology shortfalls to market volatility, public misunderstandings and the fact that cryptocurrencies and the underlying blockchain technology that powers them are still emerging and in their infancy. This means there’s a chance that this new asset class, impeded by many different factors, regulations being one of them, will never be broadly adopted, leading to a complete loss of value. There is a clear need for more regulations, technology improvements and institutionalisation to help drive trust and scale.

Security, custody & consumer rights

Storing cryptocurrencies and other crypto assets can be risky business. There have been significant incidents of theft on personal wallets but also on exchanges. Hacking remains a constant threat if cryptocurrencies are not correctly stored and protected. To make things worse, assets that get lost or stolen cannot be recovered, and mistaken transactions cannot be reversed. Also, unlike traditional investing through a bank or brokerage, cryptos don’t have official safeguards or insurances. Rebates on lost investments depend on the whim of the organisation you’re dealing with.

The good news. Custody solutions which give financial institutions the ability to hold cryptocurrencies on behalf of trading clients are beginning to emerge. This is expected to catalyse the entry of institutional capital into the industry and in-turn provide a trusted stamp of approval for retail investors as well.

Coinbase has announced its custody product upon completion of their first successful deposit. The multinational investment bank, Citigroup, has announced that it will offer crypto custody solutions to institutional investors. Citigroup launched a product called Digital Asset Receipt, intended for institutional investors to securely invest in cryptocurrencies in a regulated and secure manner. There is also Fidelity, which has announced a new and separate company called Fidelity Digital Asset Services. The Wall Street incumbent will handle custody for major cryptocurrencies such as bitcoin and execute trades for investors such as hedge funds and family offices.

Exiting the market

The crypto market’s off-ramps are a real problem for many investors. Many exchanges only allow withdrawals in USD, some also allow EUR, GBP, and JPY, but the choice is minimal, and exchanges frequently require high minimum withdrawals when withdrawing to fiat. Lots of exchanges that support fiat withdrawals also only accept a few leading cryptocurrencies and to withdraw fiat money, investors need to go through a tedious verification process that can take months.

Some exchanges have also been accused of withholding funds for unclear reasons, and many banks are still very wary of accepting money from the sale of cryptocurrency. All this exposes investors to exchange rates, fees, and risks associated with dealing with opaque exchanges. The situation is improving, but it’s far from ideal.

Did you enjoy the article? Please take a quick moment to share it with your network. Also, if you have any questions or would like to connect you can find me on Twitter or email me at [email protected] I’m always interested in meeting people working, learning, or involved with the blockchain space.

Anthony is the head of content and research at Intrepid Ventures. 

Also published on Medium.

This article on ICO law is part of our “How to Launch an Initial Coin Offering” comprehensive guide. If you are interested in understanding all the necessary aspects involved in launching an ICO and are looking for a deeper ICO checklist we recommend you download our guide here.

The fast pace with which the blockchain space has moved has made it very difficult for legislators to keep regulations relevant and up to date.

The absence of ICO-related regulations, however, does not mean that blockchain startups and their ICOs are exempt from the law. It is quite the opposite. Teams that decide to run an ICO should be extra careful and determined to be compliant to avoid inadvertently committing any offenses.

Below you can find a series of aspects you need to understand before you launch your project or ICO. This will require seeking advice and counseling from professionals who can help you better define some of these matters.

Corporate formation

One of the legal matters that must be navigated relates to what kind of structure will be chosen for the project. If you have not decided on the structure of your business, you might fall into a default general partnership, where all founders would be operating under full personal responsibility for all actions performed during the business.

One of the most common practices when doing an ICO is to separate the operating entity from the token issuer company. This is done for several reasons including separating legal liability and also choosing different business entity types according to the function of each entity. For example, foundations and trusts are commonly used entities to run ICOs but are not the best option to operate a business.

One advantage of such a separated structure is that the two entities may be located in different jurisdictions. Your operating entity could be located in almost any jurisdiction without any risk as long as you abide by the current legislation. On the other hand, for your token issuer company, you might want to choose the jurisdiction with more friendly or flexible legislation. You can find more about these in the next sections.

NOTE: When running an ICO what typically matters is where the investors are located and not where the issuing entity is. You should consider this when you decide what investors you will whitelist for your sale.

How to choose the right jurisdiction

Even though legislation continues to lag behind the industry, many national authorities have begun to issue guidelines for ICO investors. While these guidelines are not 100% ideal, they should be seen optimistically, as progress of a kind. It is essential to understand that they are being developed with investor protection in mind, and with a desire to make the space more transparent.

