It can feel like Initial Coin Offerings (ICO) are sprouting all over the place, with news every other day that yet another ICO is being launched. Though a relatively new phenomenon, the cumulative value of ICOs has already reached USD $2.5 billion.
So, what is an ICO really and is it a gold rush that the hype seems to make them out to be?
What Exactly Is An ICO?
ICOs are a spin on Initial Public Offerings (IPO) with a cryptocurrency twist, hence the “coin”. It is a way for startups or companies to raise capital, usually in dollars, because that’s what they need for the business to run, but possibly in other cryptocurrencies as well.
Rather than sell shares in the company or business (like in the case of an IPO), investors in an ICO receive a virtual token issued by the company, which could represent partial ownership in a company or used to redeem products or services offered by that company in future.
Think of it like paying for a limited-edition country club membership, before it gets built. Investors buy into it because they really want to use the service offered in future, or believe there will be a lot of other people who want to use it, and they will be able to sell it at a higher price.
ICOs Versus Traditional Fundraising
Unlike raising an investment round, ICOs do not necessarily require giving up any part of the company. In fact, the majority of ICOs are done by startups who have no track record and sometimes no working product. In the past, their fundraising options at this stage would be really limited, which explains why ICOs are so appealing for them.
This low bar for anyone to issue an ICO should be cause for concern for potential investors.
Aside from money, venture capitalists bring strategic benefits to the table, including the networks, mentorship and prestige. If this business is so viable and founding team so amazing, why has traditional venture capitalists or angel investors passed on investing?
The irony is that as form of crowdfunding, an ICO’s success is dependent on generating interesting and awareness of what the business is going to do. This might be fine when you’re making a novelty product on Kickstarter, but by holding an ICO and telling everyone what you plan to do, a competitor with deep pockets and expertise could beat your company to market.
Are ICOs Regulated?
For the government’s stand, you can read Minister for Finance, Tharman Shanmugaratnam’s answer to a question in Parliament regarding cryptocurrencies and ICOs on 2 October 2017.
In essence, rather than create new rules for cryptocurrencies and ICOs, the Monetary Authority of Singapore will apply existing regulations when these digital activities have the characteristics of something that is regulated.
So, if tokens issued in an ICO are structured in the form of securities, then it must adhere to existing securities laws. Requirements like needing to register a prospectus, obtain intermediary or exchange operator licenses will then be enforced. This only applies only to ICOs structured from Singapore. ICOs not launched locally do not enjoy these consumer protections.
As mentioned earlier, the standards for launching an ICO is really low. We have all read of horror stories in which even wildly successful Kickstarter projects that raised millions of dollars fail to deliver their promised products, due to inexperience, bad luck, or even corruption. There is little oversight around the world to hold start-ups accountable for successfully delivering their project and how they handle the money they raised.
As With All Investments, Do Due Diligence
Before investing, do your due diligence and ask critical questions. Don’t let your decisions be clouded by the FOMO (Fear of Missing Out).
You should assess the market potential and expertise of the team, as you would any other investment. However, here are some ICO-specific aspects you should also consider.
Legal Status: What is the corporate structure of the company? What rights do you have as a ICO investor? Are there conflicts of interests or security risks from key members of the team?
Coin Supply: Is the digital token supply fixed? How many tokens will be issued? This will affect tradability and your ability to sell off your token when you want to.
Security: Security is the foundation of any digital token. What is the strength of the blockchain protocol and digital token encryption used?
Digital tokens in themselves are highly volatile and risky investments. Add the fact that ICOs lack the rigorous requirements for disclosure of traditional fundraising makes it tough for investors to assess the viability of the project. Proceed with caution.