CryptoPolitics: The Irony of the SEC Tough Stand on ICOs: Part I
A lot of speculation has surrounded the world of digital currencies about the potential regulation of initial coin offerings(ICOs) by the Securities Exchange Commission(SEC). Last week, the SEC, once again, presented a tough view on ICOs that indicates that ICOs might be headed towards a more regulated environment in the near future. Speaking at the Institute of Securities Regulation last week, SEC Chairman Jay Clayton went off script to volunteer his opinion about ICOs by saying “ I have yet to see an ICO that doesn’t have the sufficient number of hallmarks of a security”. With those remarks, Mr. Clayton suggested that the SEC clearly view ICOs as securities and could implement the corresponding regulatory measures. In this essay, I would like to explore the irony of that position.
Just to clarify things before the polemic starts, the purpose of this essay is not to debate whether ICOs should be regulated or not. Personally, I think ICOs are in desperate need of a governance model and some form of regulation should be welcomed by the community. However, regardless of whether you agree with me or you are an ultra-libertarian who thinks that ICOs should fly free or a conservative pro-regulation who believes ICOs should be completely constrained this essay may be for you. The reason being is that, despite different sentiments about ICOs, I believe we can all agree that the position of the SEC results incredibly ironic. Where does the irony lies? Well, how about the fact that the SEC is talking tough about a tiny market such as ICOs while the, conceptually similar, market of financial derivatives which has been behind almost every recent crash remains largely unregulated.
Chasing Billions While Ignoring Quadrillions
How is the problem with ICOs. Maybe some numbers will put it into perspective. ICOs have raised a bit more than $3 billion this year. The whole market for cryptocurrencies is anywhere from $150 to $200 billion depending the market sentiment of the week. So if all goes to zero including Bitcoin( which is extremely unlikely), we are talking about the equivalent of a company like PayPal going under. Please don’t get me wrong, $200 billions is a lot of money but is tiny from the perspective of the capitalization of financial markets. So the idea of teachers in Iowa loosing their savings in ICOs is a bit of a stretch. The vast majority of ICO investors are people with relevant holdings in Ethereum of Bitcoin who are “experimenting a bit”. Yes, there are plenty of concerns about financial fraud and bad actors but those are common on any new financial vehicle and potential damage is relatively minor compared to other products.
One of the biggest concerns with ICOs and digital currencies is the fact that they are not backed by an underlying asset like gold. Let me please introduce you to the market of financial derivatives.
Just like digital currencies and ICOs, quantitive derivatives are hardly backed by real financial assets. Every month, new exoteric derivatives enter the financial market shifting risk from one party to another. Behind those derivatives, we find incredibly sophisticated statistical models that almost impossible to follow by regulators. The size of that market? How about $1.2 quadrillions; that’s 15 zeros or $1,200,000,000,000,000. Sounds big but a little comparison might help. Today, the market for derivatives is larger than the entire world’s economy or 17 times larger than the market cap of the world’s stock markets or 150 times the value of the world’s gold supply. In case is still not clear, we are literally playing with vaporware. The result? From the demise of Long Term Capital Management to the financial crisis of 2008 to the flash crash of 2010, derivatives have been behind every recent crisis in financial markets. Ahh yes, because of its sophistication, the derivatives market remains largely unregulated despite the best efforts from the govement. Do you see the irony now?
Where did all started? That will be the subject of the next part of this essay. A little hit: it has to do with Sir Isaac Newton and a fellow names John Law. We will get from Newton to ICOs in the next few articles ;)