That said, regulations and guidelines vary significantly between jurisdictions. They depend on several factors such as how authorities perceive cryptocurrencies, securities laws, consumer and investor protection laws, AML regulatory frameworks, and on the jurisdiction’s willingness to promote blockchain innovation.

Many jurisdictions are trying to attract progressive entrepreneurs to their territory and are quite open to helping you succeed. Below you can find some elements to look for when deciding on a jurisdiction:

– Cooperation with industry

Some jurisdiction’s frameworks may seem very flexible and work well for traditional industries, but this might not be the case for new and disruptive projects that involve cryptocurrencies.

Look for an emphasis on stimulating innovation, entrepreneurship, and small business growth. Having an open policy and cooperative approach will make a significant difference when it comes to opening bank accounts and getting ancillary business and corporate services.

– Access to legal and industry representatives

Any cooperation to help with setting up an entity or open an account will be to little or no avail if you have no access to legal and industry representatives. Running an ICO will demand a lot of direct interaction with authorities on a regular basis. The jurisdiction you select should provide direct access to an informed representative that you can easily contact to retrieve a quick response.

– Consumer and investor protection

Investors and consumers will feel more secure with their investment in your project if they see you have a regulatory stamp of approval from a jurisdiction that protects their interests. It gives them certainty that you are operating above board and provides a place they can go to argue any grievances should something go wrong.

In general, a regulator’s quality can be primarily determined by how well it protects consumers and investors and how easily accessible they are in the event of a dispute.

– Clear definition of cryptocurrency

A clear definition shows that the jurisdiction is already aware or involved in the industry and probably moving forward with more structured and definitive legislation. A definition may also signal how welcoming a jurisdiction is of “coins” and/or “tokens.” Be sure to read and analyze the definition for these in the jurisdiction you choose.

– Industry Advocacy Group(s)

Any jurisdiction which has an active industry advocacy group working to develop regulations and an amicable environment for blockchain projects should earn a lot of points on your list.

A strong and active advocacy group not only shows that a jurisdiction is robust, but it also provides you with allies and a group with whom to work with on the policies of your company.

– Kinds of corporate formations

Structuring a distributed and international small business is not easy. Making sure that the jurisdiction has the proper legal vehicles for your project is critical. Like we mentioned above, the trend in the blockchain and cryptocurrency industry is to have a foundation as the main vehicle to accept tokens and govern your ecosystem, but this does not mean it is the best, nor the only one.

Make sure to design your business structure with experts in the field to know what your needs will be. Some of the leading jurisdictions for blockchain projects and ICOs are:
– Switzerland – Singapore – Hong Kong – British Virgin Islands – Cayman Islands

– Isle of Man

(As the industry develops these may change a lot with some of these being less friendly and new jurisdictions coming up. Estonia, Belarus, and Slovenia are moving fast to become crypto-friendly countries for example.)

Remember. Even though these jurisdictions are leading the way in many respects, each one will have their benefits and drawbacks. When it comes to choosing a jurisdiction for your ICO, it’s vital to examine what your specific needs are and what you are willing to trade off.

Securities & commodities laws

Despite a large number of legal aspects to consider, the most significant concern for most projects is whether their token falls under the category of securities.

This topic gained particular notoriety when the SEC released an investigative report concluding DAO Tokens were securities, and because so much speculation and uncertainty exists right now, anxiety levels are very high. Nobody wants the SEC calling on your phone.

Most jurisdictions have yet to take a clear stance on whether tokens or which tokens, if any, will be considered securities. In other words, just because authorities haven’t come out yet and said that some specific tokens would be regarded as securities doesn’t mean it will stay this way in the future.

Non-US investors are not subject to US Securities laws, so some ICOs target only non-US investors. But this does not mean they are completely covered as it’s very easy to mask your location on the Internet and not all identity verifications (especially on exchanges) are exhaustive.

One of the most common ways of figuring out if your ICO might be considered a security offering is to run it through the US Supreme Court Howey Test. However, be wary of interpreting these results as definitive. Regulators use several other methods to define your token and even all of this cannot give you a definitive answer.

There are currently several organizations working in the blockchain space to clarify these uncertainties. One such organization is Coin Center – a nonprofit focused on policy issues facing cryptocurrencies. Coin Center has published a Framework for Securities Regulation of Cryptocurrencies and a more specific Securities Law Framework for Blockchain Tokens.

