ICOs: Who, What, When, Where and Why?

The first question is usually satisfied by ‘normal’ cash, although other cryptocurrencies may be accepted (although usually these will then be exchanged for cash).

The more important question is what can the token owner do with it? In most cases, this is answered by the “white paper” posted on the issuer’s website. Typically there are three applications for tokens:

• currency tokens,” which are cryptocurrencies (purchasers are generally hoping for appreciation, as occurred with bitcoin),
• “utility tokens,” which entitle the holders to trade the tokens for some product or service, and
• “investment tokens,” which offer the holder an economic interest in some underlying investment, such as a project or asset.

Unlike a securities offer, which is subject to wide ranging regulation and where the issuer will be the subject of extensive due diligence, and which will be backed by a verified offer document, the legal state of ICO is mostly undefined.

Ideally, the token is sold not as a financial asset but as a digital good like many other things. However, governments are becoming more cognisant of ICOs and steps to regulate them are underway through tax and securities laws. The spectacular implosion of DAO in early 2017 (where the ICO was found to be a securities offer) did a good job in drawing the regulators’ attention.

Some issuers have raised millions of dollars without considering any form of legal issue, and they may be in for a nasty surprise, particularly when it comes to the taxation of any ICO. This could also bear some financial and legal risks for investors.

In the UK, the FCA has already taken steps to alert investors to potential risks noting that:

• Unregulated space: Most ICOs are not regulated by the FCA and many are based overseas.
• No investor protection: You are extremely unlikely to have access to UK regulatory protections like the Financial Services Compensation Scheme or the Financial Ombudsman Service.
• Price volatility: Like cryptocurrencies in general, the value of a token may be extremely volatile – vulnerable to dramatic changes.
• Potential for fraud: Some issuers might not have the intention to use the funds raised in the way set out when the project was marketed.
• Inadequate documentation: Instead of a regulated prospectus, ICOs usually only provide a ‘white paper’. An ICO white paper might be unbalanced, incomplete or misleading. A sophisticated technical understanding is needed to fully understand the tokens’ characteristics and risks.
• Early stage projects: Typically ICO projects are in a very early stage of development and their business models are experimental. There is a good chance of losing your whole stake.

Initial coin offerings undoubtedly currently exist in a bubble where the usual constraints of fundraising seem to have (temporarily) disappeared.   Some companies have found success with ICOs even after failed crowdfunding campaigns. An online art gallery known as Maecenas, which failed to raise £400,000 through crowdfunding this year, raised $15 million a few months later through an ICO, the Financial Times has reported.

Many ICOs have been a lucky choice for investors. ETH, for example, has made a 10,000% profit.  Augur token were sold for around 0,005 Bitcoins each and are now traded at 0,01. The gain in value of 100 to 500 percent in Bitcoin is common for a successful ICO.

On the other side, many ICOs end with losses. In addition to DAO, cryptocurrencies like Lisk, IOTA-token or Omni did not hold the value on launch.

Often ICOs are used by scammers: build a glossy website, cut and paste some marketing words, promise the greatest project/cryptocurrency ever, and be happy if you receive just 50 or 100 Bitcoin.  Outside of the high profile offers, many ‘successful’ ICOs have collected funds and delivered nothing at all.

Certainly, some platforms are looking to legitimise the space, with Indigogo, which helped legitimise and popularise crowdfunding starting a new service on Tuesday to vet ICOs. The service will help sell them to small and large investors seeking to “bring a brand of trust to the entire industry, which we think will bring ICOs to the mainstream,” and smaller crowdfunding platforms like Republic and AngelList have started their own efforts to legitimise coin offerings.

Undoubtedly ICOs currently offer endless possibilities for those seeking to raise money quickly and effectively, however the space is highly unregulated, not widely understood and subject to a myriad of legal risks.

At Memery Crystal we are working to bring our capital markets expertise to support those seeking to undertake ICOs, to help guard against potential legal, regulatory and tax liabilities and also ensure that offerors can confidently market their ICO to investors as a legitimate investment.