After a warning period, U.S. regulation of blockchain securities has begun.

By David Z. Morris
October 1, 2017

In a move that should be welcomed by anyone serious about innovation in financial technology, the Securities and Exchange Commission announced Friday that it would prosecute the creator of two stock-like “ICOs,” or Initial Coin Offerings, which it alleges were sold on the basis of fraudulent claims.

ICOs use the blockchain cloud-ledger technology pioneered by Bitcoin to sell digital ‘tokens’ that are comparable to company shares. After a series of warnings, this appears to be the first time the SEC has filed fraud charges related to an asset marketed as an ICO. The SEC did not immediately respond to a request from Fortune.

The two ICOs in question were marketed as “REcoin” and “DRC,” and both were run by Maksim Zaslavskiy. REcoin was advertised as “The First Ever Cryptocurrency Backed by Real Estate,” while DRC, or Diamond Reserve Club, claimed to be backed by investments in diamonds. They were touted as full-fledged companies with staff, lawyers, and relationships with retailers.

But according to the SEC, neither scheme had “any real operations.” They made no investments on behalf of token buyers, and misrepresented their total level of investment. Nearly as bad, the SEC says the digital tokens they claimed to be selling “don’t really exist,” meaning REcoin and DRC – much like the notorious global scam OneCoin – weren’t running on blockchains at all, and therefore weren’t even really ICOs.

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The prosecution comes after a July SEC bulletin announcing that ICO tokens “may be securities.” That signaled that irresponsible or fraudulent sellers could be targeted for prosecution.

It’s notable that, in addition to alleged wholesale fraud, this prosecution targets an ICO that claimed to be issuing tokens linked to real-world assets. The most reputable ICOs have sold digital tokens to fund cloud-computing applications for blockchain, with hard-coded links between the tokens and the applications.

Blockchain technology shows potential in certain real-world applications, particularly for tracking supply chains shared by multiple parties, but those are private projects based on agreements between a few players. At least right now, there are few legal or technological means to link digital tokens to offline assets in the broader marketplace.

Even if Zaslavskiy’s ICOs had been doing what they claimed, in other words, they probably would have been a bad choice for the funding model.

The SEC, though, doesn’t seem to be looking to shut down ICOs as such. The agency’s targeted and graduated approach to regulation could help scare away fraudsters, while preserving the positive features of the technology, particularly its ability to raise funds globally with little friction and few fees.

That could give the U.S. a big edge over countries, now including China and South Korea, who have taken more draconian measures to suppress the technology.

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