On Monday, May 7, 2018, senior staff from the CFTC will reportedly meet with representatives from the SEC as part of a working group to discuss the regulatory classification of cryptocurrencies, including Ether. That meeting is sure to be informed by the perspectives of venture capitalist (VC) companies like Andreessen Horowitz and Union Square Ventures (USV) who possess investments in the space. Representatives from the VC firms actually met with officials from the SEC's Division of Corporation Finance late last month.
As was reported by The New York Times, at that April meeting, the companies expressed a desire for a "safe harbor" for some initial coin offering (ICO) tokens. That likely included Filecoin, a project in which Andreessen Horowitz is a major investor. The Wall Street Journal reported that the firms also sought "formal assurance" that their projects would not be subject to SEC regulation. Like Andreessen, USV is a prominent investor in the blockchain/cryptocurrency space. In fact, in March 2018, USV confirmed that it is one of the many financial backers of CryptoKitties, a wildly popular game that involves Ethereum-based feline collectibles.
In advance of Monday's regulator meeting, ETHNews revisited a podcast episode recorded by the CFTC, which featured Alex Rampell, a general partner at Andreessen Horowitz who leads the firm's FinTech investments. The episode was made in January 2018, but reposted by the agency earlier today. In the 40-minute recording, Rampell spoke about the general over-exuberance about blockchain technology, and he discussed how ICO tokens can potentially simulate the network effect.
Oh Blockchain, My Blockchain
Rampell seemed to indicate that many CEOs in the financial sector do not really understand what a blockchain is or whether it's an appropriate fit for their businesses. It appears that with some frequency, these executives would be better off learning about well-developed, existing enterprise solutions (e.g., the services provided by Oracle). There seems to be a bizarre belief that through blockchain implementations, companies will magically reduce their IT costs from billions of dollars per year to virtually zero almost overnight.
Earlier this week, at a hearing before the UK Parliament's Treasury Committee, Martin Walker – director of the Centre for Evidence-Based Management – said that the applications of blockchain technology are horrifically overstated. Rampell also seems to have recognized the strange gymnastics wherein business leaders decree that blockchain will be transformational without substantiating how it will actually change corporate structures or generate value. Walker said that many seem to confuse the words "is" and "could" – hyping up what blockchain might do without acknowledging its limitations. It would appear that there is just a substantial learning curve, and many people would rather say something vague and positive than confess ignorance about blockchain.
The ICO Framework
One of the most fascinating aspects of the CFTC episode was Rampell's assertion that distributed ledger technology requires a cryptocurrency to provide an economic incentive. It's a brilliant point that he makes, and he obviously sees that economic fundamentals will dictate whether any businesses built on blockchain will succeed.
The way that Rampell sees it, blockchain technology and ICOs present an opportunity for a new version of the network effect. He used Tinder as an example. If the platform had only two users, it wouldn't really be very valuable. By comparison, with 20 million users, Tinder is a terrific – and economically sound – tool. In essence, a network's utility and value are closely tied to how many people are actively engaging with and contributing to that network.
This intellectual framework applies quite obviously to Filecoin. As more and more users join the network, Filecoin could become a strong alternative to traditional digital storage systems like Dropbox or Google Cloud. The question is, can Filecoin tokens reach a price point where they are a cheaper option, and can they attract users away from other existing services?
With an ICO, Filecoin essentially tried to "bootstrap" the network effect, and it got those tokens into the hands of users quickly. Rampell seemed to indicate that the Filecoin token was initially full of speculative value, but that the nature of that value could transform when the network reaches a certain scale (the required size is not readily apparent).
Does Filecoin make a transition from financial utility to application utility? That's a great question, and one that regulators will likely consider at Monday's meeting.
Is a Filecoin token a security? Is it a commodity? It's very, very difficult to predict where regulators could come down on this matter because there are arguments to be had both ways. Distributed networks that expand clearly have great potential, but the economics of these systems is often questionable.
Regulators might want to examine the distribution of tokens for a given platform or ICO, and also what function (or rights) that token confers on a network. One of the clearest differences between ICOs and something like PayPal is that the capital risk is transferred away from entrepreneurs to investors among the general public (sometimes, accredited investors, but in the ICO space, that investment standard has clearly been circumvented).
When PayPal was in its early days, the company undertook an aggressive marketing strategy, depositing $10 in the accounts of new users. That's a strong incentive to join the new platform – and dollars can be spent elsewhere. ICOs from the past year really inverted this whole dynamic by asking the general public to finance ambitious (though not necessarily feasible) projects in exchange for tokens that could go up in value (if the platform itself was successfully launched and adopted). There are a lot of steps between raising capital and successfully deploying a product.
Tokens don't offer the same versatility of a $10 bonus. It's hard to know which tokens will be listed on an exchange and what sort of price manipulation might be going on. They fluctuate in value and, due to hacks (or just the loss of a private key), a user might be left out in the cold. Every business in America accepts dollars – but who is going to take your digital tokens? With cash, societies found a solution to the double coincidence of wants and we advanced beyond a barter economy. Tokens for specific platforms inexplicably limit economic versatility – it's moving backward! Just think, would you rather have a gift card to one store or a hundred dollar bill?
With that in mind, regulators will probably be concerned by the reallocation of risk in many of the ICO models. The SEC-CFTC meeting will be a fascinating jumping-off point for discussion about regulatory frameworks for cryptocurrencies and ICOs. Monday can't come soon enough!