This is the latest entry in my ICO Mania series of blog posts.
The Shapps Incident
Speaking as one who has long waited for legislators and regulators to get serious about cryptocurrency and blockchain tech, yesterday’s alleged scandal involving Grant Shapps MP is not only shocking, but it tells me that the state of ICO regulation in the UK is years away from being what it needs to be.
For those of you who were living under a rock, Grant Shapps – former co-chair of the British Conservative Party and a member of Parliament in that country – yesterday stepped down from both a Parliamentary working group and an ICO’s advisory board after it was alleged in the pages of the Financial Times that Shapps apparently failed to disclose a $3.7 million interest in tokens issued by an ICO. Note, officers of the allegedly offending ICO itself also advised the Parliamentary working group.
That something this inappropriate could allegedly happen in such close proximity to the heart of the regulatory process shows that it is more likely than not that the British government is, currently, totally blind to the size of the issues presented by the space they are only now beginning to understand, and the extent to which they are failing to exercise their duty to the public to quickly achieve competence and work with industry to establish appropriate supervisory frameworks.
It’s time for regulators around the world to (a) get serious about learning how this technology does and does not work, (b) work with legislators to get the power to put an end to market conduct which is abusive of the investing public and (c) put those powers to use.
An exercise in futility
Over the years, I have had the privilege to speak with regulators, law enforcers, legislative aides and legislators alike, in several countries, about the danger that the proliferation of ICO, or “Initial Coin Offering,” schemes poses to the investing public. I have done so consistently and unwaveringly since 2014.
To date, warning regulators about this misconduct has been an exercise in futility.
The more money these ICO schemes make for their promoters, the less the warnings are taken seriously, not only by new entrants seeking to raise money in the space or investors doing diligence, but also by regulators who have become accustomed to coin offerings as a fact of life.
The reasons why this should be the case are clear enough to me. Cryptocurrency companies with vast marketing and lobbying budgets have sent sufficiently hip and sloppily dressed technology emissaries ’round the capitals of North America and Europe, peddling decentralization prosperity gospel to our leaders, and blinding them with the promise of “blockchain technology.”
A small but not insignificant number of the companies in “blockchain” do good, honest, and solid development work. But they are in the minority. To any half-decent engineer, most of the claims peddled by the average ICO firm these days are, transparently, garbage. So-called “stablecoins” set themselves apart as being particularly awful, but many others that don’t try to be anything other than a cryptocurrency are themselves chronically oversold. The much-vaunted Eos scheme, for example, which raised more than $4 billion, utilizes four-year-old consensus tech known as delegated proof of stake which wasn’t that impressive on the two occasions it was tried previously (Bitshares and Steemit) and remains unimpressive now, at least to anyone whose opinion I respect.
The issue, of course, is that most people in “blockchain” arrived on the scene in the last 12 months. As a consequence, they are unable to exercise the requisite levels of diligence to sift out the marketing B.S. from genuine innovation. This explains, for example, the U.S. Securities and Exchange Commission’s legally puzzling pronouncement, which appeared to borrow heavily from the logic put forth by U.S. lobbying firm Coin Center, that Ethereum, which virtually any legal professional I know will agree started its life as a security, somehow transmogrified into a non-security by the mere passage of time (despite there being no basis in the precedents I’m aware of for such an interpretation).
Or why a European Parliament subcommittee produced a breathless resolution that read like a marketing document that might be more at home on the blog of the European Commission’s “blockchain observatory” development partner, ConsenSys, than it would be as serious legislation that could be found within a library of evenhanded assessments of blockchain tech.
Those of us standing against unqualified evangelism – the half-dozen or so consistent and battle-weary public “skeptics” like myself, Izabella Kaminska, Tim Swanson, and David Gerard, who between us have $0 in marketing budget and have to earn a living without recourse to the coin-capital markets – look on with ever-increasing levels of horror as unbridled greed goes unchecked and indeed is endorsed by regulators who have been told, and in good faith believe, the lie that in order to utilize blockchain cryptography, a coin is required.
This is not to say that the entire space is a waste. I firmly believe that cryptocurrency and cryptography combined with distributed systems, which currently takes the form of blockchains, will change the world. Indeed, these things already have changed the world.
However, I also believe that ICO boom is to “crypto” what the Railway Mania was to the industrial revolution. Lasting change will come not from an infinite proliferation of instamined “shitcoins,” or by handing hundreds of millions of dollars to un-tested novices whose only objective is to drive up the price of the digital assets they sell. Distributed cryptosystems will, as with all technologies, evolve incrementally and as a result of a slow and gradual process of adoption and developer familiarity with the tooling.
There are well-worn methods for promoting innovation in cryptocurrency (see e.g. the BIP process for Bitcoin) and in blockchain-without-the-coins (see e.g. the development process utilized by the Hyperledger project). Note, in each case, that the substantial development – hundreds of thousands of man-hours – that has occurred in either project has required the sale of precisely zero coins of any description, and certainly not the excessive sums like the $1.5 billion raised by Telegram or the $4 billion purportedly raised by Eos.
