ICO: 2018 boom or bust?

However, this volatility does not seem to have dampened the enthusiasm for investment. For example, the digital currency hedge fund BlockTower Capital, has already raised $140 million despite only being launched in August.

So, will 2018 be the year the ICO bubble bursts or the year they mature to become a mainstay of the financial world? How this plays out, will dictate the future of this latest trend in alternative finance.

Bitcoin is the best-known cryptocurrency, but with the increase in proposed ICOs and the excitement around other emerging digital currencies, 2018 looks set to continue to attract attention – but what questions should we be asking?

Is ICO regulation good or bad? ICOs are not regulated by the FCA and many are based overseas. In addition, instead of an approved offering document, ICOs only provide an unregulated ‘white paper’.

Due to its nature, an ICO white paper can easily be a piece of overblown marketing cut and paste, unbalanced, incomplete and misleading. A sophisticated technical understanding is needed by investors to fully understand the tokens’ characteristics and risks.  However, it is undeniable that this lack of regulation has been the catalyst for ICOs’ increasing popularity.

We all know that the financial markets need to be regulated in some form – this is not up for debate – but we also need to be objective about the long term impact of regulation particularly for smaller cap and start-ups. The Sarbanes-Oxley Act, signed in 2002, is blamed for reducing the number of IPOs in the U.S. making it prohibitively expensive for many smaller companies to get listed (between 1996 and 2016, the number of investable U.S. companies was cut in half, falling from 7,322 to 3,671).

In the UK we have a seen a tightening of the AIM rules (and concomitant costs) for London’s junior market and a resulting growth in alternative funding structures reflecting a need to find new and innovative ways of raising finance when the traditional avenues are ‘closed’.  It is very clear that ICOs allow businesses to do this. The lack of regulation means that the costs can remain low whilst opening each of those companies up to a wider international audience of investors. However, the risk for companies and investors remains high.

What is the value of an ICO Token? In most cases the issuer will address this in the whitepaper on their website. But there are three typical applications for these tokens:

1. Currency Tokens – or Cryptocurrencies, the value of which may be extremely volatile and vulnerable to dramatic changes.
2. Utility Tokens – allowing the holder to trade the token for some product or service.
3. Investment Tokens – allowing the holder an economic interest in some underlying investment or asset.

The value, of course, lies in the underlying service or asset and it’s here where investors are largely left to fend for themselves.

2017 saw cryptocurrencies gain momentum, most notably Bitcoin and Ethereum and it’s a fascinating time for an asset class that is less than a decade old. In that time (as of January 2018) bitcoin reached an astonishing market cap of $257 billion. Amazingly, that’s more than two and a half times more than Goldman Sachs’ market cap of $95 billion.

What is far from clear is whether these figures reflect the underlying value of the assets – it is hard to believe that this is the case.

How are investors protected? In short, they are not. ICOs are unique because they can crowdfund their fundraising campaigns with little or no regulatory oversight, and without the need for an MVP (minimum viable product), client base, or any semblance of financial statements or proof of an actual company existing.

As an investor in ICO Tokens, you are extremely unlikely to have access to UK regulatory protections like the Financial Services Compensation Scheme or the Financial Ombudsman Service. In addition, you need to be aware of the risks due to the lack of protection. For example, some issuers might not have the intention to use the funds raised in the way set out when the project was marketed.

What does 2018 hold?

Every investor, institutional or independent, knows that there is an element of risk to any investment. Companies know this too and will use it as way of attracting those investors. The same principles apply to ICOs. In 2018 we expect investment into ICOs to increasingly form part of a broad investment portfolio.

In addition, despite the current lack of regulation we expect to see more institutional investors dipping their toe into the ICO market. This will help to self-regulate the industry as issuers raise their game to attract investment and they scrutinize each of their investments in more detail.  The explosion of interest in ICOs has put a brighter spotlight on the legal and regulatory risks and, as both investors and issuers become more aware, issuers are being forced to be more transparent, self-regulating and communicate better with their investors.

Undoubtedly ICOs will continue to flourish in 2018 and whilst governments continue to play catch-up, ICOs free of the mechanics of regulation will continue to operate and evolve in the status quo – but don’t underestimate the power of self-regulation as this exciting market matures.

For more information on the risks, rewards and potential implications surrounding ICOs and what the future could hold for those looking to raise finance, read our latest article by corporate partner Kieran Stone.