VCs sour to ICOs as the SEC takes notice

Initial coin offerings have become controversial enough for the Securities and Exchange Commission to weigh in. And even though the commission has not announced a clear stance, technology investors are noticing a difference in its actions.

ICOs had an explosive year in 2017, boosted by investments in infrastructure, finance, data storage and payments. But the ICO market started to slow in 2018. Part of the problem is the boom in ICOs in 2017 was marred by fraud and poor business practices. That invited comparisons to the early days of bitcoin as a risky alternative currency that criminals used to hide their activities.

“We’re not thinking about [ICOs] as much,” Aileen Lee, founder and partner at Cowboy Ventures, said during TechCrunch's Disrupt San Francisco event. “There are a lot of people that have gotten burned … people want to work on ‘real’ projects.”

David Paul Morris/Bloomberg

After a rash of poorly constructed and fake ICOs, the SEC has started to crack down on the crypto token offerings. Beyond protecting investors, the commission wants to gather information on how ICOs are structured and sold, and also to constrain false marketing.

“We have brought significant enforcement actions in this space,” said Jina Choi, director of the SEC’s San Francisco regional office, during Disrupt.

The SEC has suggested ICOs should be treated as securities, which would place them under far greater scrutiny, though it has not issued a formal ruling on that matter. The SEC’s standards for what constitutes a security, the “Howey Test,” are normally based on whether an offering involves an investment of money in a common enterprise with an expectation of profit that comes from the efforts of the offering’s promoter.

That sounds like the goal of most ICOs, but the token sales often span countries, making them tough to regulate. And not all tokens are designed to be investments, but are focused on improving processes.

“It has been in the news a lot, but it’s an area that we have approached thoughtfully,” Choi said.

Beyond the legal challenges, ICOs are also not an easy win for investors. About half fail, and by some counts only one in five ICOs are legitimate. That suggests most ICOs don’t have a solid plan for the business the ICO claims to support.

“There are still token sales going on, but what people found in that first craze is this job [tech venture capital] is really hard,” Sarah Tavel, a general partner at Benchmark Capital, said during Disrupt.

Blockchain has economic incentives, but it’s not sufficient as a standalone product to build a successful venture, according to Tavel. “You need a company around the investment, you don’t just need code,” she said.