We’ve all seen it before. Maybe it was briefly mentioned in an online article, or even featured in a Paris Hilton tweet. Either way, if you’ve stumbled upon the acronym ICO and scratched your head in confusion, this article is for you.
An ICO is otherwise known as an Initial Coin Offering. Startups use it to raise funds for their businesses. In said campaign, organisers will sell some of their underlying tokens to investors for legal tender or Bitcoin (BTC).
How it works
When a firm wants to kick-start an ICO campaign, they will first list down several elements in a plan, usually in the form of a whitepaper. These include:
- the nature of the project
- what the project needs to succeed
- how much money the organisers require
- how many ICO tokens the organisers will create
- types of currencies the project will accept from investors, and
- how long the ICO campaign will last
After which, one of two things can happen. First, if the amount raised does not meet the project’s requirements, it will be returned to the early adopters; in doing so, the ICO campaign will be deemed unsuccessful. Second, if the amount raised meets the project’s expectations, said funds will be used to complete and/or expand the campaign.
Why is it appealing?
Generally, ICOs are easy to structure, especially more so now with the introduction of standards like the ERC20 Token Standard. ICOs are also seen by some as an innovative alternative from the traditional and rigorous systems imposed by banks or venture capitalists.
One such success story is the Ethereum, from we got the ERC20. The blockchain-based ‘smart contracts’ application sold Ethers (ETH) at USD0.40 each in its ICO token sale, raising USD18 million in the initial stages of its crowdsale.
And when the project went live in 2015, the value of ETH skyrocketed and reached an impressive USD14 in cryptocurrency exchanges less than a year later (3500 per cent return from the original price of USD0.40). Currently, Ethereum has a market capitalization of USD844 billion (as at Feb 24, 2018).
Additionally, other tokens such as Ripple (XRP) did well last year and even outperformed cryptocurrency behemoth Bitcoin. In fact, the former was crowned the best-performing currency in 2017 and boasted a 36,000 per cent return. Comparatively, the latter did not fare as well and was placed at the 14th position.
Word of caution
However, as ICOs are unregulated, some do view the mechanism as a way for firms to raise an unjustified amount of money for a dodgy cause.
In fact, Andy Bromberg, CEO of crypto service firm Coin List, is one such industry leader who feels that some ICOs are just too good to be true.
“The vast majority of ICOs are scams or people seeking to raise money easily,” Bromberg told CNBC.
Case in point, the U.S. Securities and Exchange Commission (SEC) – a core organisation that enforces and regulates its nation’s stock exchange – recently halted several allegedly fraudulent ICO campaigns.
These include Arise Bank’s AriseCoin, whose campaign claimed to be the world’s first decentralized bank; and PlexCoin, an ICO offered by PlexCorp and its owner, Quebec securities law violator Dominic Lacroix who promised PlexCoin investors a 13-fold profit within a month.
Therefore, as some ICO proposals can turn out to be scams, it is important to conduct some research and be on the watch for red flags.
These include, and are not limited to, campaigns that curiously do not require blockchain or some form of native token; insufficient information on said campaign’s website; and/or when the team behind the ICO project hails from dubious backgrounds (cue the Centra saga).
Legality of ICOs
While stakeholders may wonder whether or not ICOs are legal, the short answer is an unfortunate “maybe”. As most ICOs are unregulated, the legal aspects surrounding them are equally murky.
However, recent announcements by various authorities may give some clues. In the United States, the SEC deemed that virtual token such as DAO are classified as securities and can be subjected to federal laws.
However, other virtual coins such as Ether were defined as a type of currency.
That being said, the distinction between securities and currencies seem to revolve around utility. And to determine that, US lawmakers rely on the Howey Test, which helps to define investment contracts.
Under the Howey Test, an investment contract is “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”
In other words, if a token is solely sold as an investment and that there is an expectation of profit on the part of the investor, then a token is almost always seen as a security; on the other hand, tokens that serve some other purpose, will not.
For example, tokens such as Ether stems from Ethereum, a platform that facilitates peer-to-peer ‘smart’ contracts.
It, therefore, isn’t only used to drive profits- rather, Ether is also a means to an end for Ethereum’s operations, allowing its developers to use the platform to build and/or run applications.
That being said, if the above teases your brain a little too much, try understanding the difference through a nifty analogy by cryptocurrency expert Arnold Spencer.
According to Spencer, “If you buy an interest in a golf course to make money from the business, it is a financial investment and therefore a security. If you join a golf club to play golf, it is not a financial investment and not a security.”
Fate of ICOs in China and Singapore
Following this, while the SEC only extended its regulatory arm to select tokens, other countries have been less kind. In September 2017, the People’s Bank of China completely banned ICOs, labelling it as a severe disruptor of economic stability.
Here in Singapore, the Monetary Authority of Singapore (MAS) was quick to roll out a statement detailing new regulations that helped classified ICOs.
According to the central bank, “Offers or issues of digital tokens may be regulated by MAS if the digital tokens are capital markets products under the SFA. Capital markets products include any securities, futures contracts and contracts or arrangements for purposes of leveraged foreign exchange trading.”
It also included a reminder that even in the event where a token doesn’t fall under the new regulations, said token can still be subjected to other regulations that penalize “money laundering and terrorism financing”.
However, Singapore’s approach to ICOs is notably less cynical than some of its Asian counterparts (i.e. China). Despite some regulation changes, MAS Managing Director Ravi Menon expressed optimism on ‘good’ ICOs.
“[MAS is ] very keen to find an ICO that focuses on the technology of the blockchain . . . to test it… to see how it works in practice as a more cost-effective way of raising funds, and provided there isn’t a securities relationship,” he said.
In a nutshell
There is little doubt that for the most part, ICOs encompass new territories. And while many aspects remain uncertain and unregulated, supporters of the cause will tell you that the fundraising mechanism has massive potential.
On that note, it is too, highly likely that investors and entrepreneurs will continue to experiment and push the legal boundaries of ICOs. After which, all that’s left for investors to do is to practise a little prudence, a smidge of caveat emptor, and a touch of patience; and if the stars align, these ingredients might just come together and reward believers of the ICOs with a sizable piece of pay dirt.
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