This brings me to my main point. What is not required for a healthy innovation sector is the repetitive, cookie-cutter ICO industry which has been allowed to proliferate in the U.S. and the U.K. almost completely untrammeled for the last four years. Which I find problematic, which practically every lawyer I know finds problematic, and which regulators on both sides of the Atlantic Ocean have singularly failed to address directly for half a decade or more.
Parliament, in particular, should bear some responsibility for the inability of British regulators to address market misconduct occurring within the jurisdiction. Numerous coin schemes have been run out of London. Stand-out examples of regulatory inability to come to grips with “blockchain” include:
In May 2016: A “decentralized venture fund,” calling itself the “DAO,” is launched from London and Berlin. The scheme quickly raises $150,000,000 in outside capital. However, because the smart contract administering the scheme was sloppily written, the DAO was hacked and the scheme collapsed, causing user funds to be lost (although later efforts by the Ethereum Foundation ensured that some of the funds would be reclaimed). No action was taken in England and Wales; the U.S. S.E.C. wrote a “report of investigation” in July 2017 rapping the DAO scheme on the knuckles for violating securities laws in that country.
September 2016: the UK FCA warns consumers about the Onecoin Ponzi scheme while at the same doing nothing to intervene in the scheme: “This firm is not authorized by us and we do not believe it is undertaking any activities that require our authorization. However, we are concerned about the potential risks this firm poses to UK consumers.”
September 2017: the FCA, after what must have been a thorough review, confirms what many practitioners suspected when it says it has almost no statutory power to supervise cryptocurrency and ICO offerings, leaving no dedicated regulator with the remit.
January 2018: The Bitconnect Ponzi scheme, which was apparently administered by an English registered shell company, is shut down. More to the point, it is shut down after regulators in Texas of all places filed a cease-and-desist order against the company and the founders cut and run. As far as I can tell, no investigation or regulatory response ever occurred in the United Kingdom.
May 2018 – Ripple Labs states, to a committee of Parliament, that its business has no relationship with the cryptocurrency XRP despite the fact that this assertion is frequently disputed in the cryptocurrency community. Members of the Parliamentary Committee lack the competence or sector knowledge to challenge this assertion on the spot.
July 2018: Grant Shapps MP, former co-Chairman of the Conservative Party, steps down from his role in the All-Party Parliamentary Group for Blockchain tech for allegedly receiving compensation from one of the schemes he’s meant to be supervising and allegedly failing to disclose this to Parliament.
I warned in November of 2017 that failure to adequately supervise the cryptocurrency space will create levels of systemic risk which could potentially endanger the mainstream financial system. Last week we learned from the erudite Bitcoin banker OG Caitlin Long that ICO issuances were, in dollar terms, equal to 45% of IPO issuance in Q2 – with nary a prospectus or registration statement in sight.
Regulators of the world, the time for exploratory work is past. Clean house, come up with a battle plan, establish a supervisory framework, and enforce it.
It’s long overdue. There’s a real possibility it will soon be too late.
4 thoughts on “With crypto, the United Kingdom needs to put its house in order”
Pretty much everything you said. Personally I would prefer to see self-regulation, but that discussion topic has been raised and tabled more times than I can remember and so far no one in the ICO industry really seems to want to fuss with it. Which is understandable since (a) the entire ICO support service industry is making way too much money enabling the status quo; and (b) whether you’re talking about ICO consulting firms, the “crypto media,” rating/review websites, the projects themselves, the advisors to those projects, the exchanges, etc., a LOT of people have unclean hands.
If we’re not willing to regulate ourselves, maybe government regulation is the only solution. It seems far less onerous when you see examples of the regulatory system working the way it is supposed to, e.g., https://www.coindesk.com/south-carolina-ends-cease-desist-orders-against-crypto-startups/. At the same time, I wonder if even the regulators have the resources (or even the will) to deal with it. Considering it’s an international issue (with a surprising amount of activity focused in Russia – I’m still waiting for the 60 Minutes expose of cryptofriends.io to come out BTW), an international regulatory effort would seem most appropriate.
Then again, maybe, just maybe, the market will deal with the problem. Right now there is still substantial informational asymmetry between the industry hawking the “not quite scam but completely unviable in the real world” blockchain startups and all the bag holders who keep funding them on the other. That’s what leads to the misallocation (to useless cookie-cutter projects) of scarce resources (being the bag holders’ money) we are still seeing now. But eventually the seemingly endless supply of “hey I heard I can make a lot of money investing in this thing called an ICO” lemmings will have to see that the hype doesn’t match the historical ROI for these things…
Or I guess we could just let the lawyers deal with everything…
And speaking of that, for a lawyer in transition who understands all this stuff incredibly well but is not quite sure what to do next, I think starting a boutique cryptocurrency-focused litigation firm (before the inevitable post-ICO party hangover kicks in) wouldn’t be the dumbest thing said lawyer could do. Just saying.
> I think starting a boutique cryptocurrency-focused litigation firm (before the inevitable post-ICO party hangover kicks in) wouldn’t be the dumbest thing said lawyer could do. Just saying.
Don’t think it hasn’t crossed my mind!
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Release the Honey Badger (with ample marmot back-ups)!
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