An Initial Coin Offering (ICO) is a new method of raising capital for blockchain-based technology startups or projects. A new cryptocurrency is created and these ‘digital tokens’ are sold to interested investors, as well as speculators that are gambling on a significant price increase. In theory, it is an amazing method to quickly fund a startup. When undertaken properly with the guidance of a professional business mentor that has expertise in the cryptocurrency/blockchain space, or by a trusted NextGen Venture Capital organization with the same expertise, the chance of success will improve remarkably. These ICO projects need to be analyzed and vetted by an unbiased professional, before you can trust any of the claims made. Even with that, they still carry a much higher rate of risk than equities, and should only make up a small percentage of your holdings. As the ICO market stands right now, you are gambling on an extremely high risk speculative investment, with a good chance of losing all your investment. Before investing, you need to be aware of the following:
1. ICO tokens have no legal equity in the business unless it has been registered as a security. Unlike stock which represents a small share in a company, unregistered ICO tokens have no legal stake in the business, and have no claims to future profit.
2. The ICO market is global. The funds you invest could travel to another country in seconds.
3. There is a real risk of fraud. The opportunity to raise millions in minutes with essentially no strings attached is impossible for criminals to resist. The ICO issuer may have released misleading information on the token, leading investors to believe it is a necessary piece of the final project, or that it will increase in value with the project when they know it won’t. Elaborate plans with impressive websites and whitepapers can hook investors into falling for any number of well orchestrated scams.
4. The token is most likely a security. Unless the token can pass the Howey Test, it will be classified as a security and subject to the same regulation (including registration) with the SEC. There is an exemption from registration if certain criteria are met, such as selling to accredited investors only (those having a net worth over one million dollars).
“Investors should understand that to date no initial coin offerings have been registered with the SEC.”
– SEC Chairman Jay Clayton, December 11, 2017 –
5. There is a good chance the ICO is operating illegally. Many ICOs have launched in other countries in an attempt to avoid regulation. Because of the global nature of bitcoin, other cryptocurrencies, and ICOs, it is difficult to keep American citizens from purchasing ICO tokens. As soon as a token is sold to an American citizen, it becomes subject to the United States Security and Exchange Commission’s (SEC) regulations. Since most tokens have been deemed to be profit motivated securities, and the SEC has stated that “to date no initial coin offerings have been registered with the SEC”, any ‘token-based security’ that makes contact with an American is probably operating illegally. This adds the very real risk of a lot of ICOs being forced to cease operations.
6. There may be no value in the token. Unless the token is critically essential in the operation of the product or business, it is likely worthless.
7. Huge sums of money (in some cases well over $100 million) are going straight to developers that may not even have a working product. This money is to be spent on development only, and in no way automatically represents the value of the token. Yet these ‘valueless’ tokens end up on CoinMarketCap (usually within a week) with a marketcap often even higher than the amount given to the developers. These unwarranted high marketcaps can lead uninformed investors to believe that a particular ICO token is worth a lot more than it actually is. The high price paid for most tokens is 100% speculation that a greater fool will pay more, and it is very risky.
8. There are no guarantees (of anything). There is no guarantee the project will succeed and even less that the token will benefit. Technology is evolving so fast, the groundbreaking idea the ICO is based on, could be obsolete in 6 months. There is no guarantee of profit associated with the token, or that it will retain any value at all. Because of the global nature of this industry, there is very little, if anything, in the way of investor protection. Millions of dollars may be going to a ‘promise the moon and deliver nothing’ developer, that doesn’t have the foresight or business skills to see this through.
9. Anyone can come up with a whitepaper. What was meant to be an in-depth analysis of how the project/token will work, features, technical aspects, benefits, how funds are allocated, etc, now needs to be looked at with good dose of scepticism. Need an ICO whitepaper? It’s easy – hire someone to write it for under $100 on Fiverr.
10. Aggressive marketing and paid celebrity endorsements create confusion. A single person getting paid to spam social media from dozens of different social media accounts, can make a project appear much more popular that it actually is. Magnify that activity by 50 or 100 paid spammers, and throw in a paid endorsement from a public figure or celebrity, and the project appears on the surface to be a golden goose.
“I also caution market participants against promoting or touting the offer and sale of coins without first determining whether the securities laws apply to those actions. Selling securities generally requires a license, and experience shows that excessive touting in thinly traded and volatile markets can be an indicator of “scalping,” “pump and dump” and other manipulations and frauds. Similarly, I also caution those who operate systems and platforms that effect or facilitate transactions in these products that they may be operating unregistered exchanges or broker-dealers that are in violation of the Securities Exchange Act of 1934.”
“It is especially troubling when the promoters of these offerings emphasize the secondary market trading potential of these tokens. Prospective purchasers are being sold on the potential for tokens to increase in value – with the ability to lock in those increases by reselling the tokens on a secondary market – or to otherwise profit from the tokens based on the efforts of others. These are key hallmarks of a security and a securities offering.”
– SEC Chairman Jay Clayton, December 11, 2017 –
The result of a Supreme Court ruling in the case of the SEC v. W. J. Howey Co., (1946), set a precedent as to what constitutes a security. Any “investment contract” that meets the following criteria (the Howey Test) is deemed to be a security:
- An investment of money;
- with an expectation of profits arising from;
- a common enterprise;
- depending solely on the efforts of a promoter or third party.