Internet Capital Markets (ICMs) offer an alternative to traditional paths for early-stage projects to receive the capital that they need. ICMs leverage blockchain technology to allow anyone to create a token and have users purchase that token and invest money in the company.
Some ICM platforms allow creators to launch a new token simply by posting on social media, lowering the bar to entry into the funding space. By democratizing access — both for projects seeking funding and those looking to invest and reap the potential rewards — ICMs offer benefits for companies and would-be investors alike.
One of the key features of ICMs is that they sidestep traditional regulatory hurdles for seeking capital or investing in a company. While this may have its benefits, it also creates potential compliance challenges for companies and investors alike.
ICMs Bypass Compliance Requirements
Many jurisdictions have certain requirements in place to help protect investors in early-stage companies that haven’t completed an ICO. For example, a government may require investors to be registered and for companies to complete certain paperwork and processes to be eligible to receive capital.
ICMs are designed to expand access to capital, largely by bypassing these requirements. Some of the key ways that they accomplish this include:
Direct Access: ICM platforms are built on top of blockchains, which allow projects and investors to interact directly. By eliminating common intermediaries in capital raising projects, they sidestep many of the requirements of traditional markets.
Tokenization: ICMs work by allowing anyone to create tokens, which are analogous to traditional stocks and bonds. Historically, many jurisdictions have struggled to classify tokenized assets, making them more difficult to regulate under traditional financial laws.
Global Decentralization: ICMs are hosted on smart contract platforms, which are decentralized, global networks. Since ICMs can solicit investors from around the world, it’s difficult for a single jurisdiction to effectively enforce its regulatory requirements.
Smart Contracts: Smart contracts allow projects to encode the terms of investment within token contracts, which are executed and enforced by the decentralized blockchain network. Doing so streamlines processes and eliminates intermediaries who might otherwise enforce or be subject to regulatory requirements.
Regulatory Risks and Challenges of ICMs
ICMs have a complex relationship with regulators, which creates challenges for both projects and regulators. Some of the most significant include:
Complex Jurisdictions: ICMs deliberately evade local laws and regulations and the roadblocks that they create by hosting markets on the global blockchain. However, this can create regulatory challenges since various jurisdictions may attempt to apply their laws to those projects.
Scams and Fraud: While ICMs are designed to fund projects, there is no guarantee that a project will follow through to build the promised product. As a result, users may purchase a token that has no real value. Even if the project is legitimate, it may fail to live up to its promises and end with a loss to the investor.
Outdated Regulations: Many laws that pertain to the Web3 space predate the invention of the blockchain and, in some cases, the Internet. This complicates regulatory compliance and enforcement since legal requirements may not reflect the reality of the technology or may be designed to address potential risks that are obsolete in the age of smart contracts and decentralized enforcement.
Evolving Regulatory Guidance: Regulators are increasingly focused on emerging and evolving technologies, such as AI and blockchain. This means that systems using these, which include ICMs, may be subject to new regulatory requirements in the future, adding to the complexity of regulation and compliance.
Security Risks: A lack of regulatory oversight makes it more difficult for regulators to enforce security requirements and guidelines designed to protect projects and their investors against cyberattacks. As a result, insecure smart contracts or poor private key security practices may result in projects being hacked and losing investor funds.
Central Clearing Mandates: Some jurisdictions have laws regarding repo markets and derivatives, such as EMIR 3.0. The peer-to-peer model used by ICMs and other blockchain-based systems is directly contradictory to these practices.
Legacy Infrastructure: Regulators may lack the tools required to effectively track activity on blockchains and within ICMs. As a result, they may be unable to efficiently detect violations of regulatory requirements or enforce their policies and mandates.
Addressing the Regulatory Challenges of ICMs
Regulators are currently working to address the disconnect between legacy regulations and the state of the Web3 space. Some initiatives designed to help protect investors while also taking advantage of the benefits that blockchain offers to ICMs include the following:
Global Regulatory Requirements: Global standards, such as those proposed by the International Organization of Securities Commissions (IOSCO), are designed to harmonize blockchain and crypto-asset regulations across jurisdictional boundaries. By eliminating the complexity of many, localized standards, a global regulation makes laws easier to follow and more enforceable.
Sandbox Programs: Some jurisdictions are testing potential regulations for crypto-assets in sandboxed environments. This practice helps to determine which potential requirements provide the desired protection for investors without inhibiting technological innovation.
Advanced Monitoring Tools: Regulators are developing and deploying advanced monitoring tools designed to use AI to more effectively monitor on-chain transactions. This provides the visibility and analytical capability needed to effectively enforce cryptocurrency regulation.
Projects looking to streamline their regulatory compliance now and in the future should work to ensure the security of their systems and their users’ funds. Many regulations are designed to protect investors, and cyberattacks pose a serious risk in the Web3 space, where major attacks are a regular occurrence.
In ICMs, where token contracts are automatically generated, private key security is of paramount importance. Private keys control access to blockchain accounts, which hold valuable tokens for projects and investors alike.
As projects work to implement their proposed on-chain solutions, they also need to consider the security of the smart contracts used to implement them. Halborn offers advisory and auditing services designed to help ensure that projects meet regulatory requirements and are secure against potential threats. If you’re looking to build in the Web3 space or already have a project in the works, get in touch.