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Initial coin offerings: tales from the cryptos

Bitcoin and other crypto currencies tend to be regarded with scepticism due to their role in illicit transactions. Initial coin offerings (ICOs) double down on the risk for scams with “investors” able to buy “tokens” to be used in projects. This year $1.3bn has been raised by start-ups in this way.

On Tuesday the US Securities and Exchange Commission declared tokens offered “The Dao” — a business set up to invest in other businesses using digital currency — as securities. This raises the likelihood that more ICOs could be subject to US securities laws. The price for bitcoins and other electronic currencies dropped roughly 10 per cent the day after the decision.

The obvious analogy with share offerings is apt. Electronic “share” tokens have legitimate purposes. Firstly, they are often necessary to use the service that a project aims to create — similar to a laundry token. Secondly, their owners may hope to realise speculative gains by exchanging them for cash or other electronic currencies at a higher price in the secondary market.

Oversight by the SEC requires issuers to abide by rules on registering and offering securities. A scheme may qualify if it passes the Howey test. This requires that “the investment of money” is accompanied by “a reasonable expectation of profits”. The only news in the SEC’s announcement is that it has applied the security designation to a specific offering. The SEC’s authority to impose its powers in this context had never been in doubt.

The price drop highlights the suspicion with which crypto currency markets view any form of regulatory encroachment. But this view is naive. Banks are hoping to use the technology to increase efficiency, reduce costs and widen their profit margins. If starry-eyed libertarians truly want to challenge the established financial institutions, they should welcome the imposition of sensible regulatory rules. Only trusted oversight can lend the legitimacy required for widespread adoption.

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