Initial Coin Offerings provide seed capital, but are very risky

  • By Tom Cleveland

  • October 5, 2018
  • 11:18 pm BST

Imagine that you are a young entrepreneur with a great idea for a new product. You have a prototype and customers willing to pay your price. You present your business plan to venture capitalists, but no one gives you the time of day. You hear of a new method, Initial Coin Offerings (ICOs), and find an expert in the field. You modify your plans to accommodate the needs of this new genre, and Voila, you raise $5 million. Yes, it may be a little more complicated than this storyline, but you get the picture. ICOs have filled a market need, and investors have flocked to this new funding medium in droves.

We could stop there, and the picture might remain bright, but, unfortunately, there is a dark side to this innovative sector of the cryptocurrency world. There is an incredibly high failure rate for ICOs in the market to date. Consider this quote from a security professional website: “An ICO advisory company, the Satis Group, has revealed some pretty eye-opening statistics. 80 percent of all ICOs are scams.” Supporters are quick to respond that there is a 90% casualty rate for all startups in general. Some may be due to fraud, but most are due to poor business plans, management, or both.

It is not that easy, however, to ignore the preponderance of fraud storylines regarding ICOs that appear weekly in the financial press. The criminal element of our society has focused on this medium, as a marvelous way to apply “Ponzi”, “pump-and-dump”, and “take-the-money-and-run” schemes across the ICO landscape. As with startups in any arena, a potential investor must do more than the ordinary due diligence to protect themselves from a complete loss of their investment, even when the failure rate is high.

To begin with, you need to understand what an ICO is and is not: “An IPO, or initial public offering, offers a chance to make big money quickly by getting in on the ground floor of the next new Google or Facebook. An ICO, or initial coin offering, offers a chance to make big money quickly by getting in on the next new money.“ There is one big difference between an IPO and an ICO. With an ICO, you do not own shares in the enterprise. You are given coins or tokens that you hope will gain traction and appreciate in a value in the marketplace. The entrepreneur also did not have to sell a portion of his business to outsiders, nor did he have to comply with extensive disclosure regulations.

Are these newly minted coins a currency or a security under local law? Regulators are also asking this question, as well. In December 2017, SEC Chairman Jay Clayton shook the industry by saying that his staff had determined that, “A token constituted an investment contract and therefore was a security under our federal securities laws. Specifically, we concluded that the token offering represented an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.” Regulators across the globe are following his lead. Regulation is coming.

The SEC’s call to arms may have slowed the momentum of the ICO industry, but by most estimates, there have been well over 1,000 of these new coin systems generated to date. How do you invest in this genre? Find a broker or exchange that you trust and review a complete list to see which ones are really garnering attention, but be sure to follow these five simple steps:

  • Research the Team;
  • Does the Value Proposition make sense;
  • How is the money to be used;
  • Ignore the hype – Look for traction; and
  • Do your legal homework.

Will regulators stop ICOs in their tracks? Are ICOs the latest investment fad? Stay tuned!