And why do ICOs attract bad press?
Initial coin offerings (ICO) (or token sales) are an unregulated means of crowdfunding (raising money through a large crowd of people..kind of like gofundme) via use of cryptocurrency. A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency. Cryptocurrencies are classified as a subset of digital currencies and are also classified as a subset of alternative currencies and virtual currencies.
Indeed the NY times recently published an article about how crowdfunding platform Indiegogo is offering a new service to vet ICOs.
Nearly $4 Billion USD raised in 2017
It’s mind blowing how much money is being raised in such short periods of time. If you look at the stats March showed $183 million having been raised by ICOs, by May it was reportedly $380 million, July it had already reached over $600 million with Bancor raising $152 million in June and now in December 2017 is $3.763 billion.
It’s clear that ICOs are still in their infancy with so much yet to learn before there can be a blueprint for launching a successful ICO while avoiding pitfalls, but the market has moved on rapidly and regulators are becoming more involved. There will be backlash on some of the ICOs that have gone before, and some yet to come, as investors will not see returns and might even lose it all. There are ICOs that are being removed because they’re clearly fraudulent. People will be going to jail over some of these scams.
ICOs differ from crowdfunding in that the backers of the former are motivated by a prospective return in their investments, while the funds raised in the latter campaign are basically donations. For these reasons, ICOs are sometimes referred to as crowdsales.
This motivation for backers to see a prospective return in their investments has attracted the attention of regulators globally. The issue is when the coin or token offered in the ICO falls under the classification of a security (as per the Howey Test in the US, and very similar in Canada and the UK) then it falls under securities regulation. If the coin or token can be classed as a utility token, then it falls outside of such regulation.
Many ICOs have attracted investment from anyone anywhere, without following the proper regulations laid out to protect individuals. Their coin or token is a security, and should therefore only be offered to high net worth or sophisticated investors, as one example. Others, as mentioned, have been outright scams.
This has seen ICOs being banned in some parts of the world like China and South Korea, until such regulation can be properly imposed. In the US the SEC has taken a lighter approach, and stepping in to halt ICOs before they happen if they see regulations are being flouted.
However, just because it doesn’t fall within the SEC, or FCA or other financial regulation, doesn’t mean that other regulations such as Data protection and tax implications don’t apply.
Nor does it mean that because you’re registered in one geographical location that might be considered crypto currency friendly, doesn’t mean to say you can ignore the rules and regulations of other locations that govern the people who invest in your ICO.
Can an ICO offer value?
It’s critical to make sure that any ICO offers value to its investors beyond just creating a token that can be traded, a sure sign that the price will drop immediately after the sale, or fail to attract investment in the first place. As Reuben Bramanathan Blockchain Lawyer shared in a Medium post:
“It’s important to remember the differences between (1) how the token and the network actually function, (2) the problem that the application or protocol is trying to solve, and (3) the structure of the token sale.
A token which has a specific function that is only available to token holders is more likely to be purchased in order to access that function and less likely to be purchased with an expectation of profit.
A properly designed token sale doesn’t promise ‘investment returns’, ‘dividends’ or ‘profits’. Instead, it focuses on selling a digital asset that will have a clear use case in a decentralised application, as a means of both incentivising development and solving the chicken-and-egg problem for the network. A properly designed token actually serves a purpose: it is required in order to participate in the network, rather than just being a funding mechanism.”
On most occasions, the investor becomes the consumer of the service being offered by the company raising funds through an ICO, which allows investors to buy coins at a discount, though valuation will ultimately be dictated by supply and demand once released to market.
What to look out for to avoid scams or poor ICO opportunities
- Unproven Management Team
- Business Plan not clear as to the market problems or business challenges the proposition overcomes
- No Proof of Concept available
- Badly structured ICO where investor terms are not adequately explained
- Poor PR Planning (timing)
- Due diligence on management reveals links to previous scams
- Sounds too good to be true
What you do want to see in an ICO?
Clear answers to the following questions:
- What will be the initial value of the coin, the starting point and how will this be worked out?
- How many coins are going to be issued? How they are going to be distributed?
- How investors interact with your proposition, get access and be kept informed?
- What currencies will be accepted as payment for Coins, both crypto and fiat
- What level of KYC if any will be done?
- Experienced management team and advisors
- Good legal representation
As Eitan Jankelewitz explained in an interview with Giftcoin, you can tell a whitepaper that is more likely to be legitimate and has had a legal team look over it because it uses much more measured language and doesn’t include outlandish claims and too good to be true statements.
Final word of warning around ICOs
Even if you have picked a legitimate ICO that you want to invest in, legitimate websites and social media accounts are being hacked and $’000,000’s being stolen. So make sure you double check the wallet address of the ICO. Often you can connect with the team through a secure channel like Telegram where you can be kept up to date with legitimate announcements. But buyer beware, hackers are everywhere, and many people have fallen for a Slack Bot hack to hand over their funds to the wrong wallet.