The Importance of Keeping Crypto Crowdsales Accountable

By December 1, 2014Bitcoin Business
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For many entrepreneurs, one of the most compelling use cases of blockchain technology is the potential for it to enable new marketplaces that remove traditional hurdles associated with investing and crowdfunding.

The growing number of public crowdsales has been widely covered as of late. With these crowdsales, companies sell a branded bitcoin fork as a way to finance the early development of cryptocurrency-related projects. The popularity of many of the early crowdsales has sparked a conversation about where the burden of consumer protection lies.

It appears that burden, at least for the moment, falls on the consumer to do their own analysis of a project’s legitimacy, team, technology and likelihood of success.

Despite the current situation, it is inevitable that this burden will, in some form, eventually land on the companies or the platforms that support them.

Legal concerns

Legal questions regarding cryptocurrency crowdsales are uncertain right now. To avoid classification as a security, tokens sold to buyers are often said to represent future access to a company’s technology.

The motivation to participate in cryptoequity crowdsales varies from investor to investor. While some possess a genuine interest in advancing a crowdsale-fueled through their support, other investors simply aim to buy low in order to sell for a higher price.

Yet the nature of how all of these tokens are eventually classified remains uncertain for the time being.

What is often predictable about an industry that lacks legal and regulatory clarity, however, is that the participants in that industry may be tempted to take minimal steps to protect themselves from potential liability. This is not surprising, as establishing measures and policies to protect consumers costs money and affects the bottom line.

Such actions are shortsighted. Regulation, particularly in the financial services industry, is generally a reaction to current problems in the market.

Rules are written to address problems that exist. Therefore, how an industry conducts business today has a direct result on how that industry will be regulated and required to conduct business in the future.

Prepaid cards

The prepaid card industry is a good example of how this battle between innovators and regulators has played out in the past.

Prepaid debit cards are a fast-growing form of non-cash payment. For years, particularly in the early to mid-2000s, prepaid card programs were largely unregulated and issuers were able to essentially write their own rules.

Card programs imposed fee structures that punished cardholders for inactivity, charged them each time the card was used and allowed for premature expiration if the card was not used regularly.

These fees were included in card agreements that accompanied the physical cards. However, the terms were often printed on inside packaging and not accessible to a consumer prior to purchase.

As the prepaid card market developed, legislators took notice of the developing industry problems and began crafting laws to address them.

A formal reaction came in 2009 with the passing of The Credit Card Accountability Responsibility and Disclosure (CARD) Act.

The CARD Act restricted dormancy or inactivity fees and prohibited expiration dates of less than five years. The fees imposed also were required to be conspicuously stated for the consumer to easily understand.

Although consumer advocates still warn of high fees, there are proudcts in the market that reat well. Source: Consumer Reports
Although consumer advocates still warn of high fees, there are prepaid cards in the market that rate well. Source: Consumer Reports

This type of consumer protection will be required for cryptocurrencies where fees are not obvious. This will affect cryptoequity and the onramps to it, including bitcoin debit cards, bitcoin ATMs and wallet services.

Wall Street

We saw a similar reaction from legislators after the 2008 financial crisis. Wall Street was overleveraged and deeply entrenched in an experiment with exotic financial products.

When the markets went sideways, the walls came crashing down. Given the far-reaching consequences of the financial panic – and the public uproar that followed – the federal government was compelled to take some form of action.

This resulted in the Dodd-Frank Wall Street Reform and Consumer Protection (Dodd Frank) Act, which sought to bring about increased transparency to the derivatives markets and reduce the amount of speculative investments on large-firm balance sheets.

Though imperfect by some measures, the law indicates a congressional interest to legislate previously untouched sectors of the US economy. The cryptocurrency industry is not immune from the tendency of the federal government to investigate – and create rules – for new and controversial financial systems.

The major Wall Street banks were way too overleveraged prior to the 2008 crash. Source: Wikipedia
Many Wall Street banks were overleveraged prior to the 2008 crash. Source: Wikipedia

Regulators have already targeted companies in the crypto space, efforts fueled largely by the consequences of mismanagement.

It can be argued that at least some portions of the New York Department of Financial Services' proposed BitLicense program were inspired by the shortcomings of Mt Gox and other first-generation virtual currency companies.

These companies lacked adequate compliance programs, measures to combat security breaches and fraud and disaster plans. Emerging bitcoin industries such as crowdfunding with cryptoequity would do well to get ahead of regulatory issues.

Reaction is inevitable, but not imminent

History tells us that, like with prepaid cards, investment banks and first-generation bitcoin companies, a regulatory reaction to crowdsales is inevitable, but probably premature today.

Each of these industries operated for years without interference from the government.

Legislators need data points and there aren’t enough yet. Crowdsales are in their infancy, and more issues will be exposed as the market matures.

In the meantime, crowdsales desperately need some adult supervision, and it must come from within. The leaders in this space – highly publicized projects raising money via crowdsale and the platforms that support them – need to lead by example.

The bar has been set – projects like Ethereum have invested impressive amounts of time and resources to ensure that the formalities of a typical financing were not lost on the informal nature of a crowdsale. Most of these efforts were dedicated to informing the market; educating them on both the product and the potential risks.

Crowdsales have already generated tens of millions of dollars for their respective projects and this industry will only continue to grow as more technology projects seek non-traditional forms of financing.

Setting a good precedent now may inspire these future crowdsales to follow suit. It's becoming easier for consumers to identify and avoid crowdsales that disregard a framework adopted by a majority of the market, so it's in the best interest of everyone involved to keep each other honest.

This article was co-written by Andrew Beal, an attorney at Crowley Corporate Attorneys in Los Angeles. Andrew represents virtual currency companies, has been a strategic advisor to several successful crowd sales, and is a frequent speaker on the surrounding legal issues.

Disclaimer: The views expressed in this article are those of the author(s) and do not necessarily represent the views of, and should not be attributed to, CoinDesk.

Image via CoinDesk

The growing number of public crowdsales has been widely covered as of late. With these crowdsales, companies sell a branded bitcoin fork as a way to finance the early development of cryptocurrency-related projects. The popularity of many of the early crowdsales has sparked a […]

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