Go ahead, try to stop initial coin offerings

The fraud-ridden market could make us appreciate regulation

China’s ban on initial coin offerings has provided a much-needed pause in the booming market, where people ranging from legitimate entrepreneurs to outright thieves attract money by selling digital tokens. But the move also raises a question: How can any government control a phenomenon that transcends national borders and rules?

The Chinese central bank’s decision to outlaw token sales is significant in part because the country has become an important hub for the digital offerings. As of July, Chinese platforms had raised nearly $400 million from more than 100,000 investors. It’s thus not surprising that digital currencies tumbled after the ban was announced.

Regulators in China and elsewhere have good reason to be concerned about coin offerings. Although they provide global entrepreneurs with a useful alternative to traditional venture capital — which is local, labour-intensive and often inaccessible — they are rife with abuse. Promotional campaigns —which can feature such celebrities as Mark Cuban, Paris Hilton and Floyd Mayweather, and even billboards in Times Square — sometimes border on the downright predatory. About 60 per cent of exchange-traded digital currencies end up dead or dormant.

Most tokens confer no rights beyond purported access to a future service — such as a chance to win a Lamborghini. Such vague promises can attract hundreds of millions of dollars in part because they get plenty of help from the media (including this one). Reports of record-breaking token sales, or of the latest hot offering, reinforce the fear of missing out. Excited by the rare success stories — such as the astronomical gains achieved by early investors in the Ethereum currency.

Curbing token sales, though, won’t be easy. The decentralised, tamper-proof design of the blockchain resists oversight: When China tried to suspend withdrawals at bitcoin exchanges, the trade simply moved to other venues and messaging apps. Most tokens are administered through a piece of software called a smart contract, which functions like a digital vending machine running on thousands of computers around the world. Even a regulator as powerful as the US Securities and Exchange Commission can have a hard time establishing jurisdiction, as evidenced by the continued operation of the Romanian exchange MPEx, which offers bitcoin-denominated “virtual securities.” In some cases, regulators might not even have anyone to contact: New trading platforms are completely decentralised, with no identifiable point of control.

That said, maybe the threat of regulatory action could put a chill on the kind of mass marketing that helps make coin offerings so popular. FT Alphaville’s Alphachain project offers a sense of what sellers might raise in the absence of gratuitous advertising: After a month on the market, it had collected less than $10 in bitcoin and ether.

Entrepreneurs who choose digital coin offerings often complain that the venture capital industry is too clubby and insular. That’s true. It is, and it should be. Such early-stage funding is granted on nothing more than the founder’s reputation.