– AML and KYC laws

In almost every legal jurisdiction, no matter what the legal definition of cryptocurrency is, you will almost always be required to abide the financial surveillance laws.

These are better known as the Know Your Customer (KYC) and Anti-Money Laundering (AML) rules. In simplest terms, these are laws that mandate that “financial institutions” (a broad category of businesses offering financial services) must collect and retain information about their customers and share that information with the appropriate regulatory entities.

Regulated entities are traditionally required to collect a government-issued ID + a utility bill for a person, in this case, your customers. However, this may vary according to the jurisdiction you are operating under, and if your entity is considered non-regulated, these requirements could be less.

Your KYC related activities depend on how your token is defined. If it falls under the security category, KYC regulations must be fully adhered to (not to mention many other considerations like making sure purchasers are accredited investors). On the other hand, if your token is considered a utility, legislation tends to be more flexible.

– Crowdfunding laws

Although the concept of ICOs and crowdfunding through tokens is revolutionary, not every aspect of it is entirely new. Some of the problems have been dealt with before.

In mid-2016, the US implemented Title III of the JOBS Act, which legalized equity crowdfunding for non-accredited investors. At its core, it is very similar to what ICOs have come to deliver on: democratize the funding process and allow the raising of funds from a crowd or community and not just a small elite of venture capitalists. Analyzing the crowdfunding laws in the jurisdiction in which you hope to launch is an option.

– Taxation

Specific taxation frameworks on ICOs are still not entirely defined. In addition to this lack of regulation, the fluctuation of cryptocurrencies presents another challenge as to how to run your business.

It’s wise to choose a jurisdiction which provides a favorable tax policy to minimize future headaches. Each jurisdiction, based on their categorization of a cryptocurrency will require you to report tax on either; sales tax, VAT, capital gains, or all of them.

Particularly if you are not running a foundation, a low tax jurisdiction, with a clear categorization of what a cryptocurrency is and how it is taxed, will help the management and accounting side of your project immensely.

– Advertising (of token)

The language you use to refer to your token may have an impact on whether your token is deemed a security. Every promotional material you use for your ICO can and will get examined, so it’s crucial that no language misrepresents your offering.

Jargon and technical language won’t protect you. Everything you write can be scrutinized. (Including, social media, Reddit, messaging apps, etc.).

To protect yourself, be sure to set specific guidelines on how to refer to your token from the beginning and make sure that your team members follow diligently. It is always a good idea to seek the counsel of a lawyer to review all of your promotional documents, your website, token terms, and any other material.

When it comes to the legal aspects of your blockchain project and ICO you can never be too careful. There are many shortcuts and ways to bend the rules, but on the long run, this will mostly generate more problems than solutions.

With new tokens and cryptocurrencies going mainstream, and with the huge influx of money the industry has seen lately, I expect that more and better guidelines and legislation will appear. In the meantime, be sure to comply with the current ones and get professional advice to be in control of all of the above.

Key points:

1. Developments in the blockchain space have occurred more rapidly than most legislators can handle. Hence regulations are not up to date with emerging blockchain business and financing models.

2. While specific regulations are still being developed, founders should be wary and conduct their operations with the utmost care by complying with current legislation as much as possible.

3. The minimum aspects of compliance to be addressed concern corporate formation, securities laws, AML & KYC laws, taxation, and the advertising of tokens. There are, however, many other aspects that need to be examined by founders and professional counsel.

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For more details on each of the steps and more in-depth explanations download our “How to Launch an Initial Coin Offering” comprehensive guide.

If you’re planning an ICO, Token Deck is our Initial Coin Offering solution that makes the ICO process safe, compliant and easy. Check it out!

If you have any questions or would like to connect you can find me on Twitter or email me at [email protected] I’m always interested in meeting people working, learning, or involved with the blockchain space.

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Disclaimer This document does not constitute legal or investment advice nor should be taken as such. You should not rely on it and if seeking to do an ICO or any other related activity you should seek separate professional counsel. It is for informational purposes only. Views do not represent the views of my employer, investors, or partners. Furthermore, the blockchain industry and technology is undergoing constant development so this post is intended as a guide at the current moment of publication and the issues and topics, and therefore the guidance, covered are vulnerable to change and development. The reader should bear this in mind when reading.

Also published on Medium.