The breakaway money-creating machines of cryptofinance in 2017 are in trouble here in the early-going of 2018, and it might get worse for initial coin offerings, according to many people in the blockchain world.

But that might not be the worst thing for the industry, either. That’s according to Aaron Wright, an associate professor at Brooklyn’s Cardozo School of Law and the chairman of the Legal Industry Working Group of the Enterprise Ethereum Alliance.

“I think it’s going to be a net positive,” Wright explained. “I think there are a number of projects that do not seem like they’re legitimate projects [and] hopefully one or more stiff enforcement actions will derail that activity and move them out of the marketplace. It would almost be like a brush fire which would clear out the fraudulent stuff and allow this ecosystem to evolve in a healthy way.”

On Feb. 28, the Wall Street Journal reported that the U.S. Securities and Exchange Commission had issued “dozens” of subpoenas for information from people and companies working in the cryptocurrency and token offering, or ICO, space.

Exclusive: SEC issues scores of subpoenas and information requests in new wave of ICO probe. https://t.co/Qjw3ejgZji via @WSJ #crypto #bitcoin

— Paul Vigna (@paulvigna) February 28, 2018

“The sweeping probe significantly ratchets up the regulatory pressure on the multibillion-dollar U.S. market for raising funds in cryptocurrencies,” WSJ’s Paul Vigna and Jean Eaglesham wrote. “It follows a series of warning shots from the top U.S. securities regulator suggesting that many token sales, or initial coin offerings, may be violating securities laws.”

At question is whether the way ICOs are typically constructed skirts securities law. For a long time, people in the blockchain space have been saying it doesn’t, but the SEC might very well think otherwise.

An ICO is the popular name for the process by which blockchain startups put the tokens they run on up for sale. Young companies have made a fortune in ICOs, the largest among them FileCoin, which raised $262 million in an ICO last year, Tezos, which raised $232 million, and KIK, which raised $98 million.

How does it work?

As a very hypothetical example, if a company, call it Woods Inc., were building an application where users could buy and sell clever blog posts on the blockchain, it might release a token with which readers could trade the posts, call it WoodsCoin. If the idea caught on, more and more people would want to buy and sell these terrific posts, and so the price of a WoodsCoin would go up, as the growing demand and limited supply would force people to spend more to get their hands on that sweet, sweet content. The people who bought the WoodsCoins when they first come out would be able to sell them for a lot more, and make out handsomely.

That’s the logic of an ICO, more or less.

It’s really not the same thing as investing in a company, where the investor receives equity in the company in exchange for their money, and many involved say it doesn’t fall under securities regulation. But others disagree.

Mounting legal action

“The law is pretty clear that if you’re purchasing something from another with the intent to make a profit, what you’re buying is a security,” Wright said by phone last week. Count him in the “disagree” camp. “It’s a huge mess, man. But it was pretty obvious that it was a huge mess if you actually knew the law.”

To date, nearly $9 billion has been raised via ICOs, according to the leading news source on the industry, CoinDesk. And that’s for a thing which has only existed on any real scale since about May of 2017 (check out this graph).

To date, however, there has been only a few government regulation of the sales, despite several written warnings by the SEC. The department did shut down the ICO of a company called Munchee, in December. Munchee explicitly described its tokens as a promising method for speculation and was forced to return all $15 million it raised back to its investors. Also in December, it froze the assets of a company called PlexCoin, which promised that “investments in PlexCoin would yield a 1,354 percent profit in less than 29 days.” And in January it shut down AriseBank, which was raising $600 million to be “the world’s first decentralized bank.” The Dallas-based company allegedly lied to its investors, saying that it had acquired a real bank in order to be FDIC compliant.

(We reached out for comment to a Brooklyn blockchain startup that raised money via a coin offering, GRID+, but did not get back a response.)

Now, with this new round of subpoenas will there be more regulatory action to follow? And what would that look like?

“If the reports are correct,” Wright said. “I would imagine it will be a sweep or a handful of enforcement actions. I think the one thing that’s under-appreciated is that whatever the SEC does is just the first wave. That will set up a precedent for civil legal action from claimant’s attorneys. It’s like they’re throwing chum in the water and all the sharks will come out for it.”

That could mean civil suits in cases of fraud and even criminal charges for those involved in some cases. The SEC’s subpoenas went out not only to the companies raising money themselves, but also to some lawyers involved in the sales and even some of the large investors. Saying something isn’t within the purview of the law when it actually is could be a problem, especially if some investors lose big money.

‘Regulatory friction’

“All in all, on a global level I think ICOs continue to exist,” said Jake Brukhman, the managing partner of Brooklyn-based crypto investment fund CoinFund. “I think some countries put the breaks on to an extent. I think in the U.S. in particular, generally we have more regulatory friction, especially in this area of securities, and definitely in the U.S. the ICO market has gotten pretty conservative. You see projects converting to giving the tokens out for free rather than selling them. You see other projects delayed.”

Brukhman said he’s seen companies recently engage in token sales only with accredited investors and filing Form Ds with the SEC, the way a typical startup raising money by selling equity would do. But that means that we might not be seeing the big bucks that come from global, digital unregulated coin offerings.

“Obviously with these regulatory requirements, it would be hard to see those numbers,” Brukhman said, but added that he doesn’t think ICOs are over. “I just think ICOs are more private than they were a year ago because they’re being compliant.”

In a potential sign of public wariness of the crypto environment, the prices of tokens have fallen to their lowest levels of 2018. As of Thursday, the price of Bitcoin is $8,101, down more than 50 percent from its high of $19,000 in December 2017. Similarly, the price of Ether has sunk below $600, down from its high of more than $1,300 in January.

Still, even if ICOs as we knew them become a relic of 2017, neither Wright nor Brukhman thought this would be the end of the line for blockchain startup financing.

“Everyone knows there are projects that aren’t well supported, lawyers pushing schemes not supported by the law and investors pushing entrepreneurs to engage in these sales to trade and profit on. Those aren’t healthy things to have in the marketplace,” Wright said.

Blockchain technology isn’t going away, most agree. But can it adapt to regulatory scrutiny? Can it survive the brush fire and come back healthier? Or will the whole thing go up in smoke?