Can SAFTs Create a Self-Regulated Cryptocurrency Market?
The Chinese government’s recent ban on initial coin offerings (ICOs) has reignited the debate on how crypto-assets should be regulated. In the United States, lawmakers are grappling to define ICOs from a tax, legal and securities perspective. To this day, no one is certain how this new crowdfunding model will be treated.
ICOs mirror initial public offerings by allowing companies to raise money via Ethereum-based token sales. Their growth has occurred in lockstep with the broader cryptocurrency market, which has seen enormous uptake since the start of 2017. However, the key challenge for market participants has been predicting how the regulatory environment will evolve to keep pace with crypto-based crowdfunding.
The murky regulatory environment surrounding token sales has hastened the need to bring the cryptocurrency ecosystem to maturity. Recognizing the limitations of existing frameworks, the crypto community came together to create standard legal agreements for the ICO market. These efforts led to the creation of the Simple Agreement for Future Tokens (SAFT) project, which aims to streamline the verification and investor accreditation process. The open source movement is uniting technology companies, legal experts and members of the blockchain community to converge on a framework that gives rise to a self-regulated cryptocurrency market.
The Rise of SAFT
In its simplest form, a SAFT promises investors future tokens at a fixed price. It can be structured so that investors receive their tokens when the network launches or via inbuilt vesting that encourages their continued support.
SAFTs were modelled after the Simple Agreement for Future Equity (SAFE) protocol, which was created by Y Combinator to reduce the complexity of funding early stage startups. Whereas SAFTs promise investors future tokens, the SAFE guarantees future equity.
While SAFTs certainly fall under the ICO umbrella, they are structured to provide much more regulatory certainty. This is what people mean when they say SAFTs are creating a self-regulated crypto market.
Unlike plain ICOs, which sell tokens to pretty much everybody, the SAFT structure limits participation to accredited investors as defined by Rule 506(c) of the SEC’s Regulation D. This list includes high net worth individuals, high-income earners and multi-million-dollar trusts, among others. This is the demographic to which SAFT is designed to serve. By meeting these and other requirements set out under Rule 506(c), startups can theoretically raise an unlimited amount of money via crowdfunding and advertise their sale over the internet.
Uniting the Blockchain Community?
Because SAFT is open source, it can be used by anyone. It’s therefore no surprise that a budding startup community leveraging SAFTs has already emerged. Their goal is to create a more secure way for investors to access the ICO market. This will serve as an important stopgap until new laws are crafted and implemented.
Members of the blockchain community have already encouraged regulators to join the SAFT movement. At the time of writing, the only ruling on digital coin offerings has come from the Securities and Exchange Commission (SEC). Earlier this year, the agency ruled that the tokens offered by ‘The DAO’, an ether-based venture capital fund, were securities and therefore subject to national securities laws. The SEC maintains that not every token will be defined as a security, but determined on a case-by-case basis.
Other regulators expected to chime in on the digital token debate are the Commodity Futures Trading Commission, Internal Revenue Service and the Financial Crime Enforcement Network. Internationally, financial regulators in Singapore, Hong Kong, Korea, Russia and Canada are also exploring whether ICOs should be regulated as securities.
Just How Big Have ICOs Become?
The amount of money raised by startups via initial coin offerings approached $800 million in the second quarter, data from CoinDesk recently revealed. By mid-2017, ICOs had already outpaced early venture capital funding. That’s a significant achievement given that ICOs were barely heard of just 12 months ago.
The growth and widespread adoption of ICOs mirrors the massive explosion in cryptocurrency over the past nine months. Before 2017, the cryptocurrency market was synonymous with Bitcoin, which was officially launched in 2008 as the brainchild of Satoshi Nakamoto, the person or entity who designed its original reference implementation. While Bitcoin continues to lead the pack in terms of overall capitalization, nearly a dozen altcoins have surpassed the $1 billion mark in the past few months. Ethereum is among those, and is currently ranked second in terms of overall capitalization. The crypto market is collectively valued at over $140 billion, although this figure is prone to wild fluctuations.
Bitcoin has been the world’s best-performing currency in six of the past seven years. As of early September, it appears likely that the cryptocurrency asset class will retain that title over fiat currencies.
The Beginnings of a Self-Regulated Market
The ICO ban initiated by China dealt a major blow to the cryptocurrency market, with ether prices plunging as much as 30% in the days following the decision. There’s a general fear that China’s attack on ICOs marks an end to the first era of digital token offerings. At first glance, the decision appears to have set a bad precedent for an industry still finding its footing.
At the same time, China’s unique context makes the ruling hardly surprising. Beijing has zero tolerance for any activity that will undermine its financial stability. This is especially true at a time when policymakers are steering their economy away from export- and investment-dependence toward a model that is based on services and consumption. The People’s Bank of China has already intervened in the cryptocurrency market on several occasions, probably as a backhanded attempt to manage capital flight from the country. (Cryptos are a popular way for mainland investors to diversify away from a volatile yuan, which fell to more than eight-year lows against the dollar in 2016.)
While the Chinese ban may stifle blockchain development in the short run, it will only embolden industry players to converge on a new model for self-regulating this space. From a regulatory perspective, the combination of identity verification and investor accreditation offered by SAFT has several advantages, including greater token compliance and more clarity for entrepreneurs. These features make SAFT well positioned to become the industry standard. By giving accredited investors an easy onboarding platform, SAFT opens token crowdfunding to a large segment of the market, leading to vastly greater adoption than we’ve seen through the early stages of the ICO hype.